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New retirement strategy

(Shutterstock)
(Shutterstock)
An open letter to the South African National Treasury:

THE South African National Treasury has spent the past few years hard at work, tackling the difficult task of changing peoples’ retirement savings habits. 

In short, South Africans save too little over periods that are too short and they too often withdraw from these savings before retirement age.

We have a proposal that we would like to put to you in this letter, but before we do that, let’s properly summarise the problems currently undermining retirement saving in South Africa.

 - Most South Africans will not have saved nearly enough by the time they reach retirement. The resulting liability inevitably placed on either the state or their families after their retirement already burdens our economy. 

The influence of this pattern will continue to become more prominent if something is not done to address the issue effectively.

So why don't people save enough?

 - The primary reason South Africans will not have enough saved for retirement is invariably a combination of:
i simply not saving enough towards retirement each year;
ii  starting to save for retirement too late in life; and
iii  a lack of preservation (meaning that people access and deplete their retirement savings prior to reaching retirement).

 - By international standards, the South African retirement industry is relatively expensive. The largely voluntary nature of retirement savings, generally poor saving rates and lack of preservation are, of course, largely to blame for high costs across the industry.  
    
Since retirement savings are generally neither automatic nor compulsory, the industry is effectively compelled to spend significant amounts on distribution and marketing.
 
In addition, low savings rates and inadequate preservation mean that the total assets under management in the retirement industry are far lower than they should be. Given that asset management is in many respects a scale game, the greater the assets under management, the greater the scale and therefore the lower the costs incurred.  

 - The tax incentives linked with retirement savings vehicles in South Africa are not progressive. Currently, the highest income earners benefit more from retirement savings than the lowest income earners.

Someone whose marginal tax rate is 40% will receive a tax rebate on retirement savings starting at 40% of their contributions, while a lower income earner, whose marginal tax rate is 20%, will receive a tax rebate of 20% of their contributions towards retirement. 

This system quite obviously contributes towards inequality and undermines one of the central objectives of the tax system as a whole.

The papers that you as the National Teasury published shortly after the 2014 budget speech, as well as the discussion papers published over the past few years, have given some hints as to the thinking that might support your proposal to address these issues. 

As far as we can see, key among them are the following:  

 - Forced saving towards retirement

Of course, the intention is good and ultimately for the benefit of both the individual and the state. Compulsory retirement saving legislation is not uncommon across the world.

However, we would cite what is perhaps an obvious flaw in the approach – people who are already cash strapped are not likely to greet further compulsory savings with smiles; a further strain on already tight disposable incomes might in many cases spell financial disaster.  

In other words, compulsion may literally force people to starve now, in an effort to prevent them from starving later.

 - Legislated preservation of retirement funds

The active encouragement of preservation is unquestionably positive.

However, setting regulations which limit, or even deny, pre-retirement access to retirement savings could lead to unintended consequences; first among them is that it may discourage people from making use of retirement savings vehicles in the first place.  

 - Regulation of the structure and price of retirement savings products

This, in our opinion, represents a treatment of the symptom rather than the cause. In addition, interfering with free market dynamics typically comes with unintended consequences.

Even if costs were legislated down significantly, and retirement vehicles were made simpler and more transparent, we don’t believe this would result in a significant increase in the total assets under management in the retirement industry.

With all of this in mind, we make our proposal, the foundation of which lies in the removal of tax rebates on retirement savings and, in place, the introduction of a co-contribution from National Treasury into an individual’s retirement savings. The concept is not entirely new, with a similar system (KiwiSaver) implemented successfully in New Zealand in 2007.  

So, in our view, the National Treasury should contribute a percentage of each person’s annual retirement savings contribution into a retirement savings vehicle on their behalf. This percentage should, of course, be set so that the financial impact on the total tax revenue remains the same as under the current dispensation. 

Of course, there would be a maximum cap on the rand amount contributed by the National Treasury, related to the individual’s total annual income. The need may also be for the implementation of a total maximum cap to limit the tax benefit for the ultra-high income earners.

If the co-contribution percentage was, as suggested, set to keep the total tax revenue stable, it would likely be in the region of 30%. This would mean that for every R1 000 contributed to a retirement vehicle by an individual, the National Treasury would contribute an additional R300.

The co-contribution incentive

We believe that a co-contribution represents an immediate, tangible and effective incentive to begin saving for retirement early and to save sufficiently for retirement. Encouraging people to save well for retirement is one of the National Treasury’s primary goals, and one of ours. Increased savings would result in additional assets under management in the retirement industry.  

Furthermore, the system we propose could encourage retirement fund preservation without additional legislation. We would propose that the National Treasury’s contributions be ringfenced separately within an individual’s retirement fund. 

This ringfenced fund would be sacrificed, proportionally, should an individual voluntarily choose to access their funds prior to retirement. We believe people would think twice before accessing funds if 30% of their savings were to be sacrificed in the process.

Both an increase in the total value of assets under management in the industry and the encouragement of preservation would naturally, through free market forces, work to reduce costs across the retirement industry, making retirement savings vehicles even more appealing and accessible to the individual over time.

Finally, the system we propose is more progressive than the current one; high income earners would benefit no more than low income earners, relative to their retirement contributions.

Our proposal, endorsed by the success of KiwiSaver in New Zealand, addresses the key issues faced by the National Treasury. 

It does this proactively and ultimately puts power in the hands of people who will, after 40 years of work, be able to afford to enjoy the privilege of the time that they’ve earned.

Yours faithfully
FutureGuide

 - Fin24.com

*FutureGuide Staff Writer




futureguidefinance.com
 
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