Can you afford to retire at 65?
Across the world, governments and financial industries have been grappling with the challenges of providing a suitable retirement system for citizens. There have been renewed efforts to resolve problems such as longevity risks and the massive administrative burden of managing retirement systems.
South Africa has its unique challenges and is also currently reviewing its retirement system. As part of this review process, five technical discussion papers were issued by National Treasury for comments. This process resulted in the following policy proposals issued by Treasury:
- Taxation of retirement funds: Employer contributions to retirement funds to become a fringe benefit in the hands of the employee.
- Governance: Fit and proper requirements for all trustees.
- Preservation: All retirement funds need to identify a preservation fund and transfer member balances to this fund when members withdraw from the fund. Withdrawal limits to apply.
- Annuitisation: Harmonisation of the annuitisation requirements of provident and pension funds. Default annuities on retirement including living annuities.
- Non-retirement savings: Tax-preferred savings and investments schemes.
From this, one can see that a number of Treasury’s proposals are centred on increasing the savings of individuals, either through preservation or by additional non-retirement savings. Retirement vehicles and post-retirement annuity type products are being reviewed in terms of costs, as this has an impact on savings, especially when retirees start withdrawing from their savings.
Policy proposals around governance and taxation seek to address structural issues around administrating the retirement process. Many of these proposals deal with the legacy of transitioning from Defined Benefit (DB) pension schemes to the current Defined Contribution (DC) schemes. In fact, most of the current reforms directly or indirectly aim to rectify some of the unintended consequences of moving from the old DB schemes to the current DC schemes, specifically the shift of longevity risk from the employer to the individual.
Under DB schemes a pension would be paid until the member passed away whereas under DC schemes a member has a pool of money that needs to last until the unknown date on which he passes away. It is interesting to note that the only substantial active DB scheme remaining is the Government Employees Pension Fund (GEPF) which does not fall under the SA Pension Funds Act and is therefore not affected by the above proposals. The longevity risk in the GEPF is, however, funded by the tax payer in the case of a short fall.
It is clear that Treasury is trying to mitigate longevity risk by focussing on the variables which are in their and to some extent the individual’s control, i.e. increasing savings and preservation rates. A key question is whether one can mitigate longevity risk by improving savings and preservation alone. Is it realistic to assume that an individual can retire after 30 to 40 years of employment and have a sufficient amount saved up to last for 20 to 30 years of retirement? Is it economically viable for such a large portion of society not to contribute to the economy for such long periods?
Challenges facing SA retirees and possible solutions
Globally, retirement ages have been increasing due to demographic changes and aging populations. In many developed countries, the retirement age has been increased to 67 and it is expected to increase to 70 in the foreseeable future.
In South Africa, however, corporate retirement ages have decreased to between 60 and 63 over the past 20 years. This has largely been due to South Africa’s demographics, high unemployement and historical legacies. As retirement age policies are set by employers in labour contracts, and not prescibed by the Pension Funds Act, it is unlikely that corporate retirement ages will increase in South Africa in the foreseeable future. Treasury’s proposals are therefore not able to address the challenge for South African employees of retiring too early.
When can I retire?
The table below shows at what age you will be able to comfortably retire (assuming you need 75% of your final salary to cover expenses) and also prudently assuming below average market returns. The fact is clearly illustrated that a retirement age of 60 presents a challenge. There is simply not enough time to build a nest egg to support increasing life expectancies.
So what can South Africans do to increase the probability of retiring comfortably? The chart below shows the key variables in retirement planning, ranging from those within the individual’s control to those that are not within his control.
There are a number of possible solutions that fall within an individual’s control:
- Start saving sooner. Your contribution term has a significant impact on your eventual retirement savings outcome.
- Increase your monthly pension fund contributions.
- Increase non-retirement savings.
- Make sure your retirement savings are preserved in a preservation fund when changing jobs.
- During retirement, reduce expenses to decrease withdrawal rate from savings.
- Consider a post-retirement career in a company that doesn’t have stringent retirement age policies.
Retiring at the age of 65 is clearly a challenge and in the South African context, retiring at 60 is even more so. As a general rule of thumb, an individual needs to work for an additional four years for every 10 years of additional life expectancy. This means you need to consider and carefully manage the aspects of building a nest egg that are in your control to maximise your probability of retiring comfortably.
Jannie Leach is an investment analyst at Nedgroup Investments