Will your company pension fund be enough?
10 May 2016
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On mobile, on digital, on demand, this is Old Mutual Live, Money Coach, hello and welcome, my name is Chris Gibbons. There’s no doubt that most of us at least aware of the need to plan for retirement. To put something away each month for that long distant day when we walk through the companies front door for the last time. For many of us we’re doing it via the company pension fund. I chip in a bit, the company chips in a bit, and after a while everything will be okay, right? Well, perhaps not.
There’s a very strong case to be made for the fact that your company pension fund is not going to be enough to keep you in comfort in your old age. Why is that? What do you need to do about it? We’re joined now by Monica Moodley, Managing Legal Advisor at Old Mutual’s Regional Support Centre in Pretoria. Monica, welcome to Old Mutual Live Money Coach, what is your view. Is the company pension fund generally not enough and if so, why not?
Monica Moodley: Chris, research has shown that only 10% of retirement fund members actually retire with enough money saved in their pension or provident fund to be financially secure on retirement. There are various reasons contributing to why the company pension fund is insufficient.
Why company pension funds are insufficient
I’ll briefly go through some of the more pertinent ones. Firstly, approximately four million South Africans get remunerated on a cost to company basis. This effectively means that staff is left with the task to make provision for retirement, medical cover and disability.
The question that arises is, how many have the know-how, the determination, the ability and the financial knowledge to structure their own retirement in an ever-changing, increasingly complex financial environment? Thus, due to the above factors, many are not making sufficient provision for retirement. Resulting in their company pension fund not being enough.
Secondly, another major reason why the employer’s retirement fund might not be enough would depend on the choices the employee makes when changing jobs. South African law allows employees to access the full amount of their retirement fund benefit when this change occurs subject to tax. Many people elect to take the cash resulting in a major negative implication for South Africa’s long term savings.
Probably as well, most South Africans tend to get an allocated portion of the income they’ve received to get benefits as well as disability benefits. This means the more workers claim their benefits, the less money remains for retirement benefits.
The level and cost of this benefit, such as life insurance and disability allowances detract from the ultimate performance of assets that remain in the retirement fund. Firstly, the high level of season charges can reduce the members benefit.
An example, an annual reclaim charge of 2% of assets on the management can reduce a members benefit by at least 40% over 40 years of employment. Lastly, investment choices made by the trustees have a significant impact on the ultimate value of the retirement fund. Low risk results in low returns. High risk results in high returns.
Many times the members do not have a say in how the assets are managed. Some do make their own investment choices. Research, however, has shown that these invest too conservatively, that’s limiting the growth of the returns. So, these are the factors that can be taken into consideration.
So what can I do?
CG: Monica, if those are the risks of relying solely on a company plan, what should you do? Should you supplement it and if so, by how much?
MM: Employees should not solely rely on the business as a nest egg, Chris. That’s the same as placing your eggs all in one basket. Diversification is of vital importance. The employee needs to diversify to maximise returns, to ensure a comfortable retirement.
The risk is the employers, retirement fund alone may not be enough to provide you with an income at retirement. The risk of liquidation exists. If a company pension fund liquidates close to retirement, the employee’s future will be endangered. Relying solely on the company’s pension fund means settling for only a fraction of your salary to see you through the later years.
CG: How much should you supplement it by?
MM: This would totally depend on how much the employee is currently contributing to the pension scheme. Government has introduced massive tax incentives that is very favorable to the investor. The amount that should be contributed must be an amount that takes full advantage of the tax reductions relied by SARS. Pension is a percentage of your final salary. This is called the income replacement ratio.
So most people need an IRR of between 60-80%. This means they will be able to maintain a comfortable standard of living during retirement. While it is difficult considering the economic times we are facing, our lifestyles need to be adjusted. If this can be done, then you are ensuring a safety net at retirement. Alternatively, you can settle for the state survival pension of approximately R1 500 in a cycle of 12 times for 365 days.
Why even bother with a company plan?
CG: Should you even bother with a company plan? Why not just do your own thing anyway?
MM: Having coverage in a workplace plan Chris, can make the difference between subsistence living and a comfortable lifestyle at retirement. Many companies match the employees contribution. So ignoring a company’s pension fund effectively means saying no to free money or refusing a pay raise. You have to give up a little of your own cash, but your employers contribution can double or triple the size of your pension pot over the years.
You can elect to make provision by yourself, however, this should be over and above the company’s pension fund. The company’s pension fund together with the employees own planning, can be a cornerstone of one’s retirement plan. Providing the employee with a steady income that could last for a lifetime.
CG: Monica, what’s the most effective way of doing this from a returns point of view?
MM: Chris, looking at it from a return point of view, the type of investor the employee is, would determine the return. Conservative investors would be cautious in investing in a low risk manner, the returns would thus be low.
High risk investors would take more risk ensuring a better return. High risk equals high returns. The most effective way would be to diversify. Diversification ensures that a balance is obtained and the returns are such that the employee can retire comfortably.
Best option from a tax point of view?
CG: Monica, you mentioned tax, what’s the best way of going about this from a tax point of view?
MM: All right, SARS has massive tax incentives that are very favourable to the employee that contributes to the pension fund. Currently the tax deduction the greater of R1 750 or 7.5% of pensionable remuneration. So, obviously the retirement reform is coming into play where this would be changed. But if you are contributing to a pension fund, a provident fund, as well as a retirement fund in the future, it’s going to be a great tax incentive for the employee, who can get it as a tax deduction.
CG: You’re listening to Old Mutual Live, the Money Coach edition, on demand, visit dogreatthings.co.za. Monica, when it comes to retirement planning, what is the critical thing to take into account here? Is it making a full on commitment to a certain amount of money each month, come what may?
MM: Absolutely Chris, as Warren Buffet has said: What the wise do in the beginning, fools do in the end, so let’s not be fools and wait to save for retirement later on. Let’s be wise and start now, no matter what the amount is, it can contribute to that safety net at retirement.
CG: And there we’ll leave it. This has been another edition of Old Mutual Live, Money Coach, my name is Chris Gibbons. With me on the line from Pretoria has been Monica Moodley, Managing Legal Advisor at Old Mutual’s Regional Support Centre in Pretoria. R
emember, please feel free to get in touch any time if you have any questions for me or topics you’d like covered on Old Mutual Live Money Coach. Just send them direct to me at firstname.lastname@example.org., I’d be delighted to hear from you. Until the next time, thank you for listening. Old Mutual Live, on mobile, on digital, on demand.