Proposals by National Treasury aim to simplify retirement savings and reduce costs.
National Treasury recently released its latest paper on retirement reform entitled Retirement reform: lowering charges and improving market conduct in which it makes recommendations for default retirement options which will provide a reasonable retirement solution to those individuals who don’t want to be actively engaged in their retirement decisions.
Default options are automatic choices made on behalf of members who do not exercise their choices in a given situation.
The recommendations in essence will require pension and provident funds, as well as retirement annuity funds, to have a default investment option for all members, not only for the accumulation of their retirement funds but also when changing jobs or retiring.
Most retirement funds already have default options in place for members who do not make an investment selection, however National Treasury argues that “in many cases, individuals are automatically defaulted into investment strategies that have complex and high charges, complex policy conditions, exit penalties and/or expensive guarantees.” It further argues that funds do not make sufficient use of cost-effective passive investments, opting for more expensive actively managed funds.
National Treasury is therefore proposing specific criteria for these default funds including low costs, the use of passive funds and the banning of investment performance fees. Not only must all fees, as well as the impact of those fees, be disclosed to members, but National Treasury also requires that fees be competitive and benchmarked on a regular basis. Trustees will also need to ensure that any default option is appropriate based on each member’s age, time horizon and income.
Considering that the vast majority of retirement fund members use the default option, improving policies around default options will ensure that the long-term interests of members are looked after, rather than the interests of service providers.
The default options are also aimed at improving preservation rates by requiring that all retirement funds into which members are enrolled as a condition of employment, have a default preservation strategy.
This means that on resignation, a member can either leave their retirement funds with the former employer or transfer the funds to the new employer’s preservation fund. This would allow members’ retirement savings to follow them automatically from job to job as they change employment throughout their careers.
On retirement, default annuity funds will be available to retirees. National Treasury raised concerns that under the current system, retirees have no protection or advice when they retire, “making it too easy for individuals to fall prey to unscrupulous advisers or make the wrong investment decisions.”
National Treasury argues that all retirement funds have a responsibility to assist exiting members and that all defined contribution retirement funds, including retirement annuity funds, will be required to have in place a default annuity strategy.
Funds must also make retirement benefit counselors available to members on retirement to assist them in understanding the default annuity strategy. This means that members will not have to purchase annuities in the retail marketplace, which could significantly reduce costs for retirees. It is important to note that members can however opt out and move into other annuity products of their choice if they wish.
A recent discussion with a 30-something year old, who had recently moved to a new company, revealed that he had been forced to cash in his pension fund even though he wanted to preserve the money. The lack of co-operation of his former employer had made it just too difficult. He was further confounded by the difficulty of finding an appropriate investment vehicle for his funds.
So cashing in, paying the tax and transferring the money into his bond was just easier. Unfortunately the long-term impact to his retirement savings will be significant, reducing his pension income by around one-third.
It is exactly this scenario that National Treasury is hoping to address with these proposals. While currently an employee would need to receive financial advice in order to preserve their funds, under the new proposals they would be required to receive advice before cashing-in, ensuring they fully understand the long-term implications of their decision.
Furthermore, by insisting that the former employer provide a paid-up certificate which the new employer is obliged to request from the new employee, the onus is placed on the employer to assist the employee in preserving the funds. It will also make it easier for individuals to consolidate their funds and prevent the current situation where individuals have multiple preservation funds incurring high costs and further administration.
From an employer’s perspective, the amount of upheaval to meet these requirements will depend on the fund structure. Employers who use umbrella funds, which pool the retirement investments of multiple employers, may find that the default preservation structure is already in place. For employers with stand-alone funds, changes to the fund rules would need to be made.
Currently, depending on which fund you speak to, the rate of preservation is around 10% to 30%. The younger the employee, the more likely they are to cash in their retirement fund. In its earlier papers, National Treasury indicated that it would wait to see the outcome of incentives to preserve retirement funds before considering compulsory preservation.