Is “retirement” a concept created by the financial services industry? We need a reason to save, otherwise how could we keep the savings industry alive? It is like the ailment that Viagra had to invent to find a reason for people to buy it.
I, for one, have no intention of stopping working just because I’ve reached an arbitrary age. Yet, retirement savings in SA are highly important to the economy.
In this week’s budget we may well hear of planned amendments to retirement rules. There have been several lately. This year a new Regulation 28 has come into effect that now allows retirement funds to invest up to 15% in private equity and 10% in hedge funds. In the last budget the limit on foreign exposure was raised to 45% from 30% (theoretically there was another 10% for Africa exposure, but few ever used it). These changes have been material to not only pension funds, but the rest of the financial system as it has rebalanced to use the new allowances.
This year we may see some progress on the vexed question of “preservation”, a euphemism for preventing people from cashing in their retirement savings when they change jobs. Along the same theme, we may see automatic enrolment introduced, so employees default into a retirement fund when they start (which will be a first step towards compulsory enrolment). We may also hear of new mechanisms to allow emergency access to a portion of retirement savings. This was an issue at the start of the Covid-19 pandemic, when people were desperate to access liquidity but couldn’t.
The problem with the long-running effort to introduce forced preservation is that every time it is mentioned, people panic and change jobs just so they can access their retirement savings while they can. An option, as finance people will tell you, is a valuable thing. The prospect of losing the option will trigger many people to exercise it now, rather than take the risk they may want to do so at some point in the future when they will no longer be able.
I’m sure, dear reader, you would have already thought of the obvious solution. Do two things at once — force preservation, but simultaneously introduce a mechanism to allow access in an emergency. That way people will not feel they are losing an option. Indeed, because they can get emergency access without having to quit their jobs, they may well feel they are gaining rather than losing.
But how can this be done? Two years ago, the Treasury put out a discussion paper that proposed a “two pot” system. One pot, representing one third of members’ savings, can be accessed, but the other not until retirement. The paper also suggested that the inaccessible pot start accumulating only from the date of the change, so you don’t create a panic with everyone job hopping in advance of its introduction.
There is merit in the proposal, but it creates a complicated system and the accessible component seems too accessible. There is a simpler way to allow emergency access while discouraging it: tax. This is what other countries do — you can access your retirement savings, but subject to a punitive tax. You can even encourage people to put back whatever they take out by crediting back the tax if members return the money they have withdrawn.
As it is, if you withdraw from a fund when switching jobs you pay tax at lower than PAYE tax rates (R25k tax free, then 18% on the next amount up to R660k, the 27% up to R990k and 36% after that). This is surprisingly generous given the savings contributions were out of pretax income. That will be changed with the two-pot system: the proposal is that any withdrawals will be taxed at your PAYE rate.
But why stop there? In the UK, you can withdraw any amount from your retirement savings, but you pay a penalty tax rate of 55% (the highest marginal rate is 45%). Tax is much gentler if you wait until you are older than 55. This seems to work fine — people are strongly discouraged from withdrawing early, but not forbidden. The economics push most to do what they can to get through an emergency and hold on until they are 55.
What other tinkering should the Treasury be doing? Pension savings are a powerful catalyst for investment in the rest of the economy, but the increased foreign exposure limit of 45% has reduced the amount available for SA investments. As I’ve complained about before, exchange controls irrationally mean the local investment industry cannot offer foreign currency instruments, so that money all goes offshore, disintermediating the SA financial system. That problem really should be addressed through way overdue modernisation of exchange controls. If we are lucky we may see steps in that direction in the budget too. Let us hope.