The National Treasury released two technical discussion papers on promoting household savings and reforming the retirement industry. These papers, numbered B and C respectively, are titled Enabling a better income in retirement, and Preservation, portability and governance for retirement funds. Please click on these links to download the actual discussion documents.
Two other papers, D and E, will be released “by the end of September”: Incentivising non-retirement household savings (dealing with tax harmonisation and a tax-incentivised savings products), and, Simplifying the tax treatment of retirement funds.
The following synopsis of the first two papers was provided in the media release:
Enabling a better income in retirement
This paper examines the options facing a member of a retirement fund on retirement. It examines the products on offer that will provide an income after retirement, and provides an overview of the current annuities market. It examines the various products in detail and presents several options for reform.
- A Living Annuity: This is a complex product requiring financial advice and regular reviews, and exposes pensioners to investment risk (i.e. up and down movement in market prices) and longevity risk (i.e. pensioners outliving their retirement income). The proposal in this regard is to open up the market for Living Annuities to more competition, but simultaneously regulate them more tightly. Further, retirement funds will be required to identify a default product, which has some longevity protection, into which members are to be automatically enrolled when they retire.
- A Life Annuity: This is an insurance product whose value-for-money is therefore difficult for consumers to establish, and may be expensive. The reform may also allow for a default combination product, which will incorporate some longevity protection but have more flexibility than a standard Life Annuity. This paper does not deal with costs of retirement products before retirement, which will be dealt with in a separate paper to be released by the end of October (Paper A, “Retirement fund costs”).
Preservation, portability and governance for retirement funds
The paper deals with one of the major concerns of Government, that even those South Africans who save through pension or provident funds, do not save enough for their retirement. This is because many members of retirement funds tend to cash in their retirement savings before they retire (e.g. when they change jobs), and also spend their savings too rapidly after they have retired (i.e. lack of annuitisation).
The paper proposes various options to encourage preservation of retirement savings before and after retirement, with consideration for protecting vested rights. Besides requiring retirement funds to establish and enable a default preservation policy, the proposed options include:
- doing nothing now, but reconsidering the issue after the default policy has bedded down;
- preservation of two-thirds of new contributions and growth after the legislation date;
- accessing benefits only in the form of a monthly income;
- increasing the tax consequence upon withdrawal; or
- insist on full preservation of new contributions and growth after the legislation date.
Draft proposals to increase the portability of funds and strengthen pension fund governance are also proposed. The paper also presents options for requiring provident fund members to annuitise their balances when they retire, and for improving the governance over retirement funds. This paper will also be tabled at NEDLAC to seek broad consensus around a set of final proposals which will be presented early next year.
A very important focus in the discussion document concerns the impact of costs on member benefits. This could have quite an impact on the cash flow of advisors, and we will look at this aspect in more detail over the next few weeks.
The following excerpt provides a clue to Treasury’s thinking:
Today only about 20 per cent of retirees choose conventional annuities. Annuity purchase behaviour appears to be driven strongly by short-term considerations and sales incentives. In particular, the commission earned by brokers for selling a living annuity may be up to 10 times larger over the life of the product than the commission for selling a conventional annuity. Only about 10 per cent of policies sold by brokers are now conventional annuities.
In other words, we are selling living annuities for higher commission, and not because it is in the client’s best interest.