Why are so few South Africans able to retire comfortably?

By Freddy Mwabi, Actuarial Specialist

Research suggests that very few members will be able to maintain their standard of living after retirement. The question that many of our clients ask is why is it so difficult to save enough money for retirement? Is it just a lack of discipline? Is it a lack of planning or skill? Or, are the markets to blame? When one considers the fundamentals it is clear that a disappointing retirement outcome can be blamed on any one or all of the above.

But which one is the main culprit?

The planning principles
A meaningful way of measuring the pension a member will receive at retirement is to express it as a percentage of remuneration, net of contributions, prior to retirement. We term this formula the Projected Pension Ratio (PPR). A pension of about 75% of your net remuneration at retirement is generally considered to be sufficient to maintain one’s standard of living after retirement.

The four most important factors that influence the pension a member is likely to receive are: the level of contributions, the length of time during which contributions are invested, the investment return earned, and the rate at which the member’s remuneration grows relative to inflation (salary inflation). As a rule, a salary growth rate of 2% above inflation is considered appropriate for the majority of members. For very upwardly mobile individuals this rate will be much higher.

To illustrate the conditions which could lead to the desired PPR, let’s consider the position of an average member, a married male who is 25 years old, with a normal retirement age of 65. Based on the following key assumptions he could achieve a PPR of 75%.

The success of a retirement plan depends on a good outcome in respect of each one of these factors. Should any one of them fail, it is very difficult to achieve the ideal retirement income.

• If the contribution rate should reduce by 1% the PPR will decrease to 68%. If it decreases by 4% to 8.5%, the PPR will decrease to about 54%, all other factors being unchanged.
• Should the real rate of return reduce by 1% to 4.5% per annum, the PPR will decrease to about 60%. If it reduces to 3.5% the PPR will decrease to about 49%.
• If our average member were to retire 5 years earlier at age 60 instead of 65, his PPR would decrease to about 52%. This significant reduction is partly due to the lack of exposure to the powerful influence of compound interest over the last 5 years of the investment. It is also due to the fact that the pension will have to provide an income for an additional 5 years from age 60 not age 65. The cost of purchasing the pension is therefore much higher.

The secret to a good retirement outcome for a member therefore lies in the adoption of a retirement strategy at the start of their working career and sticking to it. It is actually relatively easily achieved in this way.

Trying to fix the problem when members are in their forties
What often happens is that members only take an interest in their retirement plans when they approach retirement. Let’s say that our average member runs the projected pension calculator at age 45 for the first time (having made only a 8.5% net contribution to date) and discovers that their projected pension will only be 54%. To increase their PPR to 75% over the last 20 years will require a 9.5% increase to a net contribution rate of about 18% of remuneration.

Another scenario that frequently plays itself out is that members change jobs and do not preserve their pension benefits. If a member changed jobs at 45, cashed in his withdrawal benefit and continued to make contributions (all other things being equal) he would only have a PPR of 17%. To increase his PPR to 75% over the last 20 years will require a net contribution rate of around 29% (over the last 15 years it will require 37%).

For many members who left retirement planning to their forties, the required contribution rate would be such a large proportion of their income that it would not make sense to continue to aspire to a 75% PPR. For members in this predicament the only options left are to find another job after retirement and or to scale down their standard of living.

It is very difficult to fix retirement plans if members wait till their forties and almost impossible to fix if they were not able to resist the temptation of cashing in their withdrawal benefit when they changed jobs.