Edition: Jun - Aug 2014
Eat, drink and be merry while you can. Updated longevity projections are frightening for retirement provision.
So you don't want to retire destitute. Statistically, however, the odds are loaded against you.
Okay, maybe not destitute strictly defined but something that closely resembles it when lifestyles crash after careers at work. For the great majority of South Africans, who've saved inadequately, there are perhaps only four ways out:
Palliatives are on offer, like working beyond retirement age and embarking on second careers. They aren't risk-free alternatives. Physical health might outlast mental health. Younger people looking for jobs might outnumber older people needing to retain their own; and corporates, additionally under employment-equity pressure, might prefer the younger who're more in tune with market trends and modern technologies than the older whose experience is seen to count for less than exuberance.
Antidote to longevity
It's for good reasons that National Treasury is pushing hard at retirement reform. It wants fee structures and product costs reduced, not necessarily to have a go at the profits of savings institutions but certainly to improve the ultimate benefits for savers. It wants to enforce preservation because keeping pensions in the pot is the only means by which future pensioners can optimise the wonders of compound interest.
The concern of the nanny state is to avoid legions of impoverished pensioners dependent on it. That should be the concern of future pensioners too, but they're inordinately slow in getting the message. Long-term saving falls victim to short-term indulgence. Pensions provision is subordinated to the "môre is nog ŉ dag" syndrome.
THE BIG THREE
Two of the major risks retirees face, about which they can do little, are inflation (equities remain the best bet) and investment performance (but a living annuity at the bottom of a market cycle can leave you stuffed).
The third is that you don't know for how long you'll live. If you've done your numbers and feel depressed, there are ways to shorten your longevity prospects.
So bring on the big stick of compulsion to the advantage of state and individual alike; perhaps, for that matter, also to the compensatory advantage of savings institutions when retirees are forced into the purchase of annuities. The dismal savings pattern of SA households reflects scant fear for the day that salary cheques must end and the consumption of retained or deferred income must begin.
Treasury's proposals are predicated on the realisation that lower-income earners, who'd in any case be dependent on state benefits, have a lower threshold of a suggested R150 000 not to annuitise. The upper threshold, tentatively put at R1,5m, is primarily intended "to act as a ceiling on the amount of longevity protection required to ensure that retiring individuals have adequate cover against living too long".
Longevity is the nub. Annuitisation is its bedfellow. To match ever-increasing longevity with ever-rising income from annuity policies is the problem. The former is a probability for those who've enjoyed access to first-world health care. The latter is an improbability for those hoping to maintain post-retirement a semblance of their pre-retirement lifestyles; unless, that is, they've squirrelled away the capital gains made en route or put away at least 15% of their salaries from day dot to keep drawdowns minimal.
Not many have. For those amongst them, now approaching retirement, it's too late. Best to be said is that their awaiting fate brings younger employees to their senses. Numbers don't add up.
In its discussion paper 'Enabling a better retirement', National Treasury proposed that "some measure" of longevity protection for individuals be increased through the design of a default product "possibly through purchasing life annuities from life insurers". It suggested numerous criteria – such as minimal member choice, transparent charges, a low regulatory burden on providers and payment of an initial commission only – all intended to reduce costs and hence to increase benefits.
As matters stand, without changes to the tax and commission structures, what would be the approximate costs and benefits of annuities? TT sought some examples purely for broad illustrative purposes.
Poobalan Govender, an actuary at Old Mutual, used the example of an individual wanting an initial monthly pension of R50 000 before tax. To calculate the cost, Govender then assumed that the pension would increase annually by inflation at 5%, and converted this cost to a multiple of the initial pension required.
He used an initial monthly pension amount of R50 000 (before tax) and then, to calculate the cost, assumed that the pension increases annually with inflation at 5%. He also converted the cost into a multiple of the initial annual pension required.
Assumptions are specific to guaranteed and living annuities:
The table below shows, for this individual, the comparative costs of a guaranteed annuity and four living annuities with respective terms of 15, 20, 25 and 30 years, net investment returns of cpi + 3% and a starting pension of R50 000 increasing annually with inflation.
The multiple of initial annual pension required can be interpreted as follows: for example, the 14 multiple for guaranteed annuities would imply that for every R1 of annual pension in your first year in retirement, you'd need R14 saved at your retirement date. If you wanted an initial pension of R100 000 (i.e. R8 333 per month), you'd then need R1,4m at retirement.
Costs for the guaranteed annuity were calculated for a single male (i.e. excluding dependents) aged 62. The costs for females, couples and younger ages will be higher.
Rory Gruss, a financial planner at Momentum, was asked to illustrate the monthly pension for a 62-year old male who invested his R8m pension pot in a living annuity on retirement.
Assuming a "cautious" asset allocation (e.g. 40% in equities), initial costs at 1,14% (i.e. resultant investment at 98,56% of the R8m) and ongoing costs of 1,75%, he estimated (without making provision for tax):
Assuming a 6% annual income increase and an investment return of 6%, an initial monthly drawdown at R30 000 would take 18 years to deplete; at R28 000 it would take 22 years, and at R25 000 it would take 27 years.
More optimistically, average annual investment returns of 12% would take each of these drawdowns more than 30 years to deplete. For the investment used in this example – it includes a 32% allocation to a portfolio with a capital guarantee and offshore exposure at 15% – the return over the past 12 months exceeded 13,5%.
Long may it continue. As it's repeatedly stressed, however, past performance is no assurance of future performance especially when only one year is cited.
Savings accumulated over a working life of 40 years, which could provide for a comfortable retirement of 10 years, cannot equate to a comfortable retirement of 30 years. Planning to live until age 75 is obviously dissimilar from planning to live until age 90, throwing the miracles of modern medicine and the desirability of increased longevity into imbalance.
Then throw further imponderables into the mix. One is that equities, which must balance an investment portfolio, do not forever surge upwards. In the past decade, there've been two major bear markets. Consistently to achieve inflation-beating returns is not a given.
Another is the individual's real rate of inflation against the official consumer price index (cpi). Consider, for example, that in 1979 the price of a sirloin at an upmarket Hillbrow steakhouse was R5. In 2009, with the equivalent restaurant now in Sandton, the price was R115. Projecting this same inflation rate to 2039 – 25 years hence, when many people retiring today at age 60 will still be alive – it will have increased to R2 645.
Don't fret. It's merely an indication. Retirees don't need to eat steak in Sandton, much as they might previously have been accustomed to it. But do fret if it also illustrates the trajectory of medical expenses, unavoidable in the aging process.
On standard projections, Simeka strategy head Kobus Hanekom calculates that an individual needs to set aside 12,5% (net of administration costs and risk premiums) of remuneration – and enjoy an investment return of cpi+5,5% over a period of 40 years – to achieve a projected pension equivalent to 75% of final remuneration net of contributions.
"Very few South Africans enjoy the benefit of all three components at the appropriate level in their retirement plans," he points out. "For example, if an individual retires after 35 years at age 60, his or her projected pension will drop from 75% to 52%."
The 35 to 40-year investment term is a problem for many graduates, he adds, when their long periods of study enable them to enter formal employment with pension benefits only at about age 30: "If their chosen career coincides with an early retirement age of 60 years, the 30-year investment terms will yield a very disappointing pension." Of course, it will be still more disappointing if any proportion of pension savings has been cashed along the way.
Some experts believe that individuals should now be making provision for a life in retirement stretching by up to 40 years on average, reckons Sanlam chief marketing actuary Viresh Maharaj. "The risk is that South Africans will simply not have enough money by the time they retire to carry them through," he says. "The risk is exacerbated by the reality that many people going into retirement will need to support their children – given SA's high rate of youth unemployment – as well as their own parents who themselves will live longer."
One of his suggestions is that the value of guaranteed annuities, where the risk is borne by the insurer and not the retiree, be "reconsidered". Put bluntly, it implies either that guaranteed annuities for 25-year periods be priced so expensively that people from age 60 will be hard-pressed to afford them, or that insurers could go bust in providing them.
And when he mentions retirements stretching by up to 40 years "on average", there's another twist on living annuities. "When you invest in one, you can't aim for the average even if you represent the average," points out Tracy Jensen of 10X Investments. "You then have a 50% chance of living longer than the average. That's quite a high failure probability if you ask me."
In 2011, for the first time in history, the life expectancy at birth across Organisation for Economic Cooperation & Development (OECD) countries "on average" exceeded 80 years. This was an increase of 10 years since 1970, and those with better educations tended to exceed the average. In the UK, according to data from the Office for National Statistics, one in three babies born last year will live to celebrate their 100th birthday and the total number of centenarians is projected to rise from 14 000 in 2013 to 111 000 in 2037.
Bismark's relic lives
There's a paucity of SA-specific data on life expectancy. Figures shown in the National Development Plan, drawn from the Actuarial Society, indicate that for males it increased by 5,7 years to age 54,8 between 2003 and 2008 whilst for females it's by 9,7 years to age 61,7 for the same period.
But these overall figures take no account of living-standard measurements. It can generally be assumed that "on average" the poorer-off won't need to save for retirement while the better off should be looking to OECD-type scenarios.
Those fortunate enough to be amongst the latter fall into two categories: younger people who can still save enough, to be shocked or forced into doing so, and older people who can't, to be left with miserable choices.
Either way, it should be evident that tax provisions and employment practices structured around mandatory retirement at ages 65 and below are absurd. They're an anachronism, actually derived from the attempts of Prussian general Bismark in the 19th century. Wanting to introduce a welfare state, but realising its resource limitations, he set the retirement age at 65 after he had deduced that few civil servants were likely to live beyond age 62.
Over decades almost universally, the approximation of 65 has remained although the 62 has not. Notably in France, attempts to increase the retirement age have met with mass protests sometimes turning violent. SA, facing equally serious challenges of retirement funding, is in the midst of a profound rethink.
For the longer term, behavioural adjustments will need to be radical. For the short to medium term, there's little salvation. So ponder your future over a smoke.
VIEWS FROM ABROAD
A number of overseas publications have recently highlighted issues around increased longevity and retirement funding. Here's a random selection.
The Economist: Age should no longer determine the appropriate end of a working life. Mandatory retirement ages and pension rules that discourage people from working longer should go. Welfare should reflect the greater opportunities open to the highly skilled. Pensions should become more progressive (i.e. less generous to the rich). At the same time, this trend underlines the importance of increasing public investment in education so that more people acquire the skills they need to thrive in a modern labour market. . . . Deadbeat 60-year olds are unlikely to become computer scientists, but they could learn useful vocational skills such as caring for the growing number of very old people.
Financial Times: BlackRock, the world's largest asset manager, is to swoop into Britain's pensions market mounting an aggressive challenge to UK life insurers after concluding that government reforms (effectively to remove the requirement for pensioners to buy an annuity) could lead to the collapse of the annuities market....Barclays has forecast that the value of new UK annuity business would fall from its current £12bn annually to £4bn in 2015, while other forecasters say it could decline by up to 90% if it follows the US market. The shake-up has also sparked a frenzied debate over the possible risk that pensioners will fritter away their savings.
The Spectator: Many people may wish to spend more of their life savings sooner than would have been possible under the old rules. It's not unreasonable to consume more in early years of retirement, while you are young enough to enjoy it, while frailty in advanced old age can prevent you from doing so. Why not travel in style now, rather than wait until the dismal day when a trip to the dustbins and back might seem like a bit of an adventure?
New York Times: There is a big retirement problem in America, maybe even a crisis. Many people won't have enough money to leave their jobs and live in comfort and security. About one half of baby boomers are already in trouble. . . Start to save at least 15% of income beginning no later than age 25, continuing every year until retirement. This will require serious discipline as the 15% excludes other savings you'll need e.g. for a child's education and the down-payment on a home. Cut back on restaurant meals, cable TV and cellphone packages.