a brave new world of retirement april 2014
CEO message Dear reader Last year the Prudential Insurance Company in the USA put up billboards in that country saying: The first person to live to 150 is alive today. Let s get ready for a longer retirement. It gave rise to one of the most intense online discussions about retirement ever. Many people from all over the world called the message shocking and a huge wake-up call. Although the billboards are part of a marketing campaign their underlying message is abundantly clear: longevity is a reality and it s changing our lives and our plans for our lives forever. That s why it s the focus of our first article in this, the first edition of insight for 2014. Viresh Maharaj provides some scientific insights into our newfound longevity and the implications of this for our retirement. to ensure enough income for members over their entire period of retirement. In this regard Danie van Zyl argues for a new course for DC funds where the focus is on retirement income rather than the accumulation of assets. We cannot talk about income in retirement without mentioning annuities which, for many members, represent a minefield in terms of the decisions required at retirement. Rhoderic Nel gives some thoughtful insights on how to go about choosing the most appropriate annuity. insight is again presented as an interactive PDF and therefore makes a small contribution to further reducing our carbon footprint. I trust you will find it entertaining as well as informative. Kind regards A man who dares to waste one hour of time has not discovered the value of life. Charles Darwin Flowing from that Kobus Hanekom of Simeka Consultants & Actuaries puts forward the case for phased retirement, a crucial consideration if we want to deal effectively with increasing longevity. The purpose of our retirement system is of course Dawie de Villiers CEO Sanlam Employee Benefits 1
living longer 60 is the new 40 People around the world are living for longer than ever before and this has major implications for the retirement industry. Looking at this trend from a macro level, it will affect social and economic policies in both developing and developed countries. When viewed on a micro level, someone who retires will have a very different retirement to the one they spent planning for during their working lives. By Viresh Maharaj, Chief Marketing Actuary: Sanlam Employee Benefits 2
living longer By Viresh Maharaj, Chief Marketing Actuary: Sanlam Employee Benefits 2
phased retirement Phased retirement Is this the next step? The world of work is changing, with more and more people embarking on a second career after retirement and working well into their sixties. We work for longer because We enjoy remaining active. We can t afford to retire in our early sixties. We re living longer than ever before. We re encouraged to take packages and retire much earlier than the usual retirement age. Why is this a problem? Tax laws haven t kept up with this changing world of work and do not allow for such a phased retirement. Individuals are compelled to retire and buy an annuity whether they wish to continue working and need a pension at that stage or not. What can be done about it? We believe some adjustments to these laws are urgently needed to enable taxpayers to postpone their retirement to the day when they actually stop working and can retire more comfortably. By Kobus Hanekom, Head: Strategy, Governance and Compliance at Simeka Consultants & Actuaries 3
phased retirement To retire she needs 1. an appropriately high contribution rate 2. a good investment return 3. a long investment period (probably the most important tool) She must set aside She should set aside 12.5% (net of administration costs and risk premiums) of remuneration. The return she needs She needs a return of CPI plus 5.5% on the investment over a period of 40 years in order to achieve a projected pension of 75% (of final remuneration net of contributions). The magic of compound interest The last five years are critically important in retirement planning as they allow the power of compound interest to work its magic. However, the reality is that as a result of various corporate strategies, late retirement is often not a decision an employee has any control over. The 2013 Sanlam Benchmark Survey results showed that a significant proportion of South Africans are required to retire earlier than 65. FACT Very few South Africans enjoy the benefit of all three components (left) at the appropriate level in their retirement plans. Dilemma for graduates The 35- to 40-year investment term is a problem for many graduates. Many require long periods of study and enter into formal employment with pension benefits only at about age 30. If their chosen career coincides with an early prescribed retirement date of 60 years, the 30-year investment term will yield a very disappointing pension. What s the problem? Our tax laws don t enable a phased retirement, which means retirement funding employment effectively ends at retirement date. What does this mean? Members who embark on a second career and continue to work after retirement in their early sixties are required to buy an annuity at a time when they don t need the money. What do phased retirees need? They need to be allowed to remain in the system and remain invested for a longer term so they can retire more comfortably at a later stage. Where are we now? With the proposed harmonisation of the tax treatment of pension, provident and retirement annuity funds, the National Treasury has moved much closer to a solution for those looking at phased retirement. What do we need? A few more adjustments to our tax laws that will allow an individual to park their pension benefits in a tax-neutral vehicle where they can continue to grow. By Kobus Hanekom, Head: Strategy, Governance and Compliance at Simeka Consultants & Actuaries 3
Employer Responsibility Employers have a vital role to play in the continuing evolution and improvement of Defined Contribution retirement funds, and they can make a critical contribution to resolving our country s retirement savings crisis. Employers that take greater responsibility for the overall financial wellbeing of their workers, including through the design of their retirement funds, reap the rewards of a more stable and happier workforce. National Treasury, 2013 Retirement Reform Proposals By Danie van Zyl, Head: Guaranteed Investments at Sanlam Employee Benefits Investments 4
retirement reform The annuity debate Retirement reform papers are a step in the right direction to guide retirees to make good choices. One of retirement fund members biggest fears when they retire how to make the right choice of annuity at retirement has been addressed by the retirement reform papers published recently by the National Treasury. In the past, most advice provided to retirement fund members focused on building wealth ahead of retirement, while little focus was placed on what to do with a retirement lump sum after retirement. By Rhoderic Nel, Chief Executive Officer: Sanlam Employee Benefits Investments 5
CEO message The following pages are separate from the interactive PDF. These pages are the full-length text documents, which are print-friendly. Please be mindful of your paper consumption and select only the page(s) you need when you set up the document to print. Click the return button on each page to return to the interactive PDF. 1 2 3 4 5
LIVING LONGER Longevity and retirement 60 is the new 40 People around the world are living longer than ever before and this has major implications for the retirement industry. One Of the most significant trends across the globe is the continuing increase in life expectancy. On a macro level, this will impact the development of social and economic policies in both developed and developing nations. On a micro level, individuals now entering retirement face a very different scenario to the one they ve been planning for throughout their working lives. As a responsible financial industry, we need to understand the changes taking place in order to structure a system that will enable retirees today and in the future to lead fuller and more dignified lives. Scientific research has found the human body isn t intended to fail with age, rather that it isn t designed for long-term use. This means ageing and death aren t hardwired into our biology, suggesting our health and lifespan are modifiable variables that can be influenced by behavioural changes, medical intervention and biomedical science. For instance, increases in life expectancy have resulted largely from advancements in medical technology and practice, better pharmaceuticals, healthier lifestyles and a decline in smoking. how does this affect south Africans? For working South Africans this means the assumptions previously used to plan for retirement are no longer applicable, as we re living far longer than our predecessors. Some experts believe individuals should now be making provision for a life in retirement stretching up to 40 years on average. Furthermore, research in game-changing medical fields such as molecular nanotechnology suggests we re not yet able to reliably estimate how much longer a present-day 20-year-old will live. The risk in our context is that South Africans will simply not have enough money by the time they retire to carry them through their longer golden years. This risk is exacerbated by the reality that many people going into retirement will need to support their children given SA s high rate of youth unemployment as well as their own parents who themselves will live longer. What can we do? There are several ways we can start addressing longevity risks on structural and professional levels, including: Increasing the retirement age. This has been implemented in the UK and France, to some public outcry, in an attempt to manage the state s obligations in those countries. Introducing phased retirement by restructuring the exit of employees from the workforce in stages over time so they continue working beyond their usual retirement age. Retirees taking on a second career to meet their living expenses. This may take the form of small businesses, part-time work or reskilling in a different field. This change presents an opportunity for financial advisers to play a greater role in equipping retirees to live better during retirement. Discouraging the compulsion to withdraw retirement savings at retirement. This enables retirees who have an alternative income from a part-time job, for example to continue to benefit from the power of compound interest as well as the tax efficiency of these vehicles up until the point they need to draw on these funds. Reconsidering the value of guaranteed annuities in the context of increased longevity risk, as this risk is borne by the insurer and not the retiree. Providing appropriate investment and drawdown advice on living annuities and other nest eggs in the context of significantly increased longevity. Our responsibility The financial services industry has a responsibility to its clients to lobby government to effect the legislative changes necessary to cope with this increase in longevity, design relevant products that address the needs of retirees in this context and provide the most appropriate advice during the respective stages of their lives to improve the quality of their retirement. By Viresh maharaj, Chief Marketing Actuary: Sanlam Employee Benefits 10
PHASED RETIREMENT Phased retirement: the next step in retirement reform? The days of working for one company for 30 or 40 years are long gone and the new trend is towards more varied and vibrant careers. But should we also be exploring new ways of looking at retirement? the WOrLd Of WOrk is changing. More and more people embark on a second career after retirement and work well into their sixties. Many do so because they enjoy remaining active, but many more simply can t afford to retire in their early sixties as prescribed in their employment contracts. Also, research shows people are now living longer, which means more money is required for a longer period of retirement. In addition, many South Africans are encouraged to take packages and retire much earlier than the usual retirement age. The problem is tax laws haven t kept up with this changing world of work and don t allow for such a phased retirement. Individuals are compelled to retire and buy an annuity whether they wish to continue working and need a pension at that stage or not. We believe some adjustments to these laws are urgently needed to enable taxpayers to postpone their retirement to the day when they actually stop working and can retire more comfortably. BACk to BAsICs: tools for retirement planning To be able to retire comfortably, a retirement plan must benefit from three essential components: 1. an appropriately high contribution rate 2. a good investment return 3. a long investment period. The most important of these may be the investment period. In terms of our standard projections, an individual needs to set aside 12.5% (net of administration costs and risk premiums) of remuneration and enjoy a return of CPI plus 5.5% on the investment over a period of 40 years to achieve a projected pension of 75% (of final remuneration net of contributions). Very few South Africans enjoy the benefit of all three components at the appropriate level in their retirement plans. If, for example, an individual retired after 35 years at age 60, his or her projected pension will drop from 75% to 52%. The 35- to 40-year investment term is a problem for many graduates. Many require long periods of study and enter into formal employment By kobus hanekom, Head: Strategy, Governance and Compliance at Simeka Consultants & Actuaries 11
PHASED RETIREMENT with pension benefits only at about age 30. If their chosen career coincides with an early prescribed retirement date of 60 years, the 30-year investment term will yield a very disappointing pension. the power of compound interest The last five years are critically important in retirement planning as they allow the power of compound interest to work its magic. However, the reality is that as a result of various corporate strategies, late retirement is often not a decision the employee has any control over. The 2013 Sanlam Benchmark Survey results showed a significant proportion of South Africans are required to retire earlier than 65. Since our tax laws don t enable a phased retirement, retirement funding employment effectively ends at retirement date, with unavoidable consequences. When employees retire they re forced to annuitise, meaning an annuity/pension must be purchased with the retirement benefit. If a guaranteed-type annuity is bought, the monthly pension payments will become payable immediately. If a living annuity is purchased, the employee will have to take an annuity of at least 2.5%. Such a member is free to buy a retirement annuity or join a new employer s fund again after retirement, but the amount saved at retirement must be taken as a pension. The problem is members who embark on a second career and continue to work after retirement in their early sixties are required to buy an annuity at a time when they don t need the money. What they need is to be allowed to remain in the system and remain invested for a longer term so they can retire more comfortably at a later stage. Withdrawing funds at retirement and transfering them to a preservation fund often isn t an option either because retirement is linked to a whole range of other benefits, including share incentive scheme arrangements which will be lost should a member withdraw. There are many reasons why employers prefer an earlier retirement date and these strategies aren t likely to change. Phased retirement With the proposed harmonisation of the tax treatment of pension, provident and retirement annuity funds, the National Treasury has moved much closer to a solution. What s required is a few more adjustments to our tax laws that will allow an individual to park their pension benefits in a tax-neutral vehicle where they can continue to grow and preferably where additional contributions can be made. Such an arrangement is available in the UK and the US, where an individual is required to begin drawing a pension only from age 70 onwards, for example. One option would be to allow people who buy living annuities to take no drawdown or pension up to age 70. While this would be helpful, it won t be optimal if the individual isn t also able to make further contributions to the product. Another option would be to allow people to transfer retirement benefits to a preservation-type fund where they re allowed to annuitise at a later stage. This option also won t be optimal if it doesn t allow further contributions into the fund, avoiding the need to incur added administration and product fees when an additional retirement investment is purchased. The National Treasury has made enormous strides in simplifying and harmonising our tax laws. Allowing phased retirement must be the next step to assist thousands of employees to adjust to the changing world of work. the problem is members who embark on a second career and continue to work after retirement in their early sixties are required to buy an annuity at a time when they don t need the money. By kobus hanekom, Head: Strategy, Governance and Compliance at Simeka Consultants & Actuaries 12
EMPLOYER RESPONSIBILITY A new course for defined Contribution funds Research conducted by Sanlam into the South African retirement industry shows employers have a vital role to play in the continuing evolution and improvement of Defined Contribution retirement funds. employers Are uniquely POsItIOned to assist members because they: have the necessary infrastructure and access to facilitate communication with members can utilise their new-employee induction process to help members with their retirement choices when they join the company can assist members with preserving their retirement savings when they change jobs. Becoming a proactive employer will help to address some of the poor outcomes observed in our Sanlam Benchmark Survey over the past few years. Other stakeholders have an important part to play 13 as well, but a member s journey to retirement starts on day one of employment. This is where an employer can help to put the member on the right track to a better retirement outcome. While working, 51% of members turn to their human resources department for retirement queries. the employer s evolving role With the shift from Defined Benefit (DB) to Defined Contribution (DC) retirement funds, the responsibility and financial risk of providing a pension in retirement has moved from the employer to the employee. By danie van Zyl, Head: Guaranteed Investments at Sanlam Employee Benefits Investments
EMPLOYER RESPONSIBILITY Individual members now have to shoulder the burden of saving enough, investing appropriately and securing and managing their own retirement income. While some members thrive on the flexibility and options available to them, many ordinary members find the range of choice bewildering. In the DB environment the employer was able to rely on actuarial and investment professionals to advise them on how to manage the risk. However, the same level of expert advice isn t usually available to DC fund members and our survey shows that 63% of members aren t willing to pay for financial advice. Instead of looking for help, these members often choose to ignore their retirement savings. This apathy manifests itself in a number of ways. Many members belonging to a DC fund still have a DB mindset and an expectation of a sort of paternalism from their employer and trustees. member retirement choice DC fund members need to find their own annuity solution from an array of retirement service providers. The survey showed the biggest concerns members have about retirement is whether their retirement savings will last the rest of their lives (67% of members) and whether their retirement income will be sufficient (56% of members). Given the extent of member apathy regarding their retirement savings and their dependence on trustees during their working life, it s highly unlikely these members will become adept at securing an appropriate retirement income or, in the case of a living annuity, managing their savings over several decades. In stark contrast to the popularity of living annuities, 82% of pensioners surveyed wanted certainty of a guaranteed income for life. Only 18% would accept a 50% chance of a 5% higher of 5% lower income. the drawbacks of a living annuity The risks of choosing a living annuity at retirement include: Retiring with inadequate savings. Some members may then invest too aggressively and suffer investment losses which they can t sustain. Others may choose a drawdown rate which is too high, depleting their savings. Investing too conservatively. Members who are unfamiliar with investments may do this due to their fear of loss. This reckless conservatism could lead to their income being eroded by inflation. A lack of appreciation of increasing longevity, causing some members to outlive their retirement savings. new course for dc funds Should a retirement fund be designed with the end result being an adequate income in retirement? A targeted retirement income should be the goal of members and trustees, and all benefit options should help members increase the likelihood of achieving the goal. This extends to nudging members in the right direction whenever they need to make a choice, either through targeted communication or the way in which choices are designed and presented. If employers and trustees assume a more active role, they can make a significant difference in members achieving a good outcome in employers that take greater responsibility for the overall financial well-being of their workers, including through the design of their retirement funds, reap the rewards of a more stable and happier workforce. national treasury, 2013 retirement reform PrOPOsALs 14 retirement. These actions include: Ensuring members receive adequate longevity protection upon retirement through an appropriate annuity product Giving members access to institutionally priced annuity solutions Thoroughly vetting members default annuity options with the help of the fund s investment consultants Helping members understand that accessing their retirement savings when changing employment to finance debt or discretionary purchases will have a detrimental effect on their ability to retire comfortably. By taking the lead, employers can make a critical contribution to resolving our country s retirement savings crisis this is the ultimate goal of all stakeholders involved in this discussion. new course for dc funds defined Benefit fund Focus on retirement income Provides a fund pension defined Contribution fund Focus on accumulation of assets Members have to select own annuity new approach to dc funds Refocus on retirement income Guide members and provide default annuity option(s) with opt-outs By danie van Zyl, Head: Guaranteed Investments at Sanlam Employee Benefits Investments
RETIREMENT REFORM the great annuity debate Retirement reform papers are a step in the right direction to help retirees make the best choice when they reach retirement One Of retirement fund members biggest fears when they retire how to make the right choice of annuity at retirement has now been addressed by the retirement reform papers published recently by the National Treasury. In the past, most advice provided to retirement fund members focused on building wealth ahead of retirement, while little focus was placed on what to do with a retirement lump sum after retirement. Members had to make their own decisions on the type of annuity to choose a guaranteed annuity, living annuity or with profits annuity. Guidance required Retirement fund trustees will now be required to guide members through the retirement process and not leave them in a position where the wrong decision at retirement could effectively wipe out a portion of their capital or leave them with an income that doesn t meet their needs. Identifying and implementing a default annuity strategy for members at retirement should form a vital component of trustees fiduciary duty. The question that now arises is: how can the financial industry assist trustees to offer appropriate products to members? Pension security and control of pension increases are of the utmost importance to pensioners. Investment-linked living annuities (ILLAs) have been very popular, but the impact of the flexibility in both choosing the underlying investment strategy and the drawdown (the level of income) rate on the long-term sustainability of ILLAs is only now starting to become apparent. Not everyone understands and can afford the risks associated with an investment-linked living annuity: volatile investment returns and therefore volatile income levels, or potentially decreasing income levels the risk of longevity living longer can affect the sustainability of a liveable drawdown rate for life. A living annuity is a financial product providing flexible income in exchange for a cash lump sum. The investor can draw a monthly pension for as long as there s money available in the fund. The most attractive features of living annuities are the flexibility in the drawdown rate and investment choice, together with the advantage that the remaining capital at death is paid to the investor s estate. However, the pensioner s dream of leaving a huge estate for children and grandchildren is often shattered by the reality of longevity. Low levels of financial literacy Given that most South Africans have low levels of financial literacy, it s vital that retirement funds give members access to a simple, efficiently priced product that helps them meet their monthly costs of living. Guaranteed annuities in the form of inflation-linked annuities address the need to protect pensioners purchasing power. By linking pension increases to inflation, a pensioner is able to maintain his or her cost of living. Inflation-linked annuities also provide a fair match to rising medical scheme contributions. By selecting an inflation-linked annuity, pensioners do not carry any longevity or investment risks, as initial pensions and annual increases in inflation are guaranteed for life. Even if inflation is negative, pensions will not decrease. Appropriate levels of protection can also be provided by means of a spouse s pension for life or guaranteed periods. When selecting an appropriate annuity at retirement, pensioners have to weigh up the dream of providing a legacy and having a flexible but uncertain pension against the certainty of a known pension that may well be slightly lower at inception but will maintain its purchasing power for life. By rhoderic nel, Chief Executive Officer: Sanlam Employee Benefits Investments 15