Trea­sury pa­per echoes our worries about costs

Weekend Argus (Saturday Edition) - - PERSONALFINANCE -

ow much you re­ceive at re­tire­ment from a de­fined con­tri­bu­tion fund is de­ter­mined by four main vari­ables. (A vari­able is a some­thing that does not re­main con­stant.) The vari­ables are:

How much you save monthly as a per­cent­age of your in­come; How long you save; Your in­vest­ment re­turns (in­clud­ing the com­pounded re­turns on those re­turns); and

The costs of sav­ing. The first three vari­ables are fairly eas­ily track­able. You know how much you (and your em­ployer) con­trib­ute to your re­tire­ment sav­ings; you know for how long you have been sav­ing; and from in­for­ma­tion pro­vided by your fund, such as your an­nual ben­e­fit state­ment, you can see the in­vest­ment re­turns.

The fourth vari­able, costs, is like stress on the hu­man body – it can be the silent killer of your abil­ity to re­tire fi­nan­cially se­cure.

The prob­lem is that most re­tire­ment fund mem­bers sim­ply do not know about the ar­ray of costs, or un­der­stand how they are ap­plied, or what the ef­fects will be on the even­tual pen­sion re­ceived.

And the fi­nan­cial ser­vices in­dus­try has made cost struc­tures ever more com­pli­cated to en­sure that you do not un­der­stand the im­pact of costs, un­der­min­ing your abil­ity to as­sess whether you will be able to re­tire fi­nan­cially se­cure or not.

In its dis­cus­sion pa­per on the costs of re­tire­ment sav­ings re­leased this week, National Trea­sury says that since charges trans­late into lower ben­e­fits, which may be re­ceived only many years in the fu­ture, re­tire­ment fund mem­bers may not be very sen­si­tive to the over­all level of charges in their re­tire­ment funds.

But the charges levied can be dev­as­tat­ing. Trea­sury pro­vides the fol­low­ing ex­am­ple:

If the re­cur­ring charges de­ducted from your ac­cu­mu­lated

Hre­tire­ment sav­ings were re­duced from 2.5 per­cent to 0.5 per­cent of as­sets each year, you would re­ceive a ben­e­fit 60 per­cent greater at re­tire­ment af­ter 40 years, all else be­ing equal. Al­ter­na­tively, you could get the same re­tire­ment ben­e­fit by mak­ing con­tri­bu­tions over your life­time that are around 40 per­cent lower.

In a nut­shell, let’s say you have charges of 2.5 per­cent levied against your sav­ings and you re­ceive R1 mil­lion at re­tire­ment. If Joe next door saved ex­actly the same amount as you but paid charges of only 0.5 per­cent, he would re­ceive R1.6 mil­lion.

This as­sumes, of course, that both you and Joe saved dili­gently for the full 40 years and did not with­draw any of your re­tire­ment sav­ings along the way – early with­drawals are prob­a­bly the big­gest rea­son why about 90 per­cent of South African re­tire­ment fund mem­bers do not re­ceive a fi­nan­cially sur­viv­able pen­sion at re­tire­ment.

In­ci­den­tally, Trea­sury says that the non-preser­va­tion of re­tire­ment sav­ings “im­plies that costs will be higher than they would oth­er­wise be”. In other words, if fewer fund mem­bers with­drew sav­ings be­fore re­tire­ment, the cheaper it would be to man­age the money be­cause there would be more money to man­age – economies of scale would ap­ply.

The ac­com­pa­ny­ing graph, above, which was pub­lished in the dis­cus­sion doc­u­ment, shows ex­actly what the im­pact is of dif­fer­ent lev­els of charges levied on your re­tire­ment sav­ings.

In deal­ing with costs, Trea­sury dis­tin­guishes be­tween what it calls com­mer­cial funds – re­tire­ment ve­hi­cles such as re­tire­ment an­nu­ity funds, preser­va­tion funds and um­brella funds, which are pro­vided by the fi­nan­cial ser­vices in­dus­try – and non-com­mer­cial funds, such as em­ployer- spon­sored stand- alone funds and um­brella funds pro­vided by in­dus­try sec­tors or or­gan­ised labour for em­ploy­ees within an in­dus­try sec­tor, such as min­ing.

Non- com­mer­cial funds have much lower charges than com­mer­cial funds.

Trea­sury says: “Mem­bers of com­mer­cial um­brella funds or re­tire­ment an­nu­ity funds may pay a much greater range of charges, es­pe­cially if funds of­fer in­vest­ment choice. Th­ese charges may in­clude ad­min­is­tra­tion charges, pol­icy fees, ben­e­fit con­sult­ing charges, fi­nan­cial ad­viser fees, risk charges, as­set man­age­ment charges, man­ager se­lec­tion charges, guar­an­tee charges, cap­i­tal charges, per­for­mance fees, plat­form fees, and con­di­tional charges when var­i­ous events, such as switch­ing in­vest­ments, leav­ing the plan, or ter­mi­nat­ing the pol­icy, oc­cur.

“Most of th­ese charges are levied ei­ther as a per­cent­age of salary or con­tri­bu­tions, or a per­cent­age of as­sets un­der man­age­ment. Some are levied as a per­cent­age of re­turns, pos­si­bly above a bench­mark; some may be a fixed rand cost each year per mem­ber or per em­ployer.”

It is not that you should not face costs when you save for re­tire­ment. The is­sue is whether the costs are rea­son­able and fair.

It stands to rea­son that if you save through an em­ploy­er­spon­sored scheme, your costs should be lower, be­cause there is no profit mo­tive, apart from that of those pro­vid­ing ser­vices.

Com­mer­cial schemes need to make a profit, but again that profit should be rea­son­able and fair.

And it is of­ten dif­fi­cult to judge whether ex­ces­sive prof­its are be­ing made be­cause of things such as huge bonuses and other in­cen­tives that may be paid out to em­ploy­ees and agents of the var­i­ous ser­vice providers, par­tic­u­larly as­set man­agers.

SOUTH AFRICA OUT OF LINE

When costly struc­tures are used, it is right that ques­tions are asked about costs. By any mea­sure, the costs and charges be­ing ap­plied in South Africa are way out of line with other coun­tries. Per­sonal Fi­nance has re­peat­edly dealt with most of th­ese cost is­sues over many years, and it is pleas­ing to see that all the is­sues are in­cluded in this very com­pre­hen­sive and well­re­searched doc­u­ment.

We can all be sure that the in­dus­try will come out fight­ing. It will at­tempt to jus­tify many of the bad prac­tices it has adopted over the years, from un­ac­cept­able con­flicts of in­ter­est, to mis­lead­ing in­vestors and re­tire­ment fund trus­tees, to plac­ing the in­ter­ests of its prod­uct flog­gers over con­sumers.

Trea­sury, how­ever, must per­se­vere. The in­dus­try must be brought to heel and pro­vide value for money and stop ex­ploit­ing con­sumers. This does not mean it should be brought to its knees. It is a vi­tal in­dus­try.

Re­form of the re­tire­ment fund in­dus­try, which is in the in­ter­ests of both in­di­vid­u­als and the broader econ­omy, is over­due. Fi­nally, I sug­gest two things:

Re­mem­ber that you alone are re­spon­si­ble for the first two vari­ables, namely how much you save and how long you save (and this in­cludes not with­draw­ing re­tire­ment sav­ings be­fore re­tire­ment).

Go to the National Trea­sury web­site (www.trea­sury.gov.za) and read the charges dis­cus­sion doc­u­ment. It is an ed­u­ca­tion for in­di­vid­u­als as well. It will show you where you may be un­fairly ex­ploited, which will en­able you to take al­ter­na­tive ac­tion or make bet­ter choices.

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