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Historians are likely to describe the past 30 years as a period of retirement savings insanity

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Historians are likely to describe the past 30 years as a period of retirement savings insanity

Einstein described insanity as doing the same thing again and again and expecting different results. Considering some of the retirement savings research, it is easy to see how desperate this situation is. According to HSBC, 57% of retirees globally fear financial hardship yet are simply ignoring this unpleasant reality. They expect their savings to run out about half way through retirement.


The key to this expectation is how long people expect to live. In the first world, it is about 80 years, and the developing world, about 70 years on average. It is interesting to note that life expectancy in SA is still below 60, which does bring into question the need of many to save for retirement at all.


HSBC noted that 34% of working people in the UK are saving nothing at all, 63% fear financial hardship and 1 in 3 see their home as a flexible asset. In the US, Wells Fargo has noted that 92% of people with 401k plans or Individual Retirement Accounts don’t meet a reasonable target level of savings for their age and 65% fall short when including all assets. The most concerning is that 45% of Americans have no retirement savings at all.


In South Africa, Sanlam notes that of people who earn a salary, only 7% of that salary is committed to retirement savings. They point out that at least 14% needs to be saved to have any chance of a suitably-funded retirement. Sanlam also points out that 62% of people draw their retirement savings when changing job. This is like voluntarily catching the black mamba down the snakes and ladders board.


HSBC pointed out that 66% of retirees in the UK are inadequately prepared. They expect to live 19 years on average after retirement and expect their savings to last 7 years on average. Wells Fargo point out that US retirees believe that they need about $800 000 for retirement, but on average retiree total assets are no more than $300 000. Sanlam points out that 51% of South African retirees can’t make ends meet, 33% still have debt and 53% support adult dependents.


It is interesting to note that most people don’t give their pension statement any attention, in some cases probably because the statement gives pitifully little useful information, but in most cases it’s likely to be ignoring an unpleasant reality. Behaviour around denial ranges from benign inattention, to passive acknowledgement, to full-blown, wilful blindness. This is repeatedly evident from the retirement savings research.


Wells Fargo concluded the following: you need a plan and you need to periodically retest your assumptions. The two biggest mistakes retirees make are:

  • Over-estimating investment returns, and
  • The amount that can safely be withdrawn each year.

People between the ages 55 to 64 have been unrealistic about their pensions and are living in a state of denial about their finances.


So, what went wrong with the retirement savings system? It is now about 30 years since corporates abandoned the defined benefit system – people were living too long, resulting in businesses being responsible for unfunded liabilities in their pension funds. Thus the corporate world has largely absolved itself of responsibility for its retired employees. This is a global story that spawned a do-it-yourself pension system that was destined to fail.


But, why is failure built into the voluntary, self-directed, commercially-run retirement planning system? Consider what would have to happen for the do-it-yourself pension system to work for you. You would need to:

  1. Know when you will be laid off or be too sick to work,
  2. Know when you will die,
  3. Save 14% of your earnings and start when you are 25,
  4. Earn 5% above inflation on your investments every year,
  5. Never withdraw any funds,
  6. Time your withdrawals to last until the day you die.

As we all know, these abilities are not common to most of us.


Planning on dying early is not a retirement plan

Planning not to retire is also not a retirement plan. Consider age discrimination, finding or keeping a job, physically working into your 70’s. There’s nothing wrong with not retiring, but relying on a regular pay-check to fund retirement is simply an exercise in denial, not a realistic plan.


So it’s not surprising that denial around retirement savings dominates many dinner conversations. The current retirement system simply defies human behaviour. Basing a system on people’s voluntarily saving for 40 years is like asking your pet dog to save half his dinner for tomorrow.


Let’s consider some practical realities of saving for retirement.


The replacement ratio is the percentage of your final salary that you wish to draw in retirement. A reasonable replacement ratio would be 75% of your final salary. To achieve this you would need to save about 14% of your salary for 40 years. These contributions must be unbroken for 40 years, invested to provide a return of Inflation+5% every year and assume an all-in fee of 2% pa. After 20 years, you will have saved about 4 x your current annual salary. After 30 years you will have saved about 7 x your current annual salary and after 40 years, 11 x your final annual salary. Based on this, you will be able to earn a pension that starts at 75% of your final salary, increasing every year by inflation and this will last about 20 years.


Another practical reality worth considering is yield reduction. This is the difference between the income you earn from your core investments and the actual income you get after all fees. An all-in fee of 2% pa requires saving 14% of your salary every year. An all in fee of 3% would require saving 17% of your salary every year. This will make a substantial difference to your lifestyle.


For South Africans with living annuities, it is generally accepted that a sensible drawdown level is about 5% pa. This does not include the cost of the funds chosen which, inter alia, usually equals about 2% pa. Therefore actual drawdown is more likely about 7% pa. According to ASISA’s recent report, the average living annuity drawdown is 9.08% pa, and this is before fund fees. The impact of this level of drawdown is that living annuities will, on average, not even last 15 years.


Retirement reform is effectively the state picking up the ball that corporates have dropped, and it is happening globally. South Africa appears to be following the UK model which proposes creating simple, well-managed retirement accounts which are mandatory, inexpensive, trustee guided and designed to pay out sustainable income for life.


Let’s be realistic, just as a voluntary tax system would be a disaster, a voluntary retirement savings system is a disaster

Retirement reform is likely to have a profound impact on the investment industry. Clearly, a key requirement is to reduce fees. To achieve this, choice and administrative layers need to be removed. It’s all about yield reduction. Flying in the face of yield reduction is multimanager diversification, fund diversification, fund switching, extensive investor choice, high fees and performance-based fees. Industry participants that remain anchored to practices that will, no doubt, prove inadequate in the face of new investment and regulatory realities, will find their offering more and more irrelevant. If we follow the UK model, trail commissions will not continue although existing trails will be grandfathered.


With change comes opportunity

Rather than ignoring or refusing to believe an unpleasant reality, the key is to remain relevant in a changing investment landscape.To do this, the industry needs to embrace umbrella pension schemes, lower costs, replacement ratios that give employees a more reliable indication of whether they are saving enough today and preservation of existing savings.

Last modified on Monday, 23 September 2013 10:54

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