It is not enough for retirement funds to set default investment options and then expect employees to “sleepwalk” to a financially secure retirement, Alexander Forbes said this week, when it released its annual Benefits Barometer research report on retirement funds and other employee benefits.
Fund members should be involved in retirement planning to ensure that it is suitable for their needs, senior executives of Alexander Forbes say.
And they say your employee benefits should provide you with protection to ensure that your journey to retirement is not jeopardised by events, such as disability, that could affect your ability to save.
The key issue is not to maximise retirement savings, but to optimise the allocation of your resources across short-term consumption, long-term savings and income protection, Anne Cabot-Alletzhauser, the head of the Alexander Forbes Research Institute, and John Anderson, the managing director of research and product development at Alexander Forbes, say.
Cabot-Alletzhauser and Anderson argue that employers and the financial services industry need to play a greater role in ensuring that you are involved in planning for your retirement and are protected from events that could affect your ability to save. They suggest employers adopt a range of measures that will help you to achieve this – which include providing far more information with your payslip.
The Benefits Barometer notes that the burden of managing the many obstacles to retiring financially secure – including the risk of faulty retirement planning – has been shifted from employers to fund members. This is largely a result of the switch from defined benefit funds – which provided a pension based on your final salary at retirement and your years of employment – to defined contribution funds, to which you and your employer contribute without any guarantee that what you have saved by the time you retire will be enough to provide an income that will see you through your entire retirement.
Cabot-Alletzhauser and Anderson say that, for many employed people, employee benefits are the only savings or safety net, apart from state-provided benefits, such as the disability grant and unemployment insurance.
However, employee benefits do not offer you adequate protection, because they are fragmented, Cabot-Alletzhauser and Anderson say.
Employers need to close the gaps in their employee benefits to ensure that, for example, disability benefits are paid as soon as sick leave is exhausted, they say.
Setting defaults
The government’s retirement reform programme has focused on improving your savings and, in particular, on reducing the cost of saving and setting defaults that will help you to achieve an adequate income in retirement.
Anderson says that, once regulations are in place (probably within the next two years), retirement funds will have to set defaults for:
* The investment strategy that will be used to grow your savings;
* How your savings will be preserved if you leave the fund before retirement; and
* The type of annuity (monthly pension) you can buy at retirement.
As result of the change, from March 1 next year, to how retirement contributions are taxed, employers should also be assessing default contribution rates and allowing for additional contributions to be made to employer-sponsored retirement funds, he says.
Before fund trustees can set defaults, employers need to analyse their employees’ financial circumstances to determine the needs that these defaults should meet, Anderson says.
One of the outcomes of the Treating Customers Fairly (TCF) principles, which the regulators are applying to the financial services industry, is that financial products, including pension funds and medical schemes, must meet your needs, Anderson says.
The TCF principles should also apply to employers, because they provide employee benefits, he says.
Hierarchy of needs
Anderson says research has found that employees have a hierarchy of financial needs that are linked to their income.
For example, employees who earn less than R8 000 a month want cover against accidental death and disability – often because they perform work that puts them at risk – and funeral cover. There is not a big demand for retirement funds among these employees, because many of them do not believe they will reach retirement, and if they do, they will rely on the social old-age grant.
Homeowners who earn between R8 000 and R25 000 a month want medical scheme cover, life cover and a retirement fund.
The financial needs of those who earn more than R25 000 a month are even greater, extending to short-term insurance, estate planning and discretionary investments.
Anderson says your financial needs change over the course of your life. For example, your need for medical care increases as you get older, and so you will probably have to up your medical scheme cover in your later years of employment.
You also have to set the right target for your retirement savings, Anderson says.
Many funds set their investment strategy so that, after contributing to the fund at a certain rate over their entire working lives, members will receive an income in retirement that is equal to 75 percent of their pension-funding salary.
However, a recent study found that 75 percent of income is not sufficient for 90 percent of retirees, because their expenses in retirement generally do not decrease by 25 percent of their pre-retirement income.
Anderson says your target will depend on your circumstances, and your employer or fund should provide you with the right tools to determine what you need.
Once your financial needs are identified, including how much you need to target for your retirement savings, your trustees can start setting the correct defaults for your retirement fund, he says.
Defaults can be effective in getting you to do the right thing, but one-size-fits-all defaults will not meet the needs of every member, Anderson says. Instead, retirement funds should set “smart defaults” that take each member’s needs into account. If, for example, you start saving for retirement at the age of 40, your default contribution rate should be higher than the default rate of someone who started to save at 23.
Similarly, he says, the default rate of a member who plans to retire at 65 may be different from that of a member who plans to retire at 75.
The Barometer says that setting one-size-fits-all defaults encourages you to “sleepwalk” to retirement – you disengage from your finances or do not become financially literate.