A business may offer a retirement fund as a benefit to its employees, but is the design of the benefits appropriate to ensure that the fund is worthy of the name retirement fund? That’s the question Andrew Davison, Head of Advice at Old Mutual Corporate Consultants (OMCC), was left asking after seeing the results of OMCC’s recent Retirement Gauge.

Davison wondered if there were differences in the outcomes that employees experience based on the size of the fund they belong to. ‘In theory there should be no difference between a 50-year-old in a small scheme and a 50-year-old in an extra-large scheme,’ he says. ‘They have very similar needs for their retirement, hence they would need to have saved the same multiples of their annual salary.’

But that’s not what the results showed.

The importance of appropriate contribution levels

‘The differences are stark,’ says Davison. ‘Our findings showed that a 50-year-old member of a small retirement scheme (of less than 100 members) has typically saved 1.2 times their annual salary. In contrast, the same person in an extra-large fund (of more than 2 000 members) has more than three times the capital – 3.5 times for the typical female and 3.3 times for the typical male.’

The reason for the difference comes down to benefit design. There are a few key elements that determine the benefits provided by a fund at retirement – the definition of pensionable salary, the level of contributions (net of costs including risk premiums), the normal retirement age and the investment strategy are key factors. In this case, the contribution percentage is a big part of the reason for the gap, with members of small retirement funds typically contributing between 8.9% and 12.4% of their salary towards their retirement; while their contemporaries in extra-large funds are contributing between 14.1% and 15.3%.

‘We found that some company retirement funds – especially smaller schemes – allow employees to contribute as little as single-digit percentages from their salaries,’ Davison says. ‘That creates a dangerous placebo effect, where the employees think they are preparing adequately for their retirement when they are not.’

The result, he says, is that the retirement fund fails to deliver its intended outcomes.

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6 factors determining retirement investment success

So what is the ‘right’ contribution level? The answer is not that simple – and Davison’s explanation is one that both employers and employees should take note of.

‘The most common rule of thumb is that you should contribute at least 15% of your pensionable salary towards your retirement fund,’ he says. ‘That’s a good starting point, but the reality is that there are six key levers that drive retirement outcomes and they work in tandem. Pulling one lever has an impact on the other levers. So good benefit design for a retirement fund means getting all six of the levers in the right position.’

‘As an example, if the rule of thumb is to contribute 15% of your salary, then it’s actually 15% of your cost-to-company salary, net of costs, invested to earn inflation plus 5% per year, after fees, for at least 35 years, including preservation during that period, with a retirement age of 65, and the intention of purchasing a with-profit annuity at retirement. And if you’re female you’d need to contribute around 10% more, because women typically live longer than men. So for females it’s a contribution rate of 16.5%, with that asterisk attached.’

Visit Old Mutual SuperFund, our leading umbrella retirement fund, for information on the retirement fund solutions available to employers.

Find the entire Retirement Gauge in pdf format here.