Members of many commercial umbrella retirement funds can expect a lower pension than members of well-run and appropriately structured employer-sponsored stand-alone retirement funds, despite umbrella funds, on average, having lower costs than stand-alone funds. This is according to the latest Sanlam Benchmark survey of retirement funds.
The Benchmark survey shows that, on average, the cost of managing a stand-alone fund is 1.19 percent, compared with 0.85 percent for an umbrella fund.
Viresh Maharaj, the chief marketing actuary at Sanlam Employee Benefits, says the various stakeholders involved in umbrella funds, including members, employers, consultants and product providers, have become fixated on costs, to the detriment of other capabilities that can add more value.
Many employers opt for umbrella funds because they cost less than stand-alone funds and because they are administered more efficiently. However, issues such as financial education, preservation strategies and providing members with the best overall value have received less consideration, he says.
“When someone resigns from a job, many employers and human resources managers do not want to get involved in giving employees proper guidance about the necessity to preserve [their retirement] savings. They are quite happy to let a departing employee cash in their savings. Lack of preservation of retirement savings is the single biggest cause of people not being able to retire financially secure.”
Maharaj says that when employers consider service providers, they should take into account their ability to encourage preservation through communication, default structures and financial advice.
However, he says that even stand-alone funds have a long way to go in ensuring that members can have some confidence that they will retire financially secure. For example, only two out of five stand-alone and umbrella funds target a minimum initial income for members at retirement. Having a target enables trustees to align it with variables such as contribution levels and the fund’s investment strategy. Without this crucial alignment, members may not receive the pension they expect after 40 years’ fund membership.
The survey found that:
• About 75 percent of stand-alone funds believe their default investment options will result in members achieving their targeted pension at retirement, compared with 37 percent of employers that participate in umbrella funds.
• Stand-alone funds, on average, target an initial retirement income of 73 percent of their members’ pensionable pay (normally, basic pay without allowances), while the target for umbrella funds is, on average, 67 percent.
• Stand-alone fund employers, on average, contribute more to their employees’ retirement savings (10.36 percent of pensionable pay) than participating employers of umbrella funds (9.54 percent).
• Members of stand-alone funds, on average, contribute more to retirement savings (7.27 percent of pensionable pay) than members of umbrella funds (7.07 percent).
• Only about 25 percent of umbrella funds and stand-alone funds have flexible contribution rates.
Maharaj says that unless contribution levels (net of costs) enable members to achieve their minimum targeted retirement income, they are being set up to fail.
He says if the average contributions of both employers and employees (17.63 percent of pensionable income for stand-alone funds and 16.61 percent for umbrella funds) are increased to the new maximum tax-deductible contribution of 27.5 percent of taxable income for 20 years, the average pension of members of stand-alone funds will increase by 56 percent and that of umbrella fund members by 66 percent.
Maharaj says where members had the freedom to select the level of pensionable earnings on which their contributions are based, stand-alone fund members reduced their pensionable earnings to 63 percent and umbrella fund members to 52 percent. Reducing your contributions in this way has the potential to sabotage your ability to create wealth for retirement.
He says the best solution is for employers to ensure a minimum default contribution that aligns with their retirement income target, and to encourage higher contributions.
Another problem with reducing pensionable earnings is that group life assurance benefits are typically proportionally reduced.
• Life-stage investment options are offered by 61 percent of stand-alone funds compared with 52 percent of umbrella funds.
• Only 47 percent of stand-alone fund employers and 40 percent of umbrella fund participating employers indicated that they are reviewing their benefit structures as a result of the new structure for claiming contributions from taxable income.
The structure treats employer contributions to your retirement savings as a taxable fringe benefit. But this is more than neutralised by allowing you to deduct up to 27.5 percent of your and your employer’s contributions from the greater of your remuneration or taxable income, with a cap of R350 000 on what you may deduct in a tax year.
• Almost 50 percent of respondents involved with stand-alone funds and 57 percent of those involved with umbrella funds say they find it difficult to compare costs “factually, objectively and transparently”, while 25 percent of stand-alone respondents and 19 percent of umbrella fund respondents say they find it very difficult to do so.
DEFINITIONS
Umbrella funds allow a number of participating employers to sign up their employees as members of the fund. Each employer, in effect, is a sub-fund. There are two types of umbrella funds:
• Type-A funds: mainly commercial funds, which require special rules and provisions specific to each employer, and are usually open to any employer, employee group or company. The funds are usually run by an administrator on a for-profit basis.
• Type-B funds: in these, the rules apply uniformly to all employers. Employers are usually limited to a particular industry, such as the building industry. Trade union funds are usually type-B funds. These funds do not usually have a commercial sponsor with a profit-making incentive.
Stand-alone funds: membership of these funds is limited to employees of a single employer or a corporate entity with subsidiaries. Although these funds are sponsored by employers, they offer members more protection, because at least 50 percent of trustees must be elected by the members. Umbrella funds do not have this requirement.