Clients who have been receiving holistic financial advice for many years are unlikely to be significantly impacted by the two-pot retirement system, but advisers who have not been providing this type of advice will have their work cut out for them, according to Guy Holwill, the chief executive of Fairbairn Consult.
Holwill was one of the presenters at FANews’s recent webinar for financial advisers on the two-pot system.
He said holistic financial advice consists of the following elements:
- Financial education. “Holistic advice and financial advice are joined at the hip; they are fundamentally the same thing.”
- Producing a unique plan for every client, based on the client’s particular circumstances and hopes, dream, goals, and fears. “Building that plan for them that really talks to the outcomes that they are trying to achieve.”
- Building and helping clients to establish healthy financial habits. The most obvious aspect of this is effective budgeting (creating a budget and sticking to it). In the context of retirement, the unhealthiest financial habit is resigning multiple times simply to access retirement savings.
- Implementing solutions to create and protect wealth.
- Reassessing the client’s plan as the client’s life circumstances change.
The impact of the two-pot system will depend on whether the adviser has been doing all the above over the long term, Holwill said.
Focus on the income, not the capital
The implications of the two-pot system for the role of the adviser can be looked at from the perspective of technical competencies and behavioural competencies, Holwill said.
In terms of technical competencies, it is essential that advisers know how the system works. There can be advice risk if advisers do not understand some of the technical aspects of the legislation.
Second, advisers need to be able to show clients the tangible impact of early withdrawals – the tax payable and the reduction in retirement income.
Regarding the latter, he said advisers should re-orientate clients from focusing on their retirement capital to thinking about what this capital will do for them in retirement.
For most people, the capital they build up in their retirement fund is the biggest amount of money they will accumulate in their lives. A million rand, R5m, or R10m sounds like an enormous amount of money and fosters a sense that they will be comfortably off in retirement, Holwill said. Someone who has, say, R3m in her retirement fund may believe she can withdraw R1m and still be financially secure in retirement.
Holwill said a helpful way to counter this bias is to structure the conversation around the retirement income that the capital will produce, so the client’s attention is drawn to what the capital will do for them.
A back-of-the-envelope calculation indicates that R1m invested in a life annuity will provide an income of about R7 000 a month, while R1m invested in a living annuity with a drawdown of 5% may provide about R4 000 a month. And R5m in a life annuity will produce an income of about R35 000, or R20 000 in a living annuity (assuming capital preservation).
Retirement capital of R5m sounds exciting, whereas living on R20 000 does not, he said.
The language the adviser uses during conversations about early withdrawals is important, Holwill said. For example, instead of talking about “accessing your retirement savings”, use the phrase “reducing your retirement income”. Both refer to the same thing, but “accessing your savings” sounds like a perfectly normal and good thing to do, whereas “reducing your retirement income” sounds like a terrible idea.
Clients who are ‘already listening to you’
The behavioural (managing the people instead of the money) aspect of advising clients about the two-pot system may be more difficult, Holwill said.
“We’re going to have to think really hard around people who come with the attitude, it’s my money and I want it.”
As it is, most people do not save enough for retirement, and the ability to access the savings component will make this worse in the short term. In the long term, however, “it gets much better” because of the built-in compulsory preservation, he said.
Holwill said if advisers have been providing clients with holistic advice for “a meaningful period”, he does not believe the two-pot system will have a significant impact on those clients “because those clients are already listening to you. Those clients are already following your advice.”
It is unlikely these clients will access their retirement savings early, unless they absolutely must. These clients will already have an emergency fund, and they will be saving to buy things instead of going into debt.
But advisers who have not been providing holistic financial advice will have a lot of work to do, and the main challenge will be helping clients to create healthy financial habits, Holwill said.
The biggest risk facing clients who have unhealthy financial habits is debt. “Your role now is to understand why your client went into debt […] and helping the client to solve that problem.”
Which clients will be affected immediately?
Holwill believes the two-pot system will mainly impact lower-income clients in the short term. For these clients, R30 000 or 10% or their retirement savings is a lot of money.
“I don’t see a whole bunch of people with R10m in retirement savings wanting to withdraw R30 000 […] and it doesn’t really matter if they do because it’s such a small proportion of their retirement savings,” he said.
The two-pot system will become relevant to everyone, including high-income earners, over the long term. For example, clients who accumulate R30m in their retirement fund will have R10m available to withdraw from their savings component. In anticipation of the long-term relevance of the system, advisers should start educating all their clients now, he said.
Financial impact on advisory practices
Holwill does not believe the introduction of the two-pot system will have an immediate financial impact on advisers.
It may, however, have a long-term financial impact on advisory practices if clients regularly withdraw all their savings.
“They will get to retirement with two-thirds of the amount of money they would have had previously, which means that you’re investing annuities at two-thirds of the amount. That feeds through to your trail [commission].”
But if this impact materialises, it will be felt over the long term, potentially 30 years from now, not in the short term, Holwill said.
Disclaimer: The information in this article does not constitute financial planning or tax advice that is appropriate for every individual’s needs and circumstances.
