South Africans face difficult choices regarding retirement. Some choices are easier than others, but all have an impact on their retirement outcomes. Old Mutual Corporate’s Retirement Reality research indicates that one in three pre-retirees is not even aware that they have a retirement fund at all, which speaks to the pressing need for greater financial awareness and education. Ignorance about the difficult choices retirement fund members need to make is one reason why working-age South Africans are not saving enough for retirement.

Economic factors beyond their control – such as rampant inflation, higher-for-longer interest rates, ‘sandwich generation’ obligations and more – compound the issue. Saving is hard, but even the members who actively save for retirement are not always making the best choices. Most members are intimidated by glossy brochures advertising complex products that they don’t understand. Some may feel overwhelmed when trying to figure out which choice will serve them best in retirement. For others, the uncertainty of future outcomes erodes trust in the system. Little wonder, then, that many members tick the box with the lowest contribution to a pension or provident fund, and redirect funds into other personal investments (like property or starting a side business) where they feel more comfortable with the expected outcome – even though these are often riskier investments.

The most important choices impacting retirement outcomes are choosing how much to contribute, how to invest those contributions, and how to draw a sustainable income from one’s savings later in life. The introduction of the Two-Pot Retirement System in September 2024 adds further complexity, with additional choice around saving for short-term emergency needs.

Making the most of the earning years

Few fund members understand that during their economically active years, they should be spending a lot less than they are earning in order to invest more than the bare minimum for their retirement. Our earning years are the only chance we get to save and invest for a future in which we will no longer be earning an income. Being enrolled in a fund that offers retirement benefits is a very good start, but fund members are still a long way from meeting their responsibilities to their future selves.

The first critical choice is the amount that the member will contribute to their pension fund. This is often a function of what they can afford, given their standard of living. Choosing a more affordable lifestyle not only allows the member to direct more money towards their retirement savings, it also makes it more affordable to maintain that lifestyle during retirement. Viewing retirement savings as being ‘expensive’ or ‘unaffordable’ is a mistake. Members who adopt a saving mindset early in their working life typically set themselves up to live within their means more comfortably now as well as later in life.

The unfortunate reality for many South Africans is that their income levels are not sufficient to even sustain their current basic cost of living. This makes sufficient contributions towards their retirement savings very hard. For these people, the importance of getting the other two choices that follow right is even more critical.

Adjusting contributions

Many fund members only think about retirement twice in their life: when they join the fund, and when they are about to retire and need to select a post-retirement vehicle. That’s not sufficient. Members should review their retirement fund contributions at least once every five years, if not more regularly.

Making a small contribution is understandable when members are in their 20s, but once they’ve had a salary increase or two, they should increase their contributions accordingly instead of allowing lifestyle creep to change their standard of living.

Old Mutual’s OnTrack™ research shows that only 20% of retirement fund members are contributing at the recommended rate of 15% or higher (down from 22% in 2022). Worryingly, only 6% are on track to a secure retirement. To help remedy this, employers and funds should help employees understand how much they should save and how much they can afford to consume, even before making nuanced choices about investment funds.

Investment choices

The range and complexity of investment choices available to fund members can be daunting. Given constrained personal finances and limited contribution levels, most investors need to earn high real returns to give them any chance of achieving reasonable outcomes. Any strategy that is too conservative and only able to deliver returns marginally above inflation is almost guaranteed to fail in delivering the required outcome. Not taking enough investment risk is probably the biggest risk of all.

It is critical that investors choose a strategy that has high exposure to risky asset classes that are more likely to deliver high real returns. When looking at most South African retirement funds, this is well understood: many offer relatively aggressive high-growth investment funds, especially during the early accumulation phase. Unfortunately, these funds also come with high risk of significant loss over shorter periods of time. This can be devastating for members who need to draw on their retirement savings due to an emergency or at retirement.

Faced with a choice between conservative and aggressive funds, many fund members find themselves between a rock and a hard place. This problem is neither new nor unique. Other successful pension systems around the world provide examples of how to effectively manage this risk, while recognising the need for sufficient exposure to risky assets to deliver the required real returns.

These systems actively choose to invest sufficiently in risky assets, and then manage the investment risk by pooling assets and facilitating investment risk-sharing between members. We see this simple yet very effective principle at work with the rise of modern Collective Defined Contribution (CDC) funds in many of the Nordic countries, and more recently in the United Kingdom. Although South Africa does not (yet) have a regulatory framework that allows for CDC funds, there are well-developed smoothed bonus funds within our Defined Contribution system that are based on the same risk-sharing principle.

While there are many differences between CDC funds and the smoothed bonus funds available in South Africa, they share the same fundamental principle of risk-sharing to deliver more consistent outcomes. While these funds were originally designed and used within Defined Benefit funds, they have changed significantly to make them modern, outcomes-focused and compelling options within a Defined Contribution framework.

Risk management in action

Employees must remain invested in growth assets for as long as possible to reap the rewards. However, this can be tremendously challenging given global market volatility and the lived reality of many South Africans. Marvin Nair, Head of Smoothed Bonus & Investment Strategy at Old Mutual, says this became clear during the global pandemic, when some balanced funds dropped by more than 20%. ‘This outcome would have been devastating to people close to retirement, or for retirees newly invested in a living annuity underpinned by a typical balanced fund,’ he says.

Smoothing empowers members to beat inflation over the long term through strong growth asset exposure, while also achieving more consistent outcomes by ‘smoothing out’ the volatile returns of underlying assets. ‘Smoothed bonus funds performed well during the pandemic, with much more consistent outcomes compared to balanced funds,’ says Nair. ‘They provide a level of protection that guarantees a minimum benefit on retirement, creating more consistent outcomes.’

Old Mutual’s AGP Stable is an example. ‘It provides an 80% of fund value guarantee, which means if a member invests R100 with this 80% protection, upon retirement they will receive an amount that is no less than R80,’ Nair explains. ‘Similarly, if this R100 invested grows to R200, upon retirement the member is guaranteed to receive at least R160. This is an optimal solution for fund members, since the portfolio is well positioned for growth but their funds are protected at the same time.

‘Looking at the performance of these funds, it is hard to argue against the data,’ Nair adds. ‘These funds deliver exceptional real returns at a fraction of the risk associated with similar market-linked balanced funds. And in the South African context, the extent to which risk sharing empowers members to participate in growth asset performance at acceptable levels of risk is compelling.’

Old Mutual Absolute Growth Portfolios

The Old Mutual Absolute Growth Portfolios provide investors with different risk-return appetites by offering a range of guarantees on benefit payments:

• Absolute Smooth Growth with a focus on smoothing plus a 50% guarantee
• Absolute Stable Growth with an 80% guarantee

Annuity choices

The next critical choice that members are faced with is what to do at retirement. The choice here boils down to how much of their retirement savings to take as cash and how much to direct towards purchasing an annuity. This is followed by the critical choice between a guaranteed annuity and a living annuity.

Old Mutual’s OnTrack™ research shows that many fund members take significant amounts of cash at retirement. And with the portion that they use to purchase an annuity, most choose a living annuity.

There are advantages to both life (guaranteed) and living annuities. While retirees may be locked into a guaranteed annuity, the main benefit is that they won’t run out of money later in life. This is not the case with more flexible living annuities, where investors run the risk of running out of money in pursuit of greater flexibility, higher growth and the ability to leave a legacy.

Again, members can find themselves between a rock and a hard place. Choose a guaranteed annuity, and you have little flexibility or chance of leaving behind a legacy. Choose a living annuity, and you risk running out of money.

Fortunately, again, we can borrow from international principles and find a middle-ground solution. In addition to the need to share investment risk, with-profit annuities also allow longevity risk to be shared between annuitants in the same pool, as opposed to insuring only with an insurance company. The combination of using smoothed bonus funds in a living annuity and underpinning that with a with-profit annuity to fall back on becomes a compelling middle ground.

‘Smoothing also mitigates the sequence of return risk,’ says Nair. ‘That is, the risk of losing a significant amount of capital early on due to an event such as the pandemic or a global financial crisis. Smoothed bonus funds can limit the impact of extreme drawdowns in the market on living annuity outcomes.’

Smoothed bonus funds that offer guarantees can play a critical role in a living annuity structure, because members can rely on the guaranteed component to secure a life annuity, if necessary, while still enjoying some of the upsides of a living annuity. This is where next-generation hybrid options can offer significant advantages.

What pre-retirees fear most about life in retirement

67% Affordability – being unable to maintain their family and living standards
11% Health –being unable to live a healthy life
10% Less socialising –being alone and bored
7% Death – nearing the end of their life and missing their youth
7% Finances – being scammed out of their retirement savings, their pension not paying out as much as it says it will, or still having debt
6% Unachieved Goals – being unable to fulfil their dreams or follow their passions
4% Nothing – no fear, as they are confident they have prepared well for retirement

SOURCE: Old Mutual Corporate’s Retirement Reality research

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