Index forecasts a lower pension when you retire

Alexander Forbes’s Pension Index shows that your pension will probably be lower than you expect, and you’ll need to save more to make up the difference, writes Laura du Preez.

The average retirement fund member in their 40s or 50s may retire with only half or two-thirds of the pension they are targeting, as returns on their retirement savings are likely to be lower in future and the cost of buying a pension has risen.

This is highlighted in the latest Alexander Forbes Pensions Index, which shows the changes, since the index was launched 12 years ago, in expected replacement ratios – the pension you are likely to receive expressed as a percentage of your final income – for members of defined contribution funds.

At retiremeht, members of defined contribution funds receive the investment value of the contributions they and their employers have made to the funds and must use at least two-thirds of these savings to buy a pension.

Alexander Forbes, the country’s largest retirement fund administrator, launched the index on January 1, 2002, tracking the change in replacement ratios of members born in 1952, 1962 and 1972. The index is based on the assumption that members saving 13.3 percent of their salaries (including employer contributions) from age 25 to age 65, retire with a replacement ratio of 75 percent of their final salaries.

Recently Alexander Forbes added an index value for a member born in 1982.

The changes in the index paint a gloomy picture: if you had been on track in 2002 to achieve, when you retired at 65 years, a replacement ratio of 75 percent, you may now be looking at a ratio of only about 50 percent if you are in your fifties (25.2 percentage points off the 75-percent target) or just over 40 percent if you are in your forties (34.9 percentage points off the 75-percent target).

The index shows that the average member born in 1952 and now in their early sixties would be nine percentage points off the 75-percent replacement ratio, at 66 percent.

In terms of the assumptions of the index, members in their thirties started saving at age 25 in 2007, when expected investment returns were already lower than in 2002. As a result, such a member, saving at a contribution rate of 13.3 percent, was not saving enough even then to provide a pension of 75 percent of his or her income at retirement.

However, since the fund started tracking this member’s savings, the member’s replacement ratio has declined by 9.3 percentage points to 37.6 percent of final income as a pension at age 65.

John Anderson, the managing director of research and product develop- ment at Alexander Forbes, says the decline in index values can be largely attributed to the fact that bond yields have fallen sharply since January 2002.

This had led to expectations that retirement savings will ear n lower investment returns going forward, and the price of an annuity, which you must buy with at least two-thirds of your retirement lump sum to provide a monthly income, has gone up.

ECONOMIC CHALLENGES

Anderson says there are two big economic challenges, both locally and globally, that are likely to affect your retirement savings. They are:

Reversing the liquidity and credit bubbles that formed as the world tried to recover from the global financial crisis. He says this is going to happen, but trying to either time it or work out which asset classes it will affect most is uncertain. If economic growth were to pick up, a lot of this pain could be avoided.

Slower economic growth over the long-term, compared with the past. This will be the most significant issue for retirement funds, Anderson says. If future economic output dips and the global economy doesn’t grow, retirement funds will lose value because either share prices and other investment values will fall or the prices of goods and services will rise, he says.

Anderson says the expected lower growth will mainly be due to:

The global financial crisis damaging the supply-side of the economy. Companies shut down, people were unemployed for long periods of time, skills decayed, capital decayed, and there was very little additional investment as companies (and governments) cut back on costs and investments – basically, a lot of “shooting ourselves in the foot for shortterm profits”.

The high growth rates of emerging markets are slowing to converge with the lower growth rates of developed economies. The higher the base, the harder it is to grow at that rate – this is just mathematics, and fairly wellaccepted in economic theory, Anderson says.

In South Africa, the link between the economy and investment returns is fairly weak because:

So many local listed companies derive a significant proportion of their revenue from outside of South Africa;

South Africa has one of the most liquid financial markets among emerging economies, whether it be in currency, bonds or, to a lesser extent, equities, so investors will regard an investment in our bonds and equities as being representative of one in emerging markets;

Foreign investors have become key players in our markets and they make decisions based on their local interest rates.

Anderson says real (after-inflation) interest rates are likely to remain relatively stable over the next three to five years, but the biggest concern is the downgrading of the country by ratings agencies, as this lowers the attractiveness of the country to foreign investors.

However, over the 30- to 40-year period for which you are saving for retirement, the influence of these factors should “even out”, he says.

Anderson says the Pension Index is not a substitute for an individual assessment of your savings by a professional financial adviser, but measuring the change in the expected pensions of average members over time does provide you with an indication of how your retirement prospects change.

Alexander Forbes has developed a Retirement Savings Tool for you to work out what income your savings will provide you with in retirement.

The tool is available on Alexander Forbes’s website (www.alexanderforbes.co.za) and in both Apple and Android app stores.

You will need to fill in information about yourself, such as your age, current retirement fund savings and intended retirement age. The tool will show you how far off you are from a target pension of 75 percent of your income under three different return scenarios.

This can help you make critical decisions, especially when you join a new employer, such as how much to contribute and what your retirement age should be. The tool also guides you on the steps you can take to improve your retirement funding position.