This Elton John song came to mind when I read two publications on retirement planning last week:
“Who’ll walk me down to church when I’m 60 years of age/When the ragged dog they gave has been ten years in the grave…”
The results of Sanlam’s authoritative Retirement Benchmark Survey showed a lot of similarities to opinions expressed by Professor Matthew Lester in an article titled “Sleeping through a revolution”.
Dawie de Villiers, CEO of Sanlam Employee benefits, notes that, over the same 20 years referred to by Lester, only 29% of retirees are able to maintain their standard of living in retirement. This is despite the growth in aggregate assets of retirement funds in South Africa, from R171 billion to R2 749 billion and active members having increased from 7 838 533 to 15 005 306 as at 31 December 1994 and 2012, respectively.
Lester article covers the following developments over the past twenty years:
Life expectancy
South Africa’s current average national life expectancy of 53 years is a very misleading statistic in the context of financial planning and takes into account the tragedy that is the HIV/Aids pandemic. It is critical to note that the privileged have far greater life expectancy. Simply put, the privileged have enjoyed access to food, housing, sanitation facilities and medical services during their lifetime without being subject to the physical risks created by menial work. These factors alone increase life expectancy by 20 to 25 years above the national average.
Taxation
SARS statistics reflect that the average rate of taxation for all South Africans has reduced from 34% in 1994 to 18% today. The increased exposure of pensioners to indirect taxation is a factor. The 14% VAT rate may have remained constant across 20 years but there have been substantial increases in sin taxes and fuel and electricity levies that have contributed to the increased cost of living. Few pensioners have factored in the effect of stealth taxes. But it is highly unlikely that the increased levels of indirect stealth taxes have outweighed the reduction in direct taxation enjoyed by most pensioners over the past 15 years.
Residential property
When developing a financial plan one must consider the substantial increase in utility charges associated with South African property ownership since the promulgation of the Municipal Property Rates Act, 2004. This must be coupled with a 550% increase in electricity charges between 2000 and 2014 caused by the Eskom debacle and the introduction of an electricity levy in 2008. In most instances insurance and security costs have also increased at well above the official inflation rate.
Associated with the residential property debate is also the decline of empty-nest syndrome. Internationally there has been a substantial lifestyle change as Generation Y reached adulthood and the temptation to leave home has evaporated. No pension plan can be expected to accommodate the associated costs of an indefinite visit from children and grandchildren, let alone grandparents.
All of the above are factors in the unhappy predicament of today’s pensioner. But the biggest change is rarely recognised.
Interest rates and Inflation
Twenty years ago (with sky-high interest rates) it was reasonable to devise a retirement plan based on the following:
- Cash in all retirement funds, thereby substantially reducing taxation by applying exemptions and the average rate of tax or rating formula available at the time.
- Invest the after-tax proceeds in interest-bearing risk-free instruments.
- If a tax problem arose, investments would then be placed within insurance policies and preference shares.
Applying the above, it was reasonable to base the retirement plan on a risk-free return of 8 – 10% above the inflation rate.
In round numbers, applying a return rate of 10% above the inflation rate, retirement capital of R4 million can yield an inflation-linked after-tax income of R30 000 per month for 20 years without exhausting capital.
Today the after-tax interest rate can be as much as 3% below the inflation rate. This would lead to a R30 000 per month after-tax inflation-linked pension eroding R4 million retirement capital in just eight years.
In order to sustain a R30 000 per month after-tax inflation-linked pension for 20 years on a 3% below-inflation return, retirement capital of R11 million would be needed.
Taking the above into account Lester comes to the following conclusion:
South Africans have slept through a revolution in Reserve Bank strategy. Most have failed to recognise the staggering effect of the decline in real interest rates on their financial planning.
Today it is simply impossible to base a financial plan on a savings plan yielding risk-free fully taxable interest.
Even using an equity investment strategy, it is hard to justify a return assumption of more than 6% above inflation. Thus the financial planning has to incorporate other strategies to supplement lower anticipated growth rates. These strategies can include:
- Downward adjustment of income expectations on retirement.
- Postponement of retirement date.
- Reinvestment of tax savings achieved on contributions to retirement funds.
- Maximising tax-free growth of retirement investments within retirement funds.
- Management of tax-profile of withdrawal benefits from retirement funds.
- Containing exposure to dividend tax and capital gains tax via retirement funds.
A sustainable financial plan is still achievable in South Africa. But while South Africans slept for 20 years, the challenge of a financial plan has escalated from a simple savings strategy to the integrated science that is financial planning today.
This information is critical for the lawmakers to bear in mind when considering legislation affecting financial advice. The proposed review of retirement provision is a welcome initiative, but without timeous financial planning provided by a professional advisor, nothing much is going to change just because there are nice new laws.
Pensioners could end up singing with Elton John: “I’ve no wish to be living sixty years on”.
