Defaults and a dummy’s guide to product choice
By Karen Wentzel
During July 2015, National Treasury published the which set out detailed requirements to consider when setting up default strategies.
As the current system provides no protection for members at retirement, individuals have been left on their own to make one of the most important financial decisions of their lives. Most people have focused on building wealth before retirement, while paying no attention to what should happen at and during retirement.
All retirement funds should have an active responsibility to assist exiting members, many of whom are at their most vulnerable when they retire, with little or no financial advice provided. The draft regulations stipulate, therefore, that all defined contribution retirement funds will be required to have a default annuity strategy in place.
There are several reasons why people may choose not to make a choice. They may feel they’ll make the wrong decision. They might simply not enjoy choosing. They might be too busy. They might lack sufficient information or could be overwhelmed by too much information. The role of trustees is thus very important in setting up the appropriate default solution.
The following options are allowed as default annuities:
Guaranteed pensions, living annuities, with-profits pensions
Life annuities guaranteed
by insurers Trustees will be allowed to mix different products as part of the strategy. Funds must give members access to retirement benefit counsellors to assist them with understanding the defaults. Defaults will not be compulsory and members will be allowed to opt out.
Treasury’s requirements for a fund’s default annuity strategy are: good value for money, well communicated to members, and transparent
disclosure on all fees and charges.
For all life annuities, the pensioner will carry no longevity or investment risk, as initial pensions and increases are guaranteed for life and guaranteed to never decrease. These annuities provide the annuity holder with a pension that increases at a fixed rate over the remainder of their life. These annuities will provide the highest initial pension, but pension payments may not necessarily keep up with the increase in the cost of living. The inflation-linked annuity provides pensioners with a guaranteed monthly pension with annual increases equal to inflation (CPI), to protect the pensioner’s purchasing power. Pensioners can choose to receive between 50% and 100% of CPI inflation increases. Index-linked annuities provide pensioners with a guaranteed monthly pension with annual increases linked to published indices, for example the All Share Index or All Bond Total Return Index. Normally an explicit, fully transparent formula is used to determine the increases, which removes all subjectivity and associated conservatism.
Living annuities provide pensioners with an income from their retirement savings with flexible investment choice and withdraw rates. In exchange for this flexibility, pensioners take on the risk that they outlive their savings and the risk of poor investment returns.