Retirement outcomes in South Africa are very poor. National Treasury estimates that 94% of members in employer funds are not on track to achieve desired retirement outcomes. There are several reasons for this, including the macroeconomic challenges facing our society, which increase the need for take-home pay and limit opportunities for additional savings.

Blessing Utete, Managing Executive at Old Mutual Corporate Consultants (OMCC), says that while there are several factors which contribute to poor outcomes, fund design is a challenge. ‘Funds are not always designed appropriately to achieve the right results for members,’ he says. ‘It’s not a governance issue, but rather speaks to how a board, management committee or employer has designed and set up the fund.’

More than 90% of companies in Old Mutual Corporate Consultants’ OnTrack™ database have a one-star rating (the poorest rating). For employers and retirement fund trustees, identifying problem areas is a vital first step in fixing inadequate or inappropriate fund design.

‘There are six significant factors – or levers – behind why people are not able to retire comfortably, and those are what OnTrack™ measures to help recommend design revisions for better outcomes,’ says Utete.

The six levers

1. The type and price of a pension being bought at retirement age

The price of a pension at retirement age, which is the cost of converting retirement savings into an annuity, is crucial for determining retirees’ income streams. These annuities come in various forms, each offering different benefits, risks and costs. The choice of annuity significantly impacts the financial security and quality of life for retirees, making it a crucial factor in retirement fund design.

The primary types of annuities include guaranteed annuities, living annuities and hybrid annuities, which encompass a combination of a guaranteed portion and a pool of assets from which a member may draw down. Each type serves distinct needs and preferences, affecting the price and the retirement income they generate.

2. Pensionable salary

Pensionable salary is the portion of an employee’s earnings used to calculate retirement contributions. It plays an important role in determining retirement savings. Higher pensionable salaries, with regular and equitable inflation adjustments, lead to increased contributions from both employees and employers, boosting retirement fund growth.

Decision-makers are also encouraged to explore inclusive pensionable salary definitions that consider bonuses, commissions and overtime to provide support through clear communication and regulatory compliance, and to maintain transparent employee policies for efficient planning. These stakeholder actions have the potential to significantly improve the adequacy and sustainability of retirement benefits.

3. Preservation rates

Preservation rates refer to the percentage of retirement savings retained when employees change jobs. This is pivotal for the uninterrupted growth of retirement funds. Higher preservation rates mitigate the risk of premature withdrawals, thereby sustaining compound growth and boosting retirement security.

Strategies such as implementing mandatory preservation policies through the pending Two-Pot Retirement System, enhancing benefit portability, providing educational resources on the importance of savings retention, and introducing incentives and flexible withdrawal options play significant roles in bolstering preservation rates.

Regular monitoring of these initiatives ensures their effectiveness, contributing to the stability and adequacy of retirement savings within an organisational context.

4. Percentage of contribution

Contribution rates, which determine the percentage of salary allocated to retirement savings by both employees and employers, are vital in shaping the adequacy of retirement funds. Default contribution levels and the design of contribution categories by employers have a significant impact on retirement outcomes. Higher contribution rates directly correlate with increased retirement savings accumulation, thereby enhancing future financial security for employees.

Strategic considerations such as automatic enrolment and escalation mechanisms, employer matching programmes and educational initiatives on the benefits of higher contributions play crucial roles in promoting optimal contribution rates. These strategies not only encourage proactive retirement planning, but also foster a culture of financial preparedness among employees.

Regular assessment and adjustment of contribution policies by decision-makers ensures alignment with evolving financial goals and market conditions, thereby maximising the effectiveness of retirement fund designs in facilitating robust retirement outcomes.

5. Investment strategy

The setting of the investment strategy in retirement fund design refers to the approach taken to allocate and manage assets with the goal of achieving optimal returns while managing risk. This strategic decision is key in determining the growth and sustainability of retirement savings.

A well-constructed investment strategy considers factors such as risk tolerance, time horizon and market conditions to effectively balance growth potential with the preservation of capital. Strategies may include diversification across asset classes, active or passive management styles, and the use of target-date funds tailored to retirement timelines.

By aligning investment strategies with the specific needs and risk profiles of participants, retirement funds can enhance long-term financial security by achieving the required investment growth over time. Regular monitoring and adjustment of investment allocations ensures alignment with evolving market dynamics and participants’ changing needs, thereby optimising retirement outcomes and

mitigating investment risks.

6. Normal retirement age

Setting the normal retirement age of a retirement fund is a critical factor in design, as it represents the time frame for saving until retirement and directly influences all participant outcomes. The decision on when employees can retire impacts both the accumulation phase, where contributions grow through investments, and the distribution phase, when savings are drawn upon for income.

A longer time until retirement allows for greater contributions and potential compound growth, bolstering retirement savings. Strategic retirement age policies, such as offering flexible retirement options and incentivising later retirements, can optimise retirement outcomes by aligning savings accumulation with longer life expectancies and changing economic conditions.

Additionally, providing education on the benefits of delaying retirement and adjusting retirement age policies in response to demographic shifts and participant preferences ensures retirement plans remain effective in meeting diverse retirement needs. Regular evaluation of retirement age policies helps adapt to evolving workforce dynamics and economic realities, thereby enhancing the overall effectiveness of retirement fund designs.

Staying OnTrack™

‘The Board of Trustees and/or employer must peg defaults for the fund at the areas around which it will achieve the right outcomes for its members,’ Utete says. ‘The contribution rate, for example, needs to be set at a default level that helps joiners contribute at the right level right away.’ It is extremely difficult – if not impossible – to move contribution rates upwards once members have become accustomed to a certain level of take-home pay.

OnTrack™ is a tool that shows areas of improvement and offers continuous monitoring of retirement funds to measure the effectiveness of the fund in delivering the right outcome for members. ‘OnTrack™ measures actual and required savings for each member on their path to retirement, showing the gaps between targeted and actual results,’ explains Utete.

‘Measurement of the six levers shows where improvements can be made and compares the fund’s effectiveness against others in the same industry. From an employer perspective, it also helps MANCOs understand whether their fund is set up in a way that can make it enhance their employee value proposition.’

While occupational retirement funds remain one of the largest sources of private retirement savings in South Africa, and can provide significant benefit to employees when suitably designed, members’ savings success can vary, depending on factors such as the level of employee and employer contributions, investment strategies, the flexibility of member choices and the defaults of a fund.

‘These design factors have a statistically significant effect on member outcomes,’ says Keri-Lee Edmond, Consulting Analytics and Insights Manager at OMCC. ‘Through OnTrack™, we’ve been able to get a clear and powerful picture of the quantum of success of each of these employer funds in delivering sound retirement outcomes for their members.’

More than 90% of funds score a 1 on a rating scale of 1 to 5. This is driven mainly by two factors. ‘Firstly,’ says Edmond, ‘most retirement professionals recommend an ideal replacement of income at the time of retirement to be around 70% to 75% of one’s working salary. What many people underestimate is the amount of savings required to sustain this level of income for your entire post-working phase, which is usually around 11 to 12 multiples of your annual salary if you retire at 65, and even more if you’re planning to stop work before then. However, many fund defaults are designed to deliver a significantly lower replacement ratio than the ideal 70% to 75%, and many employees remain in these defaults.’

The second factor is member choice. ‘For example,’ says Edmond, ‘employees might actively select the lowest possible retirement contributions to maximise their cash receivable or opting into investment strategies that do not match their age or risk profile. It’s Old Mutual’s mission to systematically scale the enhancement of fund designs and member choices to drive significant improvement in retirement outcomes.’

Prioritising preservation

Another aspect of member choice is preservation. Preservation levels are low across both pension and provident fund members – especially true for younger members under age 30, who withdraw 80% to 100% of retirement benefits in cash when switching between jobs.

‘The great news is that the introduction of the Two-Pot System will absolutely have a significantly positive effect on these preservation levels, especially for younger members who will spend a longer duration of their working lifetime in the Two-Pot Retirement System,’ says Edmond. ‘Our financial modelling has shown that this retirement reform is going to improve retirement outcomes for younger members by up to two to three times.’

In comparison to the previous scenario, where individuals could withdraw 100% of savings when leaving an employer, Edmond expects this mandatory saving to ensure these amounts are ring-fenced for one’s retirement years. This, in turn, will have a significant effect on overall member outcomes.

Despite the emphasis on preserving retirement savings, Old Mutual Workplace Benefits Primary Research, powered by LIMRA, found that 53% of the surveyed employees who say they have some knowledge of the Two-Pot system intend to withdraw all or some of their retirement savings when it becomes available.

Edmond says this makes a case for effective and timeous member communication, education and financial planning. ‘It’s important for the member to receive sufficient support in understanding the realities of withdrawing or preserving retirement savings when changing employers,’ she says. ‘It’s also important for employers to facilitate simple and easy processes for members to preserve at these turning points in their career.

‘However, the regulatory intervention is also going to play a very significant role in improving preservation of retirement savings. By introducing compulsory preservation, this reform will ensure that two-thirds of all contributions, from the implementation date, be secured for an individual’s retirement.’

Prior to the introduction of the Two-Pot Retirement System, younger retirement fund members (those under 30) tended to withdraw nearly all their retirement benefits in cash when they switched jobs. The average 24-year-old, for example, was taking 98% in cash. But this doesn’t only apply to young people. Preservation levels are low across all age groups and funds. The highest preservation rates were among 62-year-olds, who – with retirement on the horizon – withdrew on average 43% of their retirement savings.

‘Most concerning is the behaviour of fund members over 55,’ says Utete. ‘They are within 10 years of a normal retirement age, yet they are still cashing in more than 50% of their retirement savings when changing jobs. These preservations are simply too low to ensure a comfortable retirement.’ Utete notes a spike in cash withdrawals at age 64. This is likely due to pre-retirees cashing out their retirement savings as capital to start a new business.

Who fixes a broken fund?

Globally and in South Africa, the onus of retirement savings has been shifting considerably towards individuals, placing an increased responsibility on citizens to manage their own retirement funds, whether through their employer fund or outside of it.

Edmond says that if an individual belongs to a fund that doesn’t target their ideal level of retirement savings, there are several ways they can supplement their employer fund, including increased employee contributions, additional voluntary contributions, personal retirement savings plans, additional investments and assets, savings vehicles and financial planning. ‘By taking proactive steps to supplement their employer fund, individuals can enhance their financial security in retirement and ensure they have enough funds to support their desired lifestyle,’ she says.

However, regulators and policymakers also have a key role to play in improving retirement fund member outcomes. The new Two-Pot Retirement System is an example of how government policy can help to de-risk funds. ‘The fact that the regulator is enforcing strong default settings for funds and employees means that the funds are compelled to offer default settings that give members a chance to get the best outcome,’ says Utete.

There are other issues around governance, and how fund operators communicate with members – and behavioural science also plays a role. ‘Communicating certain elements as “opt-out” rather than “opt-in” helps members make better conscious choices,’ he says.

While the primary aim of designing a retirement fund is to build a financial reserve for the future, elements like life insurance and funeral plans are important supplementary benefits. ‘It’s important for trustees to gauge whether those supplementary elements lean the fund more towards being a risk benefit fund than a retirement fund. They can be provided through the fund but shouldn’t erode retirement savings,’ Utete concludes.

* This article originally appeared in the Old Mutual Mindspace Thought Leaders Forum special issue. Read the full publication here.