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Retirement Provision Challenges

November 23, 2021

Pension, provident and retirement annuity funds are some of the most tax-efficient ways to save for your retirement. Contributions up to 27.5% of taxable salary are tax-deductible, investment income is not taxed, and currently, the first R500 000 of a lump sum withdrawal on Retirement, death and retrenchment is tax-free.

The commonly accepted advice is that to achieve a retirement outcome of a 75% income replacement ratio, a person should contribute 15% to retirement and achieve a net investment return of 5% to 6% above inflation over their entire working career of approximately forty years.

The key here is “over their entire working career”. The reality is that many people change jobs and do not preserve their benefit on exit, leading to a reduced retirement outcome.

If a fund member has only twenty years fund membership before they retire, the pension fund will not likely provide a 75% income replacement ratio, as it only covers twenty years of a forty-year career. It is not the responsibility of the employer or pension fund to make up for this shortfall.

The second challenge is the investment portfolio that the fund member is in. Suppose fund members have an option to select their investment portfolio from a range of options, in that case, they can choose a portfolio or combination of portfolios, which best suits their needs and risk appetite. Where a person selects too conservative an option, this will also result in a reduced outcome.

If the pension fund is the member’s sole income stream at retirement, this becomes even more important, and members need to supplement their retirement savings.
Many fund members contribute additional voluntary monthly contribution amounts to improve their retirement outcome. This is very tax-efficient for them as these additional contributions are tax-deductible within the total of 27.5% allowed by SARS.

There is only one person that will determine your retirement outcome. That person is you.

Retirement V Risk Provision

A compounding factor is to balance the need between retirement and risk-benefit provision. This has become very relevant in the new normal of Covid 19 and the Coronavirus pandemic and the impact that it is having on the costs of risk benefits. Whether these costs will escalate remains to be seen, while the majority of the population remains unvaccinated.

If you are a member of an inclusively costed fund, the retirement component changes if the administration and the risk-benefit costs increase. The retirement risk is thus on the fund members.

Some funds offer members a choice of the level of death benefits, such as 1x, 2x or 3x annual salary. This allows fund members to select the cover that suits their needs. In an inclusively costed fund, a lower death benefit results in a higher retirement component.

Any additional risk benefits added to the fund will reduce the retirement funding component unless there is an increase in the employer and/or member contribution to compensate for this.

There is a fixed retirement contribution in an exclusively costed fund, and the employer pays the administration and risk-benefit costs over and above this. If these increase, the employer pays the higher amount, and it does not affect the retirement savings component. Thus, the structure and provision of risk benefits depend on affordability and what the employer is prepared to pay towards the fund.

Risk Benefits Provision: Individual Needs V Group Risk Benefits

So, what additional risk benefits should a company provide via its pension fund for its employees? This is subjective, depending on who is being asked.

A benefit becoming more widely provided for by some pension funds is critical illness cover. Insurers have different terminologies to refer to this benefit, and it is referred to as critical illness/trauma / dread disease benefits. This provides cover in the event that a member is diagnosed with a critical illness, as defined in the policy. It pays out a lump sum benefit as a multiple of the member’s salary and can be in addition to, or an accelerated payment of part of the existing death benefit.

Members and employers are questioning whether a benefit such as this should be provided via a pension fund or if this should be a member choice benefit in their personal capacity.

In conclusion, there is a delicate balance as to what is a realistic benefit structure and retirement outcome as to what is affordable. Employers should regularly assess the benefit structure to see if the benefits offered are relevant and cost-effective. Fund members need to critically assess their benefits and needs and make additional provision where necessary.

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