In Quarterly Commentary 1 of 2008 we introduced you to the Allan Gray Group Retirement Annuity. Two years on we reflect on how this system is proving to be a cost-effective solution to the problem of retirement funding for small to medium-size organisations.
Regular readers of our commentaries will know that we often write about the cost and danger of delaying investing for your retirement. Many people rely on pension income for the same number of years as they save; add increased medical costs to longevity and the picture looks even scarier.
According to the Sanlam BENCHMARK Employee Benefits Survey 2010, 30% of pensioners in South Africa find themselves looking after dependants other than their spouses as a result of extended families and the impact of AIDS. On average, pensioners have 1.97 dependants, putting added pressure on already stretched retirement resources.
At current annuity prices you need a capital sum of 15-20 times your final annual pre-tax income to retire independently. This will give you an income equal to about 70% of your income at a retirement age of 65 (if you buy a conventional annuity with 5% escalation at retirement). To achieve this you would have to save 10% of your salary from age 25. This is based on the assumptions that inflation over the period averages 6%, your salary increases at an average 7%, and your investments achieve a real (i.e. above inflation) return of 5%.
If you start saving for retirement from age 25 you will have significantly more to retire on than if you start at 35. Losing 10 years 'costs' 40% in retirement income. So, for example, instead of getting R10 000 a month, you would only get R6 000 (see Graph 1).
Starting early will go a long way to helping you sustain yourself comfortably in retirement. This is the power of compounding - earning interest today on the interest that you earned yesterday.
Employers can make a difference
Employers have the ability to make a difference by helping their staff save for retirement. Pension or provident funds may be the ideal solution for some organisations. However, for many smaller companies, providing a pension or provident fund may be costly and the administration and compliance requirements can be onerous.
The Allan Gray Group Retirement Annuity (Group RA) is an example of a system that circumvents these problems, enabling employers to administer member contributions to individually owned Allan Gray Retirement Annuities (RAs). In so doing, employers are able to offer their staff the individual benefits of an Allan Gray RA and encourage them to make provision for their future financial security. Employers can ensure that employees' contributions are applied to retirement savings, as opposed to paying employees cash as part of their remuneration package and placing the onus on them to buy into their own scheme. This creates a savings culture and a sense of joint responsibility.
The Allan Gray Group RA is not a 'typical' group-based product; rather, it simply provides employers with a facility to manage employees' individual contributions to their retirement savings on a group basis. Contributions are allocated to individual investment accounts in the Allan Gray RA for the employees' benefit.
By selecting a system like the Allan Gray Group RA, employers can ensure that their employees get:
1. Clear individual accountability and choice
Employees join the RA in their individual capacities and become individual members - with autonomous and member-specific investment choices and options. This gives each member control of his/her retirement savings. This is a move away from the paternalistic culture of traditional pension and provident funds, which often do not offer choice, and ticks the box for those who have been looking for more control of their investments in the wake of the global financial crisis. According to the BENCHMARK Survey, 55% of retirement funds offer member-directed choice, up from 44% in 2006. A further 13% are considering offering member choice.
Allan Gray provides an uncomplicated range of unit trusts across different sectors, from different providers. Individual members need to select unit trusts that best meet their individual investment objectives as their underlying investment options. While we caution against switching too often, members may switch between these unit trusts at any time, at no cost, as their needs change, giving them flexibility.
2. Tax efficiency
RAs essentially defer tax until employees retire. Contributions are tax deductible to the greater of R3 500 or 15% of their pre-tax income. Investment growth is then generated off this pre-tax base and this growth is also tax free.
EMPLOYERS HAVE THE ABILITY TO MAKE A DIFFERENCE BY HELPING THEIR STAFF SAVE FOR RETIREMENT
When a member retires, he or she can withdraw a lump-sum benefit of one third of the capital from the RA. This is taxed favourably: the first R300 000 of total pension withdrawals (including RA withdrawals) is tax free, the next R300 000 is taxed at 18%, and the following R300 000 at 27%. Above R900 000, the tax rate is 36%, which is still below the maximum 40% marginal rate for individuals.
The remaining two-thirds of their RA capital must be used to purchase a pension-providing vehicle such as a living annuity or a guaranteed life annuity. The tax rates used for payments from this annuity are based on the members' marginal tax rates after retirement, which may be lower than when they are working.
3. Value for money
In many 'modern' RA funds, including Allan Gray's, an annual administration fee is charged which is reduced by any fee discounts received from the providers of the chosen unit trusts. There are no initial administration fees, no switching fees and no exit fees. Initial and annual fees for investment management depend on each member's choice of unit trusts. The fee structure is transparent and provides value for money.
4. Flexibility
Gone are the days of life-long employment - today's workforce is highly mobile. Because each RA under the group system is individually owned, employees can continue contributing even if they leave their employer. Or they can stop contributing without any penalties. They may also transfer their Allan Gray RA to another approved retirement annuity fund. There are no penalties or fees charged.
5. Transparency, communication and education
The BENCHMARK Survey notes that 65% of members invested in retirement funds with member-directed choice rely on the trustee or default choice and, as such, do not choose their own investments. There are many reasons people fail to make their own investment decisions (see Marisa Kaplan's piece in Quarterly Commentary 3 of 2009, 'The cost of too much choice'), but complexity and lack of understanding play a key role.
Allan Gray is committed to keeping our communications and investment products simple. Members of the Allan Gray RA are sent quarterly statements showing how their investments are performing. They can also monitor and administer their investments by registering to become users of the secure section of our website. This is key in giving members ownership and a sense of responsibility for their investment.
- Employees cannot cash in their fund before age 55, unless the value of their savings is under R 7 000 or if hey are emigrating. In this way the RA is in line with government’s thinking on retirement savings preservation. A big issue for government is the loss of retirement savings when individuals change jobs and take their accumulated pension money in cash instead of transferring their savings to a preservation fund.
- Employers have no rights or duties in the fund rules. Employees merely give permission for employers to deduct and pay over contributions on their behalf. Any unpaid contributions are a matter to be resolved between the employer and the employees, and there is no statutory protection for non-payment of contributions as provided for with pension funds.
- There is no requirement for all employees to become members unless an employer makes membership a condition of employment (but this would need to be enforced by the employer).
- The Allan Gray RA is governed by a board of trustees, some of whom are independent pension experts. Allan Gray pays for the board-level and some other expenses of the Allan Gray RA (i.e. they are not currently deducted from members’ investment accounts). Neither the employer nor the staff play any role in electing trustees of the Allan Gray RA.
- There are no insured death or disability benefits available for members of the Allan Gray RA under the fund. Any risk protection or additional benefits of this nature would have to be sourced and provided separately.
Note:The tax information on retirement fund lump sums used in this article is for the tax year ending February 2011. Also note that a new tax treatment for retirement fund contributions will be effective 1 March 2012.