A starting point at retirement

The South African retirement industry has been the focus of a lot of government attention. Issues like high costs and complex products have driven reform in the sector.

Speaking at the launch of the South African Independent Financial Advisor’s Association (SAIFAA) in Cape Town last week, the head of projects at Sanlam Employee Benefits, David Gluckman, said that the fundamental problem is that outcomes for customers are still poor.

“We have a good retirement system in place, but 90% of South Africans are still not retiring with enough money,” he noted. “Treasury is looking to structurally change the retirement system to change that situation.”

One of the most significant proposals that has now made its way into draft regulation is that all retirement funds should offer an annuity solution for members. At the moment, most pension and provident funds only look after a member’s money until they retire. After that, they have to take their capital to get an annuity somewhere else. Default annuities will change that.

Purchasing power

Government’s primary concern with the current model is that while members have some comfort of being looked after by fund trustees as long as they are within the fund, they are largely on their own once they leave. Unless they use a financial advisor, there is no one to guide what they do with their money.

Secondly, there is a recognition that many annuity products can be expensive. And government believes that pension funds can change this because of their scale.

“The aim of the draft default regulations is to increase competitiveness in the market,” explained Gluckman. “They want retirement funds to use their purchasing power to drive down costs, and that should lead to better solutions.”

The responsibility will fall on the trustees to identify suitable solutions and negotiate the best terms for their members.

“The idea is that every retirement fund in the country will be obliged to put in place a default annuity strategy,” said Gluckman. “Default is perhaps a misleading term, as it’s really a trustee-endorsed annuity strategy. It can never be a default because unless the member actually gives an instruction you cannot put that member on any annuity product.”

Uptake

Although this regulation has not yet come into effect, the 2017 Sanlam Benchmark Survey found that 22% of the fund’s covered in their analysis had already put a default strategy in place. A further 8% were planning to do so within 12 months and a further 18% within the next two years. That is just under half of the total.

In other words, many retirement funds are not waiting for the regulation to be passed, but are already acting.

Quite simply, there are two reasons why it makes sense for pension funds to offer an annuity strategy for their members. The first is that it makes the pension fund itself more attractive as members already have a potential post-retirement solution in place, but it also means that the fund retains those members who elect for the default instead of taking their money elsewhere.

“We also surveyed pension fund members and asked them if they would be likely to take a pension from their employers’ retirement fund if it offered one, and 47% said that they would,” Gluckman added. “In some ways that shows that many people have trust in their employers to do the right thing for them, as they are not experts themselves.”

Taking pressure of members

The potential for lower costs is not, however, the only direct benefit to fund members. Currently many retirees feel a lot of pressure when it comes to making a decision about what to do with their retirement capital. They have to act quickly if they want to start drawing an income immediately, and annuity strategies take away that urgency.

“The beauty of an in-fund annuity is that members don’t have to take any final decisions with their money straight away,” said Gluckman. “If the experience is seamless, one month they are making contributions and the next they start to get a pension, but they are not tied into that.”

This gives retirees time to scrutinise all of their options. It is likely that for many of them the default option won’t be the best choice over the long term, but they can use it until they have identified what they really need.

“Defaults are not always going to be the end solution,” Gluckman said. “It will be very few members who stay in there forever. They are likely to switch, either in one go or over time, to other products. But that is the beauty of the option – you are not rushed to make a decision at the point of retirement.”

What this also means is that default annuities have the benefit of giving fund members a benchmark. They provide something against which other options can be easily compared.

That can be extremely useful for South Africans who don’t know what choices are available to them and what their retirement pot is actually worth in terms of a monthly income. A default option would at least give them a starting point.

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