01 May 2013 - Pieter Koekemoer
‘If choice architecture is thoughtfully established, it can nudge us in beneficial directions without restricting freedom of choice’ – Richard Thaler and Cass Sunstein
National Treasury released an updated paper on South Africa’s proposed retirement system at the time of the 2013 national budget announcement. The document summarises the current state of the retirement reform process after a period of detailed and intense consultation with a wide variety of stakeholders, including Coronation Fund Managers, and further refines reform proposals first mooted nearly a decade ago.
While the current proposals are still subject to a final round of consultation intended to be completed by the end of May, the future shape of the retirement system is starting to take form. All interested parties should watch the process closely, as National Treasury intends to take all required legislative changes to white paper stage over the next 12 months. Expect the first changes to be implemented in 2015 or 2016.
The reform proposals aim to achieve the following:
- Harmonise the tax breaks granted for saving, and spreading these more equitably
- Improve the likelihood that retirees will have adequate capital at retirement
- Make sure that the bulk of this capital is used to purchase an efficient income stream
- Improve governance of retirement funds
Tax breaks – harmonisation
The key tax proposal is to harmonise the tax break on contributions between pension, retirement and RA funds by moving the deduction to the individual, rather than the employer for all fund types, while introducing a cap of the lowest of 27.5% of taxable income or R350 000 p.a. This will happen on a future date, called T-date.
In addition, a discretionary tax-incentivised account will be introduced, where all investment gains will be tax free. Individuals will be able to contribute R30 000 p.a./R500 000 per lifetime to this account, regardless of the level of contributions already made to a retirement fund.
Some form of tax incentive for long-term saving is at the heart of the contract between a government and its citizens which gives rise to a formal retirement system. If done well, this provides a virtuous cycle where the overall economy benefits through the underpin of a reliable permanent pool of capital, where government benefits because retired citizens can live off their accumulated capital rather than rely on the tax base, and individual households can more efficiently smooth their consumption (because your effective tax rate in retirement is expected to be lower than during your working life).
These tax breaks are also the primary reason why government believes that there is more need for intervention in the retirement market than the discretionary savings market. While the proposed changes will weaken individual savings incentives for high income earners through the introduction of a cap on tax-deductible contributions, we do not believe that the overall impact will be materially negative for South Africa’s savings pool. This is primarily because the intention is to shift incentives to a wider range of income earners across the economy, which in theory is a more efficient use of limited resources. These proposals amplify the incentives available to the middle market and should hopefully lead to an improvement in the country’s dismal household savings rate. A major unresolved challenge is to extend the benefits of the savings incentive system to the significant proportion of the working population below the tax threshold, primarily working in the less formal parts of the economy.
Adequacy of capital – compulsory preservation
Trustees will be required to pay resignation and divorce benefits into a preservation fund rather than in cash after a future date (called P-date). Fund members will be allowed to make one limited annual withdrawal from their preserved benefits. Unused withdrawals can be carried forward to future years. Vested rights will be protected as the existing level of access will still be allowed on all contributions (and growth thereon) made before P-date.
The fundamental reason why most full-career employed people have inadequate capital at retirement is due to significant ‘accidental’ leakage from the system: more than 80% of those that resign jobs or get divorced take accumulated retirement benefits in cash. This is partly because of how the system is designed; there is less admin for employers in making cash settlements, which creates a bias in subtly favouring this option. Forcing funds to rather pay money into preservation funds presents a classic behavioural nudge that will make it easier for individuals to make a good decision by simply selecting the default. The current proposal also strikes an acceptable balance between protecting vested rights and improving preservation rates. While it may be critiqued for taking a generation to fully achieve the preservation objective, it is acknowledged that, as noted by Otto von Bismarck in the 19th century, ‘politics is the art of the possible’.
Annuitisation – harmonisation and institutionalisation
Harmonisation: The ability to take the full proceeds from a provident fund as a lump sum will be phased out from a future date (T-date referred to earlier). Retirees from all funds will therefore have to buy a compulsory annuity with two-thirds of their retirement capital if they have more than R150 000 in their retirement account (currently R75 000). The means test on the state old age grant will also be abolished at T-date to prevent prejudice as a result of this change. Vested rights will be protected as the new rules will only apply to provident fund members younger than 55 at T-date, and for those below 55, only to new contributions made after T-date.
Institutionalisation: The responsibility of trustees will be extended to the day after retirement, by requiring them to make available a default retirement product to members. This default could be a guaranteed, living or hybrid annuity. Members can opt out of the default with their entire retirement balance. Trustees will receive some protection from the advice risk of providing a default if they make advice available to members on a paid-for-time basis.
While the logic of compulsory annuitisation cannot be faulted, it may prove to be a controversial proposal subject to further debate from large stakeholders in the current provident fund environment. The requirement for trustees to provide post-retirement income advice is arguably the most fundamental proposal in terms of its impact on fund governors and service providers. It is likely that this proposal will lead to significant changes in the way in which advice is delivered to retirees.
Individual financial advisors will have to ensure that their client relationships are strong enough pre-retirement to ensure that they have the opportunity to pitch their pro-posed retirement income solution against the default. Trustees will have to decide on appropriate default design: Do they provide members with the flexibility of a well-structured living annuity solution, or do they opt for the locked-in-for-life guaranteed annuity route? The major improvement in the current annuitisation proposal over its 2012 predecessor is that current market infrastructure and product providers can be used as both default and opt-out solution providers, rather than requiring a major and expensive overhaul of available products, systems and processes.
PF Circular 130 on fund governance will be elevated to a Directive. Trustees will be subject to FAIS-inspired ‘fit and proper’ and code of conduct requirements, and will also have to undergo compulsory training. All public sector funds will be made subject to the Pension Funds Act.
A strengthening of the governance requirements for funds should be welcomed subject to being implemented in a manner that does not unduly increase operating costs. We await the consultation process on the new rules to gain more insight into the detail behind these proposals.
While the proposed reforms remain far-reaching, they are philosophically very different from the 2012 version. National Treasury has chosen to support implementation of a framework founded on the principles of ‘libertarian paternalism’ as described in the book ‘Nudge: Improving decisions about health, wealth and happiness’ by Thaler and Sunstein. Broadly speaking, the intended changes aim to make better default choices available, while still allowing individuals the freedom to opt out of these defaults if they believe that their individual needs are better served through alternative solutions.
The future environment will eventually result in a significantly larger formal savings pool, and will be more demanding on fund trustees and service providers. If your focus remains on putting the interests of your clients or fund members first, these additional demands should not prove too demanding.
PIETER KOEKEMOER is head of the personal investments business. His key responsibility is to ensure exceptional client service through a combination of appropriate product, relevant market information and, above all, strong investment performance.
If you require any further information, please contact:
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Notes to the editor:
Coronation Fund Managers Limited is one of southern Africa’s most successful third-party fund management companies. As a pure fund management business it provides individual and institutional investors with expertise across Developed Markets, Emerging Markets and Africa. Clients include some of the largest retirement funds, medical schemes and multi-manager companies in South Africa, many of the major banking and insurance groups, selected investment advisory businesses, prominent independent financial advisors, high-net worth individuals and direct unit trust accounts. We are 29% staff-owned, have offices in Cape Town, Johannesburg, Pretoria, Durban, Gaborone, Windhoek, London and Dublin and are listed on the Johannesburg Stock Exchange. As at the March 2013 quarter-end, assets under management total R409 billion.