How to improve your existing pension/provident structure at minimum cost (part 2)
By Paul-Gordon /Guidao-ǂOab
Head of Distribution (Corporate Segment)
Old Mutual Namibia.
In my previous article, we looked at what to consider when setting up a pension fund from scratch. In this article, we will touch on what to consider when the employer already has an existing pension/provident fund. Even if the pension fund is operating perfectly fine, it is always good to review and evaluate the pension fund to ensure it is aligned with the employer’s long-term goals.
That said, there are 3 factors that impact the ultimate retirement saving of any person; it’s the net retirement saving/contribution rate, the period of retirement saving/contribution and the investment portfolio.
As stated in my previous article, you need to have a net retirement saving/contribution rate higher than 8% to achieve a somewhat adequate salary replacement ratio for employees on retirement, albeit the 8% will struggle to achieve a 40% salary replacement ratio. And this is the challenge most employers are faced with – with some employers’ net retirement savings/contributions rates being as low as 5% and in some extreme cases in even 3%. This almost certainly defeats the purpose of a pension fund, with salary replacement ratios of about 20%.
So, how do we go about increasing the retirement contribution rate without impacting the employer’s budget significantly? The best way is to allocate a portion of the annual staff salary increase to retirement. For example, if an employer has an annual staff salary increase of 5% for 2022, the employer could allocate 1% towards pension funds and 4% cash. And if the employer does this over a 5-year period, the employer would have increased the retirement saving/contribution rate of their employees by 5%
The other factor to consider is the period of contribution towards retirement saving
The earlier you start the better, to take full advantage of the power of compounding. However, the sad reality is that most employees only actively start saving towards retirement in the late ’30s. A common mistake is the withdrawal of retirement savings when changing employers. Thus, most employees have no other option but to work well beyond their retirement age as they cannot afford to retire. And the only way an employer could try to assist employees is to extend the normal retirement age to allow the employees to retire later and thus save more towards retirement.
However, there are other labour challenges associated with this, such as severance pay. We would advise that the employer contact a labour consultant before changing the normal retirement age to 65 or higher.
The third factor is the investment portfolio
The higher the exposure to high growth assets (which are also high risk and volatile) such as equities and properties, the better the returns are over the long term. Thus, the common practice in the pension fund industry is that you start off with high-risk assets exposure when you are young and move towards low-risk assets (such as bonds and cash) as you get closer to retirement. The rationale is that should the market experience a significant dip, those closer to retirement do not have sufficient time to recover before reaching retirement age. However, most members (about 95%) do not have sufficient retirement capital saved to retire with to financially sustain themselves. Thus, upon retirement, they tend to increase their exposure to high-risk assets again in an effort to increase their return to meet their income needs. The solution to this is the smooth bonus portfolios, which continue to have exposure to high growth assets yet reduce volatility and risk. This way employees can enjoy exposure to high growth assets and returns well into and beyond retirement with very little volatility or risk.
Hope the above addresses some of the concerns that employers have around their existing retirement funds and how to improve these with little impact on the employers’ budget.