Issue: April 2005

Now You See Benefits, Now You Don't

Check on how much you’ll actually receive on your retirement, and you might get a fright. Having paid into a fund bolstered by your employer, you might be looking forward to a comfortable life as a pensioner. Chances are you’ll have to think again. What you thought you’d get could be very different from what you will get.

There’s often a world of difference, sad to say, between the projections on which retirement products are sold and the realities of ultimate payout. The projections are dressed in the hyperbole of salesmanship. Projections for salary increases, inflation and investment returns are at best illustrative thumbsucks, at worst flights of fancy, which can lull unsuspecting buyers into a fool’s paradise.

The day of retirement might arrive as a cold shower. If the heady projections haven’t materialised, people who have relied on them will get not a cosy nest egg but a big shock.

This is starkly apparent from a single table in National Treasury’s discussion paper on retirement- fund reform, that will be scrutinised and debated for months ahead.


Years of contribution 
before retirement
real return
real return
real return


If the contribution rates changes, the discussion paper notes, the replacement ratio changes proportionately. On a 3% real return, the after-expenses replacement ratios at different contribution rates would be:


Years of contribution 
before retirement
Replacement ratio contribution rates of

The table (right), stripped of salesmanship, shows various “replacement rates”. These are essentially the percentage of final salary paid to the member after retirement. Related to it is the “replacement ratio”, which is retirement income expressed as a percentage of a person’s salary immediately before retirement.

What the table possibly suggests is that few, precious few, South Africans have much hope of being financially independent when they retire.

That they will be unable to maintain their living standards is primarily a consequence of having started too late in their working lives to save, and having diverted their retirement savings into debt repayments and consumption when they were able to do so – for example, when they changed or lost their jobs.

The discussion paper frames this moral in more positive terms. It says the table highlights the benefits of contributing, in sufficient amounts, for a long time towards retirement – and of staying invested.

Indeed it does. But how many people have? Conventional wisdom in the industry is that 9% of South Africans will retire financially independent. It would be a relief if the number were in fact so high. At a guess, even 9% of the roughly 7,7 million members of private-sector retirement and retirementannuity funds could be optimistic when viewed in the context of South Africa’s dismal savings pattern.

The table assumes that 10% of payroll, after expenses and risk benefits, goes to retirement. In this event, the various replacement rates in the table will be achieved on real investment returns (after inflation) of 2%, 3% and 4% respectively. In other words, if inflation is running at 6%, the nominal investment return would need to be 10% for a real return of 4% to be achieved.

It has been calculated that conversion from savings accumulation to retirement income will take place at a rate where R13,80 of capital will buy R1 of pension at age 65. Under current market conditions, say the authors, this should enable retirement funds to pay increases equal to the rate of change in the consumer price index (inflation).

Now look again at the table. The general industry guide is that, to achieve a 75% replacement ratio, a person retiring at age 65 would need a minimum of eight times final salary. In an environment of fairly modest inflation, 10 times would probably be safer.

What the table tells us is that only people who’ve saved for over 45 years (where their funds have earned a 3% real return) and those who’ve saved for 45 years (where their funds have earned a 4% real return) can look forward to financial independence. If you aren’t in this category – and chances are you aren’t – you certainly aren’t alone.

Of course, people could have sources of savings other than retirement funds. For example, by retirement age their mortgages might have been paid off.With children off their hands, they might be able to realise the capital appreciation on their houses. They could then downsize their accommodation, using the balance of the house’s capital to help fund their retirement.

Final salary is an important yardstick because it normally represents remuneration at its highest career level and covers the standard of living to which new retirees have become accustomed.While they’d have discretion to travel less, for instance, they’d have little control over what they cannot anticipate. This includes their likely longevity, their medical expenses and inflation.

What sort of real returns on regular amounts invested have actually been earned? In the 20 years from 1981-82 to 2001-02, they’ve varied considerably (see graph).

These, though, are gross returns. Deducting estimates of likely costs at current levels – 0,6% for retirement-fund tax and 0,6% for investment-management fees – while adjusting 1% for salary increases above price inflation, suggests to the authors that “a rate of 3% real is reasonable if the trend stabilises at current levels”.

The replacement rate from the average defined contribution retirement fund is slightly more than the rate in most developed countries. But this observation by the authors is founded on vital assumptions that there have been real rates of return at 3% and that the retirement- funding contribution has been 10% of salary net of expenses.

Most vital of all is that the contributions were made throughout an employee’s working life. Therein lies the rub.

For one thing, to use the authors’ terminology, “leakages” from retirement savings have been “significant”. For another, it presupposes formal-sector jobs where employees have been required to save or have used the opportunity to save over the duration of their working lives. They’d be the fortunate. It’s the less fortunate and the unfortunate – whether by economic circumstance or their own volition – who’ll be learning the hard way.


Retirement-fund members must have both direct and indirect costs disclosed to them, and have a clear illustration of how much of their total retirement-fund contribution effectively goes towards paying various costs, including the cost of the provision of risk benefits.

Furthermore, commissions and fees paid to service providers should be fully justified to the board of management of a fund, and should not be disproportionate to the value of the service or product provided.

– Retirement Fund Reform discussion paper


In the 1980s and 1990s there was a “dramatic transfer”, the discussion paper recalls, of employees in the private sector from defined-benefit to defined-contribution (DC) funds. Employers, trade unions and white-collar employees all saw advantages in it.

In a DC fund the investment and expense risks are transferred from employer to employee. The member’s retirement benefit is secured by the accumulation of contributions, fixed as a percentage of remuneration less expenses, at the nett investment return earned by the fund.

The paper adds: “Where the contribution rates by members and employer are fixed in total, the members bear any increase in expenses such as rising insurance premiums as a result of HIV/AIDS. Members’ benefits are directly impacted by any investment gains or losses.”


The discussion paper is an incisive and comprehensive piece of work. Produced under the direction of Elias Masilela, deputy director-general in National Treasury, the main authors in his department were Jonathan Dixon, Baron Furstenburg and Martin Grote. Also involved, from outside the department, were actuary Jeremy Andrew and attorney Rosemary Hunter.