Pension fund changes towards a better retirement

Changes in the retirement sector

The retirement industry in South Africa underwent two big changes for the better. The first change had to do with the regulation of fees charged by managers, especially regarding the early termination of contracts. This was done to protect the investments of people who for some reason were unable to continue certain contractual pension savings.

The second change is the introduction of a two-pot system in March 2021, which simplifies the rules for the different products (pension, provident, preservation and annuity) and enables members to better access their pension funds. The change is aimed at restricting early withdrawals of two-thirds of their fund but makes it easier to access a third whenever a need arises.

Further simplifications would be desirable for instance to provide an ability to combine different products into one and the option for individuals to stay with one fund and manager regardless of the source of the contribution.

This would save costs to the beneficiary and would ensure that they are less likely to forget they have funds somewhere, which happens when people move from one employment to another. It would help avoid the 56 billion in unclaimed benefits currently sitting with the Financial Sector Conduct Authority (FSCA), part of which is possibly sorely needed by some.

Status of the retirement industry in South Africa

The WOW report “Retirement Funding in South Africa – Sept 2022” relates that the South African retirement industry has more than R4.6tn in assets under management (AUM). This is an impressive number, although less impressive in that it covers only seven to 10 million people with these saving products out of the 14.1 million employed (2020). If we consider the information in the WOW report, the absence of pension savings is much more prevalent among the lower income group, earning less than R14,000 per month, and if one extends that number to the unemployed on government grants, estimated at more than 29 million in 2022, the picture becomes bleak. It confirms that too many South African do not have adequate pension savings and will become dependent on state aid in their twilight years.

To provide context, in South Africa, the ratio of pension savings assets to GDP is about 36%, which seems appropriate until you compare it with the Netherlands, which ranked number one with a ratio of 191.85. One can argue that it is an unfair comparison given that the Netherlands probably has the vast majority of its people covered with more generous benefits.

Retirement funds performance in South Africa

A one-year retirement fund performance can be very misleading compared to long-term investments. This has to be borne in mind when looking at the fund managers’ reported gains in terms of AUM as well as increased profits.

It is encouraging to see that the government continues to relax rules in respect of offshore investments, increasing the limit from 40% to 45%.

What is not that clear is how the nudging of pension funds to invest more in (national) infrastructure projects will pan out. This approach has produced good results in other countries with Macquarie Bank of Australia performing well with its investment focus on this asset class, but it has to be acknowledged that big infrastructure projects are generally less liquid and carry much higher risk. The semi-privatisation of South African toll roads is a good example. The N4, N3 and N4 West were successfully financed through equity and debt, mainly with pension fund money. The e-tolls, however, were carried out by state-owned SANRAL and later shunned by the private sector due to some irregularities in the financing and the process.

The government now aims to relax retirement funds investment rules in a bid to attract more investment in infrastructure. While higher infrastructure investment would be good for economic activity, if these investments are made by pension funds, it could raise the risk profile of pensions. In the case of defined contribution, members would suffer, but in the case of defined benefit, as is the case for civil servants, the taxpayer would have to bear the brunt if the fund does not perform well.

Strong regulation would be required to safeguard the industry from undue influence.

Basic universal fund

According to Momentum Investments, only 6% of South Africans can afford to retire comfortably. This calls for a change of direction. The regulators might want to consider a universal fund. Such funds are usually administered by the government but can be managed by private sector fund managers. This approach has been applied in several European countries with great success.

To some extent, this is applied to the public service pension fund where the PIC has managed the funds reasonably well, apart from a few incidents. Given the tight fiscal status of the South African government, it would have to be a very gradual process that complements the existing pension funds.

This might go a long way toward avoiding billions of unclaimed funds accumulating and excessive fees being payable because of the current restriction on different funds being merged.

The 2022 Mercer CFA Institute Global Pension Index ranked South Africa 31st out of 43 pension systems in the world. While it can take time to resolve, work needs to be done to improve South Africa’s pension system.