Fee bonanza in offing for retirees who park savings
Competition for your retirement savings after you leave an employer, including when you “retire” but park your savings and continue working, is set to get interesting with potentially positive spinoffs for the fees you pay on your retirement savings.
Since 2015, you are not obliged to start drawing a pension when your employer retires you, but have the right to leave your savings in the fund or transfer them to a retirement annuity (RA) until you elect to retire and buy a pension or annuity.
Employers may be eager to ditch older, higher-earning employees, but the National Treasury saw fit to allow you to preserve your retirement savings while you continue working — for example, as a consultant — after formal employment.
The concession came partly at the behest of financial services companies seeking a resolution to the problem of complying with tax legislation when dealing with retirees who failed to inform their funds what portion of their savings to pay out as a lump sum and what portion to use to purchase an annuity.
But if you can work beyond your formal retirement date, the change that was made to the Income Tax Act can work in your favour in two powerful ways.
First, it reduces the number of years for which your savings will have to provide an income.
Second, it allows your savings to compound for longer. This can have a huge impact on your income in retirement, especially in the face of our increasingly long lives — with potentially 30 years postretirement.
At the time the tax act was amended, actuaries and consultants at Simeka in the Sanlam group published a calculation that showed that a retiree with savings able to provide a pension equal to 50% of his or her income at age 60 could increase that pension to 94% of his inflation-adjusted income by leaving the money invested and continuing to work until age 70.
When the change was introduced, the rules of some occupational retirement funds did not provide for members who wanted to preserve their savings in the fund after retirement from an employer.
But since then, the Pension Funds Act has been amended to introduce new default strategies and, as of March 1 this year, retirement funds must by default preserve your savings in your fund after you leave employment for whatever reason — retirement or resignation.
If you want to be paid out or to transfer your savings, you must request as much.
Furthermore, the draft regulations have created what Rowan Burger, head of strategy at Momentum Investments, described at the recent Pension Lawyers Association conference in Johannesburg as a bit of an “earthquake” in the retirement fund industry.
The regulations state that if you preserve your savings in your employer-sponsored fund, the fund cannot charge you a higher fee than it was charging you when you were contributing to the fund.
This means preserving in your existing fund could offer you a lower fee than if you transfer your savings to an RA or preservation fund.
Umbrella funds that cater for members from multiple employers have a practice of charging members from larger employer groups less than they charge members from smaller groups.
But, as Burger explains, if you preserve your savings in the fund after you leave an employer, the fund trustees may have a hard time explaining how charging, for example, one former employee a fee of 0.4% and another 1% meets the objectives of treating customers fairly.
This could ultimately lead to all members of umbrella funds being charged the lower fees.
As of March 1, there is a third option for those who continue working after formal retirement: to transfer your savings to a preservation fund.
This option was initially not allowed as preservation funds provide for you to make a single withdrawal, which could be part of or all your savings.
The Treasury was concerned that this would counter its efforts to get retirement savers to use at least two-thirds of their savings to buy a pension that would sustain them through retirement.
But an amendment to the Income Tax Act means you can now preserve your savings in a preservation fund until you elect to retire. However, you will not be able to withdraw the entire amount in the single withdrawal as other preservation fund members are able to do.
This means three different funds will be competing for your savings if you postpone your retirement — your employer-sponsored standalone or umbrella fund; RAs; and preservation funds. Most large financial institutions offer all three funds and may need to give some thought to whether they want one fund to be more competitive than another.
For us, as members, Burger advises that we use the costs our employer-sponsored or umbrella fund is offering as a benchmark. If an adviser wants to persuade you to move to another fund, they will have to show you why it will be worth your while to incur the higher costs, he says.
The change to the Income Tax Act can work in your favour in two powerful ways