IN A NUTSHELL: Trustees of defined-contribution retirement funds can guide members towards smarter decisions by advocating a goal-based approach. This shifts the focus from fund balances to ensuring members are on track with their unique pension goals.
Educating fund members to make smart decisions about retirement remains a tricky business. People tend to live for the here and now, while retirement seems far away.
Members also often think of their retirement savings as a “pot of gold” they can access if they resign, are retrenched or retire. This mythical amount is viewed as something that will solve their financial woes.
In reality, the goal of these retirement savings is to provide members with a steady monthly income, like a salary, once they stop working.
How can trustees help members understand the impact of their decisions better?
By advocating a goal- or income-focused framework. This framework shifts the focus from simply tracking the fund balance to considering the monthly pension a member is on track for in retirement.
Currently, most member statements reflect members’ fund balances and how they have changed over a period (as a result of investment growth, fees and contributions). While this information is important, it can reinforce the idea of a pot of gold.
All members see is the amount accumulated to date. If they’ve worked for many years, the amount might seem large compared to their current salary, and could give them a false sense of security. It does not show whether a member is on track to achieve his or her retirement goal (of replacing his/her salary or a portion thereof) or the impact of withdrawing savings before retirement.
A step in the right direction was the introduction of the replacement ratio on member statements. This refers to the percentage of your pensionable salary that you’re on track to achieve.
Although better, the replacement ratio is shown as a percentage of “pensionable salary”, which is often a percentage of one’s salary, a concept with which most members are not familiar. Therefore, the “thumbs up” result may be misleading. For example, this member may be on track to replace 85% of his/her pensionable salary (which is 70% of his/her current salary). Therefore, he or she is on track for approximately 60% of his/her salary (85% of 70% of salary). This may not be enough to maintain his/her current lifestyle.
It would be much more useful for members to receive a statement that gives them a realistic idea of their projected monthly pension in rands. Retirement funds can use member statements as a tool to change members’ thinking of their retirement fund balance as a single “pot of money” to a regular income stream that has to last until they pass away.
A goal-based statement would include the projected monthly pension at retirement in rands, split by:
- the pension that can be purchased with a member’s current savings, and
- the pension that can be purchased with a member’s future savings.
Example of a regular fund statement
Proposed goal-based statement
A goal-based approach gives members a sense of control of their retirement savings. Importantly, members understand how they are tracking to their retirement goals. The consequences of early withdrawals, increasing or decreasing contributions, different investment strategies and retiring earlier will be in plain sight.
And ultimately, as trustees, that’s the goal: for members to understand retirement, plain and simple.
Sources
Colourfield: Change retirement fund statements to change members’ thinking;
Defined-contribution retirement fund investment strategies: An appropriate default?
