By Martin Hesse
Two actuarial models show that the government’s proposal to have a “two-bucket” system for retirement savings is likely to have positive outcomes for members overall, because at least the bulk of their savings will accumulate (and compound) until retirement.
National Treasury’s proposal essentially splits your retirement savings into two “buckets”: a larger bucket must be retained until retirement, while a smaller one may be accessed for short term-emergencies. Many details of the proposed system are still to be ironed out, but the split is likely to be a quarter to one-third of savings in the short-term bucket, with the remainder in the long-term bucket.
At present, people can access all their retirement savings each time they change jobs, resulting in extremely low preservation rates.
Two studies have shown that, if employees preserved at least 60 - 70% of their savings each time they changed jobs (as they would be compelled to do under the two-bucket system), overall outcomes for South African retirees will be dramatically improved, because of the power of compounding.
Study 1: Actuarial Society of SA
Natasha Huggett-Henchie, a member of the Actuarial Society of SA (Assa) Retirement Matters Committee and principal consulting actuary at NMG Consultants and Actuaries, says a recent analysis of fund administrator data shows that more than 80% of retirement fund members cash in their retirement benefits when changing jobs rather than preserving their savings.
Huggett-Henchie says people take their benefits when changing jobs despite the punitive tax levied on the withdrawal of these benefits. To make matters worse, cashing in retirement benefits also reduces the tax-free lump sum normally available at retirement.
She says a well-designed, actuarially sound two-bucket system will therefore solve two problems for retirement fund members: they will have access to emergency funding when needed and their savings will benefit from compound growth, leaving them with a substantially bigger nest egg on retirement.
Compounding is enabled when the returns earned on your retirement savings together with any capital growth is left to attract further gains. The effect of earning income on income and further growth on capital gains is referred to as compounding.
To illustrate this, the members of the Retirement Matters Committee modelled the following scenarios, based on a one-third/two-thirds split between the two buckets:
Scenario 1: A retirement fund member who joined a fund at age 20 changes jobs every seven years and withdraws (and spends) the full benefit every time. However, once the member reaches age 50 they focus on saving for their retirement and start preserving their benefits until age 65.
Scenario 2: The two-bucket system has been implemented and the member, who joined a retirement fund at age 20, has access to one third of their benefit in the access pot. The member withdraws the full available amount in the access pot every five years until they reach age 65.
Scenario 1 result: The member in the first scenario is likely to retire with a net replacement ratio or NRR (the ratio of the member’s pension expressed as a percentage of their pre-retirement salary) of about 15%, which means that they will have to survive with a monthly pension of 15% of what they earned in the year before they retired. Huggett-Henchie points out that if this member further reduced their retirement benefit by taking another cash portion at retirement, their NRR drops to 10%. Therefore, someone who was earning R20 000 a month before retirement would now have to survive on R3 000 a month, reducing to R2 000 if they take a lump sum at retirement.
Scenario 2 result: By contrast, the member in the second scenario will retire with a NRR of 36% on their full benefit, or 32% if the cash portion is accessed. In other words, their monthly income is more than three times higher than if they had been allowed to follow the path of the person in the first scenario. Huggett-Henchie says that despite withdrawing their full one-third over their working years up to retirement, the remaining savings were able to benefit from compounding. Someone earning R20 000 a month before retirement would therefore have a monthly pension of R7 200, reducing to R6 400 if they take a lump sum.
Huggett-Henchie stresses that by far the best outcome at retirement is achieved by retirement fund members who never access their retirement savings, thereby enabling the power of compounding to deliver the best possible outcome.
She adds that for this reason, all retirement fund members should be provided with meaningful information about the impact of accessing their emergency bucket on their long-term retirement aspirations.
Study 2: Alexander Forbes Member Insights
As part of the annual Alexander Forbes Member Insights study, the company’s actuarial team also calculated to what extent the two-bucket system would improve retirement outcomes for South Africans. They used a 30%/70% split between the short-term and long-term buckets, based on a new member taking the 30% cash each time he/she changed jobs.
They found that, for every R100 contributed, a retiring member can expect to have accumulated after 40 years:
- Just under R600 under the current system.
- A minimum of R1 200 under the two-bucket system.
- An expected R1 400 under the two-bucket system.
- R1 800 if all savings were fully preserved.
John Anderson, executive of investments, products and enablement at Alexander Forbes says: “We can see quite a nice improvement in outcomes: people saving from two to two-and-a-half times more over a 35 to 40-year period, even if they were to take their entire short-term bucket. It’s the savings done at an early age that contribute the most to retirement. If people were to contribute fully over the period, they would definitely get to the NRR of 75% as targeted by the industry.”
Rules regarding access
While Treasury is still working out the details of how the two-bucket system will work, Assa’s Retirement Matters Committee has made a number of recommendations, especially regarding the rules and restrictions regulating the accessibility of the emergency portion.
Huggett-Henchie says the committee feels strongly that there should be no need-based rules, as this is open to abuse and onerous and costly to administer. “Our modelling indicates that compulsory two-thirds preservation actually improves outcomes at retirement, and members will find a way to borrow against or spend their one-third anyway. Access to the one third should therefore be available to all members regardless of need.”
She says the actuarial modelling indicates that the frequency of withdrawals from the short-term pot does not affect the ultimate NRR at retirement. “If you withdraw more frequently you just get a smaller cash amount each time as it doesn’t have time to build up, but the preservation part remains unchanged.”
She says there will, however, be an administrative burden to pay the cash amount and therefore some restrictions would be needed to reduce frequency.