Phased Retirement Will ‘Revolutionise Retirement Planning’
By Richard Tyler, Managing Director, Simeka Consultants & Actuaries
The introduction of phased retirement in the 2014 Taxation Laws Amendment Act was excellent news for retirement fund members. When we called for these regulatory changes early in 2014, we did not expect the Government to respond so quickly. Now that is has officially become effective as from 1 March 2015, it is expected to revolutionise the retirement planning options of many South Africans.
How it works The definitions in the Income Tax Act have been changed so that when a member retires from employment, he or she will not be compelled to retire from the retirement fund (and to purchase a life annuity, in the case of a pension fund). In future, a member will be able to elect to stay on in the fund and retire from the fund on a date which could be long after he or she terminated employment, and only then elect to receive a lump sum and/or purchase a life annuity.
- The ability to retire from the fund at a later stage is important for at least the following two reasons: Firstly, longevity is increasing and people are living longer. The life expectancy of members who retire at age 65 has now increased to around 20 years and this is expected to continue to increase. The implication is that retirement will be longer and therefore more expensive than before. To counter this, members must either retire later or set aside more money to be able to retire at the same income level.
- Secondly, the world of work is changing. Despite the fact that employees are productive for longer, the date on which members are required to retire in South Africa (the normal retirement date), is slowly reducing from age 65 down to age 60. The 2014 Sanlam Benchmark Survey showed a 2.5% decrease in the average normal retirement age for new employees. Just under 30% of new employees are required to retire at age 60 and just over 45% are required to retire at age 65.
The challenges Members’ actual retirement ages are even younger. Of the retirees who participated in the 2014 Sanlam Benchmark Survey, 48% voluntarily retired early between age 55 and 60. Many members may not know the immense cost they have to pay to retire early. As a rule of thumb, a member’s retirement fund assets double in the last 6 years before retirement. A member with a 50% projected pension ratio (PPR) at age 60 can retire on a 72% PPR ratio at age 66, even if no further contributions are paid.
The biggest challenge in South Africa is that members take their money in cash when they change jobs and end up with an inadequate pension. The average pension that members retire with is reported to be a paltry sum in the order of 20% of final salary. Because so many members have not saved enough for retirement, around 90% purchase a living annuity. This type of annuity allows them to draw a fairly high pension during the earlier years. The dilemma of course is that when the capital begins to run low the pension will drop sharply. Members in this position have no option but to lower their standard of living or to find a way to earn an additional income.
Pros and cons: who can benefit? To benefit from phased retirement measures, you have to be able to live on other investments or the income of a second career and postpone the purchase of your pension / life annuity for a few years. Your patience will be rewarded in two important aspects. The longer your money stays invested in the market, the more it will grow. In addition, for each year that you postpone retirement, the burden (and therefore cost) of the life annuity will reduce by one year. The table below shows how a PPR of 50% at age 60 will increase assuming no further contributions are made and assuming a 4% real investment return. The annuity income is based on a joint life annuity, targeting 100% inflation increases.
The concept of phased retirement will offer many members much greater flexibility as they approach their normal retirement age. The notion that when you reach retirement age you have to retire from employment and sit on the “stoep” is one that resonates with fewer and fewer people. Phased retirement will allow many members to review their retirement strategies and respond to the changing world of work. It will enable them to time the purchase of their pension better and to decide when they hang up their boots.