Treasury paper echoes our worries about costs

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.