The Actuarial Society of South Africa (ASSA) has released research suggesting that National Treasury’s “two-bucket” proposal, which will allow retirement fund members to access a portion of their retirement benefits for emergencies, will result in a significantly higher monthly income for pensioners.
That the two-bucket system will result in a “better outcome” for retirees only makes sense when compared with what is currently the case: most fund members cash in their retirement savings when changing jobs/resigning from their fund. The idea behind the two-bucket system is that giving members access to some of their savings before retirement – without having to quit their jobs or being hit by a punitive tax rate – will be balanced by making the rest of their benefit off-limits until retirement.
Natasha Huggett-Henchie, a member of ASSA’s Retirement Matters Committee and principal consulting actuary from NMG Consultants and Actuaries, said a well-designed, actuarially sound two-bucket system will solve two problems for retirement fund members: they will have access to emergency funding when needed and their savings will benefit from compound growth, leaving them with a substantially bigger nest egg on retirement.
She said the ability to access a portion of the retirement benefit comes with the condition that the other portion must be preserved until retirement (not before age is 55).
What ASSA’s modelling found
ASSA’s Retirement Matters Committee modelled the following scenarios to illustrate the benefits of the two-bucket approach:
Scenario 1: A retirement fund member who joined a fund at age 20 changes jobs every seven years and withdraws (and spends) the full benefit every time. However, once members reach age 50, they will focus on saving for their retirement and start preserving their benefits until age 65.
Scenario 2: The two-bucket system has been implemented and the member, who joined a retirement fund at age 20, has access to one-third of their benefit in the access pot. The member withdraws the full available amount in the access pot every five years until they reach age 65.
The results – Scenario 1: The member is likely to retire with a net replacement ratio (NRR) of about 15%, which means that they will have to live on a monthly pension equal to 15% of what they earned in the year before they retired. Huggett-Henchie says that if this member further reduced their benefit by taking another cash portion at retirement, their NRR drops to 10%. Therefore, someone who was earning R20 000 a month before retirement would now have to survive on R3 000 a month, reducing to R2 000 if they take a lump sum at retirement.
The results – Scenario 2: The member will retire with a NRR of 36% on their full benefit, or 32% if the cash portion is accessed. In other words, their monthly income is more than three times higher than if they had been allowed to follow the path of the person in the first scenario. Huggett-Henchie says that despite withdrawing their full one-third over their working years up to retirement, the remaining savings were able to benefit from compounding. Staying with the example of someone who was earning R20 000 a month before retirement, this person would have access to a monthly pension of R7 200, reducing to R6 400 if they take a lump sum.
Of course, as Huggett-Henchie said, by far the best outcome is achieved by not accessing any portion of the benefit before retirement. “Someone who doesn’t access their benefits ever could end up with an NRR of almost 52% if they don’t take cash at retirement, or 32% if they do. The rand equivalents are a pension of R10 400 per month, or the same R6 400 if they take a lump sum, relative to the salary of R20 000.”
This, she said, highlights why all retirement fund members should be provided with meaningful information about the impact of accessing their emergency bucket on their long-term retirement aspirations.
Although ASSA’s scenarios assume the ability to access up to one-third of savings (which ties in with the one-third in cash available retirement), National Treasury has yet to confirm what the percentage will be.
Huggett-Henchie said ASSA proposes a rand cap – possibly R247 500 a year, or a lifetime cap of R500 000 or R1 million – on pre-retirement withdrawals. This would avoid abuse by high-income earners.
She said the implementation of the two-bucket system would be subject to the ‘grandfathering in’ that National Treasury usually does when these changes are made. In other words, all accumulated savings at the date of change would be available at all times on resignation and new contributions after the change date would go into the two-bucket system.
“However, the problem with that is that the emergency bucket would be empty to start with and only build up post the change, which defeats the purpose that people have a need ‘now’. Our suggestion therefore would be to allow a once-off switch of some or all of the accumulated money into the two-bucket system at the date of change, or possibly a once-in-a-lifetime switch, which could happen a bit later as elected. However, the same trade-off would apply: if you make the switch, only one-third will go into the accessible bucket and two-thirds will be tied up until age 55.”
Asked how the ability to withdraw a portion of savings would work in tandem with the current tax rebate on retirement fund contributions, she said: “The tax detail still needs to be completely ironed out, and the tax rebate above R350 000 affects relatively few South Africans, but we have assumed that the current tax regime will remain. Therefore, they probably would get that access on their first withdrawal. However, with limiting the early access to some rand limit, the bulk of the amounts would effectively still be deferred to retirement.”
Limitations on access
The ASSA Retirement Matters Committee has made a number of recommendations, based on its modelling work, for Treasury to consider, particularly regarding regulating the accessibility of the emergency portion.
Huggett-Henchie said the committee feels strongly that there should be absolutely no need-based rules, as this is open to abuse and very onerous and costly to administer.
“Our modelling indicates that forcing the compulsory two-thirds preservation actually improves outcomes at retirement, and members are going to find a way to borrow against or spend their one-third anyway. Access to the one-third should therefore be available to all retirement fund members regardless of need.”
She also said the actuarial modelling indicates that the frequency of withdrawal from the access pot does not affect the ultimate NRR at retirement. “If you withdraw more frequently, you just get a smaller cash amount each time, as it doesn’t have time to build-up, but the preservation part remains unchanged.”
However, she said it will be an administrative burden to pay the cash amount and therefore some restrictions would be needed to reduce frequency. “Here we would suggest that the regulators allow annual withdrawals, with a free once-off withdrawal, and a free withdrawal every five years. Additional withdrawals should be subject to an administration fee deducted from the benefit.”
Huggett-Henchie said the biggest concern for retirement funds is the potential for a proverbial “run on the bank” if all retirement fund members are allowed to withdraw their emergency funds immediately after the legislation is promulgated. To avoid this, some initial controls and safeguards will have to be put in place.
Will it really make a difference?
With South Africans’ low rate of retirement savings, which means members won’t have a lot of money in the “accessible” bucket, will the two-bucket system overcome the pressure on government for fund members to be able to withdraw all of their savings?
Huggett-Henchie responded: “We do think it will relieve some pressure, and the hope is that it will also create a virtuous (as opposed to a vicious) cycle. People are cash-strapped, especially in a crisis, and so get sucked into loans, which charge exorbitant interest, which means they are more cash-strapped and need more loans, etc. If they can access something, maybe they will not need the loans at all, and the pressure relief on their cash flow might mean they can save.
“The hope is also that it will encourage people to make extra savings, because they know they can at least access one-third of those savings if they need to. Yearly, we go on client roadshows to encourage members to make additional voluntary contributions to boost their pension benefits, with low take-up rates. If they are accessible, we hope to get more buy-in.”