LIBERTY CORPORATE: Expert Opinions: Edition June / August 2020

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Financial distress amidst Covid-19

Different countries have responded differently in the use of retirement savings.
Tiaan Kotzé, managing executive of Liberty Corporate, compares them with
relevance to SA and examines the impacts of early withdrawal.

Many South Africans are facing significant financial uncertainty as the lockdown required to manage effects of the Covid-19 pandemic wreaks havoc on the economy. Millions of employees are expected to lose their jobs, while others are receiving reduced salaries or are not being paid while in lockdown.

As many of these employees are members of retirement funds, the option of a Covid-19 linked fund withdrawal could alleviate their immediate financial distress. This does, however, come at a long-term cost to the retirement-fund member, the retirement-fund industry and to government.

A number of countries have implemented relief measures. For example, they’ve amended their retirement-fund legislation temporarily to grant members early access to their retirement savings.

Australia is allowing members who have lost their jobs or had working hours reduced, as well as sole traders facing financial difficulties, to access up to AUD10 000 (about R120 000) of their retirement savings before 1 July 2020 and an additional AUD10 000 in the third quarter of the year, tax free.

India’s Employees’ Provident Fund Organisation is allowing employees who have lost their jobs to withdraw the lower of 75% of their retirement savings or three months’ salary as an advance from the fund while remaining an active fund member.

The Malaysian Employees Provident Fund, which is the eleventh largest pension fund in the world, has said members under 55 years’ old will be able to withdraw the equivalent of R2 175 a month for the next 12 months from their retirement savings.

In the US the Coronavirus Aid, Relief & Economic Security Act (CARES) has introduced a number of relief measures for retirement-fund members. This includes suspending required minimum distributions and waiving the 10% tax charged on early distributions from individual retirement accounts and employer-sponsored retirement plans for members affected by Covid-19.

These countries operate significant retirement funding industries. The Global Pension Asset Study report of 2020 shows the size of these markets relative to SA. The figures in brackets in the first column indicate the ranking, out of 22, by size of assets.

Current legislation

The SA retirement fund industry is regulated by the Pension Funds Act and the Income Tax Act. Under this legislation, active members of most retirement funds — in particular defined-contribution funds — cannot access their retirement savings while employed unless it is for housing purposes. However, the full asset value can be withdrawn when they resign or are retrenched.

Where members who leave employment choose to take a portion of their retirement savings as cash, this is subject to tax. However, where the member was retrenched some tax relief is available. The SA National Treasury and the Financial Sector Conduct Authority (FSCA) have to date not announced plans to follow the international trend and amend the current retirement industry legislation, but we think this is a potential consideration.

Extraordinary measures for extraordinary times

Early access to retirement savings is in direct contradiction to National Treasury’s retirement reform measures that aim to encourage more savings and ensure South Africans have sufficient income for a comfortable retirement.

However, the measures introduced to combat the Covid-19 pandemic have started an economic crisis that could have a far-reaching effect into the future. The SA Reserve Bank (SARB) has said that approximately one million workers could be retrenched as a result of the economic crisis. A business impact study by Statistics SA found that 28,3% of respondents said they had reduced their workforce hours and 19,6% reported laying off staff in the short term.

Allowing access to retirement-fund savings may at first sight be seen as contradictory to the industry’s long-term savings objective. But the immediate financial needs and uncertainty our members face, dueto the Covid-19 lockdown, also need to be considered. President Cyril Ramaphosa has called on the country to work together to respond to the crisis, saying we face “an extreme situation that requires extraordinary measures”.

Utilising retirement fund savings to alleviate financial hardship

Allowing financially distressed retirement-fund members to access their savings early could alleviate some of their financial hardship. Members could access much needed income without having to apply for loans, sell assets, or resign to access their retirement funds.

Mentenova Consultants and Actuaries (MCA), a part of the Liberty Group that offers specialist benefit consulting and actuarial solutions, has looked at various scenarios to understand what effect early access to retirement benefits could have for SA. If we follow the international examples, early access to retirement funds could be made available to members who have been negatively affected by the coronavirus; for example, through salary cuts, retrenchment, reduced pay, or they or their spouses are suffering from the virus. Access to retirement savings could be limited to a portion of the total value of their savings and be made available for a limited period that could coincide with the members’ return to work or receiving their full salary. The value of the early withdrawal benefit could be expressed as a fixed amount or as a percentage of total savings, or a combination of both.

Impact on industry

If projections are correct, around one million retrenched workers are predicted to make retirementfund withdrawals. This will place an administrative burden on retirement-fund administrators. If early access to retirement savings is allowed, it will further add to the number of withdrawal claims to be processed.

SA has 11,245 million active members of retirement funds (including the Government Employees Pension Fund) with total industry savings of R4,26 trillion, according to the FSCA 2018/2019 Annual Report. MCA has considered various scenarios to estimate the expected outflows of funds from the industry, should members make use of the early withdrawal benefits. In one such scenario, based on 50% of the three million members being eligible for the early withdrawal benefit (applying the 28,3% working reduced hours) and assuming an average withdrawal of R100 000 per member, we could see R150bn being withdrawn.

Impact on individual members

One measure of an individual’s income at retirement is the Net income Replacement Ratio (NRR). This is the level of income that an individual’s retirement savings can fund after retirement, expressed as a percentage of salary immediately prior to retirement. The higher the NRR at retirement, the better the retirement outcome. If a member were to gain early access to their retirement fund savings, they would have a reduced NRR at retirement if they were not able to replace the withdrawal amount through investment savings growth or lump sum contributions. This would negatively affect their ability to fund a comfortable retirement.

MCA compared the impact of early access to retirement savings on a member who is on track to achieve a 75% NRR if they withdraw 25% of their current retirement fund savings, without any future increase in contributions or payment of an additional lump sum into the fund. For illustrative purposes, MCA has used a 30-year-old and a 50-year-old member. This assumes the 30-year-old has been in the system for eight years and the 50-year-old for 28 years. It is assumed both members have no retirement savings outside the retirement-funds system. After accessing the 25%, the 30-year-old member’s NRR would reduce to 69% while the 50-year-olds would drop to 60%.

Accessing retirement savings at this time would be detrimental to members. History has taught us that liquidating a portfolio immediately after a market crash can be costly as investors miss out on the subsequent recovery. Following the market crash in March 2020, there has been a significant recovery, but markets remain uncertain.

Impact on the government

Taxation of the early withdrawal benefit would provide a source of revenue for SARS while a tax-free payment would mean that SARS would forgo revenue that will not be collected. Our calculations show that between R5bn to R20bn of tax revenue could be lost to the fiscus, depending on how the early withdrawal benefit is implemented and the take up rate.  The introduction of an early withdrawal benefit has to consider the need to alleviate immediate financial distress against the desired outcome of members having sufficient savings for retirement, and the cost to the retirement-fund industry and government.

This article does not constitute tax, legal, financial, regulatory, accounting, technical or other advice. The material has been created for information purposes only and does not contain any personal recommendations. While every care has been taken in preparing this material, no member of Liberty gives any representation, warranty or undertaking and accepts no responsibility or liability as to the accuracy, or completeness, of the information presented.

Liberty Group Ltd is an Insurer, Retirement Fund Administrator, provider of investment solutions and an Authorised Financial Services Provider (no 2409). Liberty offers retirement fund solutions to more than 10 000 employers and sponsors the umbrella fund with the highest number of participating employers. Mentenova Consultants and Actuaries is part of the Liberty Group and an Authorised Financial Services Provider (no 46671).