Find­ing rad­i­cal new ways to fund re­tire­ment

The tra­di­tional ap­proach of sav­ing for re­tire­ment by putting away cash is out­dated. We need a dif­fer­ent way of think­ing about pen­sions if we are to en­sure that mem­bers of the older gen­er­a­tion live com­fort­ably post re­tire­ment.

Finweek English Edition - - COLLECTIVE INSIGHT - By Kevin Lings

pro­vid­ing peo­ple with a pen­sion dates back to Ro­man mil­i­tary times when it was in­tro­duced as a way to re­ward sol­diers. In 1881, Ger­many’s Otto von Bis­marck first pro­posed ex­tend­ing pen­sions to the work­ing classes, mak­ing the of­fi­cial re­tire­ment age 70 – long af­ter the av­er­age life ex­pectancy of the time, which was 40 for men and 56 for women.

In the US, the So­cial Se­cu­rity Act passed in 1935 set the of­fi­cial re­tire­ment age at 65, seven years af­ter the av­er­age life ex­pectancy at the time of 58 years.

While the no­tion of pen­sions is a con­cept cre­ated abroad and long ago, its prin­ci­ples have be­come en­trenched in South Africa over time, even though the coun­try has a dif­fer­ent so­cio-po­lit­i­cal his­tory and de­mo­graphic.

There are just 11.4m South Africans out of a pop­u­la­tion ex­ceed­ing 53m in for­mal em­ploy­ment. Ac­cord­ing to the World Bank, only 6% of South Africans can af­ford to re­tire com­fort­ably. South Africans who are fi­nan­cially able to do so may re­tire as early as 55, while com­pa­nies can in­sist peo­ple re­tire at age 65 (or even younger de­pend­ing on their em­ploy­ment con­tracts).

It is clear we need a rad­i­cally dif­fer­ent way of think­ing about pen­sions in SA if we are to en­sure our older pop­u­la­tion lives com­fort­ably into old age.

Lev­er­ag­ing prop­erty

One ap­proach could be the use of re­verse mort­gages to fund re­tire­ment.

Build­ing new houses is one of the most ef­fec­tive ways to grow an econ­omy. The ex­per­tise re­quired draws on ev­ery level of skill within an econ­omy from en­gi­neers, quan­tity sur­vey­ors and fi­nanciers to plumbers, elec­tri­cians, brick lay­ers and other labour.

US sta­tis­tics show that res­i­den­tial in­vest­ment, in­clud­ing build­ing new fam­ily homes, re­mod­elling and pro­duc­tion of man­u­fac­tured homes, con­trib­utes be­tween 3% and 5% of to­tal GDP. In SA, this per­cent­age was a mere 1.8% in 2016.

Us­ing the re­verse mort­gage con­cept you could rather use your pen­sion al­lo­ca­tion to pay off a home loan, pro­vid­ing you with a home to live in and an as­set you can bor­row against to give you an in­come in re­tire­ment.

In the US, Aus­tralia and Canada a re­verse mort­gage is a type of home loan for older home­own­ers that al­lows them to bor­row against the value of their prop­erty with­out hav­ing to pay monthly in­stal­ments. When they sell the prop­erty, they repay the money they have with­drawn from their mort­gage, or if they die, the lender sells the home to re­cover the money that was paid out. In the mean­time, home­own­ers can live on the equity built up in the prop­erty’s value and only have to pay prop­erty taxes and home­own­ers’ in­sur­ance.

In a South African con­text, and ap­plied in a slightly dif­fer­ent way, “mort­gage-funded re­tire­ment” could mean you en­ter the hous­ing mar­ket when you start work­ing. In­stead of pay­ing con­tri­bu­tions into a re­tire­ment fund, you could re­di­rect th­ese sav­ings into a bond.

At re­tire­ment age, you would have a fully paid-for house, which has grown by mar­ket value for around 40 years. You could then ap­proach a lender who would pay you monthly in­stal­ments un­til you die, which would give you an in­come to live off. The lender would take own­er­ship of your house on your death.

A house bought in SA in 1977 for R100 000 would be worth R6.1m to­day. That rep­re­sents an an­nual

com­pound growth rate of 10.82% for 40 years.

Ben­e­fits of a mort­gage-funded re­tire­ment

The ben­e­fits of a mort­gage-funded re­tire­ment ap­proach are nu­mer­ous. Typ­i­cally, we work for sev­eral years to build a cap­i­tal base be­fore buy­ing a prop­erty. By buy­ing a house when you start work­ing, you ben­e­fit from, on av­er­age, seven to 10 years of ad­di­tional prop­erty growth. The ap­proach is no dif­fer­ent from gen­eral re­tire­ment ad­vice of sav­ing as soon as you start work­ing to ben­e­fit from com­pound growth.

By for­mal­is­ing a struc­ture that al­lows you to ac­cess 100% bonds straight­away, in­sti­tu­tions and gov­ern­ment will fa­cil­i­tate greater in­clu­siv­ity in prop­erty growth while stim­u­lat­ing the econ­omy. De­mand for new hous­ing will in­crease ex­po­nen­tially, sig­nif­i­cantly boost­ing GDP growth and low­er­ing un­em­ploy­ment.

Sav­ing into your own prop­erty is far stick­ier than cash­based re­tire­ment fund­ing. One of the big­gest threats to en­sur­ing peo­ple have enough re­tire­ment sav­ings, is en­sur­ing

Ac­cord­ing to the 6%World Bank, only of South Africans can af­ford to re­tire com­fort­ably.

they don’t with­draw their sav­ings when chang­ing jobs.

House build­ing has been used as an eco­nomic stim­u­lant through his­tory. In the early 1930s, Bri­tain re­cov­ered im­pres­sively from a dou­ble-dip re­ces­sion that ended in 1932 with growth ex­ceed­ing 4% a year. Its “cheap money pol­icy” led to an in­crease in the num­ber of houses built by the pri­vate sec­tor from 133 000 in the early 1930s to 293 000 by 1935.

Prop­erty is widely used for its in­fla­tion-beat­ing re­turns. Over a 40-year pe­riod, the only time the SA House Price In­dex un­der­per­formed the CPI In­dex was dur­ing the ex­tremely high in­ter­est rates of the early 1990s. In 1990, in­ter­est rates peaked at close to 19%. In the past 13 years prop­erty has sig­nif­i­cantly out­paced in­fla­tion.

Prop­erty own­er­ship is a widely un­der­stood and as­pi­ra­tional con­cept in SA. Link­ing for­mal re­tire­ment sav­ings to a phys­i­cal prop­erty – one that you live in for many years – may be a more suc­cess­ful way of struc­tur­ing re­tire­ment.

Pay­ing zero tax on re­tire­ment in­come can ex­tend your re­tire­ment cap­i­tal by a decade or more, which is equiv­a­lent to hav­ing at least 30% ex­tra in sav­ings at the point of re­tire­ment.

Tax-free re­tire­ment in­come for men­tor­ship

An­other rad­i­cal ap­proach to re­tire­ment con­sid­ers our in­creas­ing life ex­pectancy. At age 65 (the “nor­mal” re­tire­ment age in SA) many in­di­vid­u­als are not emo­tion­ally or fi­nan­cially ready to re­tire.

SA has the dual chal­lenge of a high num­ber of youth who need jobs but don’t have skills, and older peo­ple ap­proach­ing re­tire­ment who can­not af­ford to re­tire.

Con­trary to the per­cep­tion that older work­ers are lag­gards in busi­ness, a Univer­sity of Syd­ney Busi­ness School study found that the most in­no­va­tive com­pa­nies are those where the age of em­ploy­ees doesn’t mat­ter.

We could solve both is­sues by cre­at­ing men­tor­ship roles for older em­ploy­ees to share their skills and knowl­edge with younger em­ploy­ees. In­stead of re­ceiv­ing a salary, they would be com­pen­sated through a tax de­duc­tion on their re­tire­ment in­come.

To en­sure re­tire­ment sav­ings grow in line with in­fla­tion, you re­ally only have two tools at your dis­posal: gen­er­ate enough in­vest­ment per­for­mance, or re­duce your costs.

Pay­ing zero tax on re­tire­ment in­come can ex­tend your re­tire­ment cap­i­tal by a decade or more, which is equiv­a­lent to hav­ing at least 30% ex­tra in sav­ings at the point of re­tire­ment.

The tru­ism “if you keep do­ing the same things, you’ll keep get­ting the same re­sults” has never been more rel­e­vant.

Re­tire­ment glob­ally is a chal­lenge most gov­ern­ments, busi­nesses and peo­ple are grap­pling with and it is only set to get worse over time. Tra­di­tional ap­proaches, in­clud­ing re­tire­ment ages and pen­sion fund­ing, haven’t kept pace with chang­ing longevity and de­mo­graph­ics.

SA’s de­mo­graph­ics are dif­fer­ent to global de­vel­oped mar­kets where birth rates are low (1.86 live births per 1 000 of the pop­u­la­tion per year for the US and 1.42 for Ja­pan). SA’s birth rate of 2.36 brings its own chal­lenges, but mostly it brings op­por­tu­ni­ties to ap­proach re­tire­ment with new think­ing.

With an av­er­age age of just 26.8, SA’s pop­u­la­tion may be young now but it will age. When to­day’s new­borns reach age 30, the coun­try will have an es­ti­mated pop­u­la­tion of 65m peo­ple. If in 30 years’ time 94% of South Africans are still un­able to re­tire com­fort­ably, we would have failed to rad­i­cally re­think our ap­proach to re­tire­ment.

The fi­nan­cial ser­vices sec­tor is in a unique po­si­tion to be a cat­a­lyst for the con­ver­sa­tions needed to ad­dress re­tire­ment plan­ning. As with any form of re­tire­ment plan­ning, the sooner we get started, the bet­ter. ■

SOURCE: Stan­lib

SOURCE: Stan­lib

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