Making retirement contributions meaningful
Most working South Africans rely on the money saved in their employer's retirement fund to provide them with an income in retirement.
For many people, these are their only formal savings but too often, this money is not enough to sustain them in retirement, explains Vickie Lange, head of institutional best practice at Alexander Forbes.
Alexander Forbes Member Watch analyses over one million retirement fund members' behaviours and retirement outcomes. It has found that more than 50% of pension fund members who retire each year receive less than 20% of their pensionable salary as an income in retirement.
"The first problem is that people don't consciously connect what they are contributing now and what happens when they retire in the future. It is an abstract concept that people struggle to connect with," says Lange.
Generally most members default into the lowest contribution category.
If you're saving 13% of your pensionable salary for your entire working life, you will get less than R60 for every R100 earned at retirement, as a pension income. But if you're saving 17%, then R75 for every R100 is achievable, explains Lange.
If you are currently 40 years old, you should have saved at least 3.2 times your current annual salary. By age 65 (at retirement) you need to have saved 12 or more times your annual salary. This is calculated on a 75% replacement ratio.
Auto-escalation of contributions over time could be a way to increase contribution rates without significantly affecting employees' take-home pay.
This concept has worked around the world to raise contribution levels, according to Lange.
A small 0.25% increase each year since 2012 at salary increase time would have led to a 1.5% of salary contribution rate increase by 2018, leading to an almost 10% improvement in expected retirement benefits for younger members.
"Retirement funds are also tax incentivised and making contributions is a sensible way to save. If you assume a marginal tax rate of 36%, and you contribute an extra R1 000 a month, your take-home pay will be reduced by only R640," says Lange.
"One of the benefits of contributing more is a greater tax deduction. Another is that money in the fund can grow without being taxed while in the fund – this means you pay no dividends tax, no capital gains tax and no tax on interest. You are only taxed when you withdraw your savings from the fund."
Retirement funds tend to offer flexibility regarding contribution rates - or even contributing a portion of your annual bonus - so that you can contribute more.
If you are unable to do this, or if you don't want to contribute more to that fund, retirement annuity funds and tax-free savings accounts are an option, according to Lange.
Changes to regulations for pension funds have meant that service providers are starting to offer retirement savings options at lower cost.
"Remember that the decisions you make today will have ramifications for others. Consider the implications for your family or children," says Lange.
"Contact your fund for the options open to you, including the availability of retirement benefit counselling, or speak to an accredited financial adviser for advice on your individual situation."