Retirement savings: why preservation is so important

By Mayuri Reddy Actuarial Specialist Sanlam Employee Benefits

A significant portion of employees do not have an adequate understanding of the consequences of cashing out their retirement fund benefits when changing jobs and employers aren’t helping them to come to terms with the implications.

This is one of the key takeaways from this year’s Sanlam Benchmark Survey. The survey, which will be released later this month, is the result of engagement with standalone employer funds, employers in umbrella funds, active pension fund trustees and pensioners. It highlights current trends, issues and perceptions in the retirement industry.

Early withdrawal is one of the main reasons why many South Africans can’t retire comfortably. A lack of preservation means savings don’t have enough time to accumulate and members lose out on the significant benefit of compound interest over long time periods.

Viresh Maharaj, marketing actuary at Sanlam Employee Benefits (SEB), says of current members who have withdrawn their pension fund benefits, 40% regret their decisions. Just over 45% did not have an idea of the consequences that taking their benefit in cash would have on their retirement outcome.

“That’s big. Almost half of members who withdrew, had no idea that this would affect their retirement outcome negatively,” he says.

Of current members, 49.3% did not realise the level of tax they would need to pay on their withdrawal benefit.

It seems many of the issues the industry is grappling with emerge during the induction process when members first join an employer.

Mayuri Reddy, marketing strategist at SEB, says 74% of employers emphasise the member’s responsibility in a defined contribution fund when members first join, in other words, that members are responsible for the retirement outcomes (not the employer) and that they need to make sound decisions.

Reddy says 65% of employers provided access to information and told the members how and where they could access it, while 53% highlighted how important preservation was when members leave the fund.

However, 36% of members say they didn’t receive any communication on retirement benefits when they joined the company. Of those that did receive an explanation of retirement benefits during their induction, 57% said saving early was emphasised while 53% indicated that tax benefits came up quite strongly.

Reddy says although the industry believes it is stressing important topics like preservation and investments, only 12% and 19% of members respectively cited receiving this information. She says members’ focus seems to be on those topics that affect their immediate environment like saving early and tax benefits, while decisions around preservation and investments are taking a back seat and are postponed to a future date.

What makes the situation even more concerning is that the 12% of members who recall being informed about preservation during their induction, represents just about 8% of the total sample.

The impact of non-preservation
The graphs below illustrate the impact of withdrawing retirement benefits early.

The first slide depicts the savings journey assuming a monthly income of R5 000 in year one, a 12,5% contribution rate and the withdrawal of the retirement benefit every five years when changing jobs.

Maharaj says although it sounds like quite a bit of churn, younger people tend to change jobs more regularly than in the past.

The top graph in the slide below (purple) shows the capital accumulation over time. The member accumulates savings and withdraws the savings in cash every five years, effectively “rebooting” the retirement savings. After the final five years of employment, the member retires and lives off the capital accumulated over the last five years of employment, he explains.

The bottom graph in the slide below (turquoise) shows the employee’s salary, which increases at a regular rate. The blue bars show the income from the annuity the employee would be able to purchase with the capital that was accumulated.

Source: Sanlam Employee Benefits

Maharaj says the solid purple lines in the top chart of the slide below (barely visible at the bottom) represent the capital (savings) from the previous purple graph (on an adjusted scale). The lighter purple graph shows what the retirement savings could have looked like, had the member preserved the capital every time he changed jobs.

Source: Sanlam Employee Benefits

By preserving retirement benefits at each resignation the capital at retirement is about 16 times as much as it would have been had the employee continued to withdraw every five years. “[Having] 16 times your capital at retirement makes a material difference to the quality of life that you have,” Maharaj says.

The benefit of preserving retirement capital is also visible at an income level (light purple bars on the bottom chart), with the income at retirement around six times as much as it would have been had the employee decided to cash out every time he changed jobs.

The solution?
Ultimately, the high percentage of people who aren’t able to retire comfortably is a complex problem that requires a multidimensional approach.

It may be worthwhile to look at examples from other industries.

The prevalence of smoking in the US, South Africa and Australia is considerably less than it was 20 years ago because of a coordinated, dedicated effort by government to implement a programme of stopping people from smoking at earlier ages and through their life cycle because it is beneficial to have a healthy population, Maharaj says.

He says although there have been various advertisements promoting the use of seat belts, the step that made the biggest difference was when it became illegal not to wear a seat belt. A step in the complex solution is compulsion, Maharaj says.

“We need to apply our minds on how compulsion can set people up for success as opposed to the independence and autonomy we currently provide, allowing them to fail,” he says. Ultimately the answer is probably a mix of legislation, fund governance and structures and getting people to care, he says.

“Knowing isn’t good enough.”

Sanlam Life Assurance Company (Ltd) is a licensed financial services provider.