GUY CHENNELLS: Incentives boost chances of keeping retirement savings intact

The recent medium-term budget statement, tabled in November by finance minister Enoch Godongwana, carried the latest signal that big retirement savings changes are on the cards.

The precise details of the proposed changes are expected to be revealed in a discussion document due for publication imminently, perhaps as soon as late December.

What has been confirmed, however, is that the Treasury is considering a “two-pot” system designed to achieve apparent opposing ambitions.

Through one pot, Treasury is looking to bolster retirement savings among South Africans by limiting early access to those savings.

Through the other pot, it is looking to allow South Africans early access to their retirement savings to cater for unexpected emergencies.

As described by Godongwana: “Individuals would be able to access contributions to the one pot, while contributions to the other pot would be saved until retirement.”

In light of this, I believe there is an even more pressing need for innovation in the retirement industry. In a system like this, having a carrot alongside the regulatory stick will be crucial if we’re going to achieve dignified retirement outcomes.

Any effort to promote a responsible retirement savings culture in SA is both noble and urgent.

The statistic we often hear, quoted also by the Treasury, is that only 6% of people in SA are likely to save enough for a decent retirement.

This is a persistently alarming reality, and it’s not going to fix itself. 

With this harsh retirement situation as the backdrop, change is clearly needed, and the government is trying to be pragmatic as it sets out to do that. The trick is, from a regulatory perspective, it’s a near impossible task — they are trying to square a circle.

On the one hand, they want to restrict people’s early access to their retirement funds, because that’s what those funds are for.

The rule now is that you can only access your retirement savings early when you leave your employer — when changing jobs or if retrenched. Too often people succumb to this temptation, at times even going as far as quitting their jobs for the sole purpose of accessing their savings.

It makes sense that the government wants to clamp down on this, but the issue is that there isn’t much of a social safety net in SA and people do face financial crises. When they do, they might need to access some of their savings.

On the other hand, the government wants to allow people early access to their retirement savings for emergency-type situations.

In effect, they are trying to apply a stick to promote the preservation of retirement savings, but they can’t apply it too harshly because we are faced with certain realities in the country.

To balance these conflicting ambitions, they have come up with a creative solution, dubbed the “two-pot” system. The idea is that some of your retirement savings, ring-fenced in the “one pot” cannot be accessed at all before retirement and that some of it, the “other pot”, can be accessed at any time.

The issue with this proposed system is that people would have a much lower barrier to access their retirement savings early, though they will be able to access less of it.

When this easy access meets well-documented behavioural biases, we might have a problem.

First, people have a “present bias”, which is the tendency to give much stronger weight to financial payoffs that are closer to them in time. Retirement is far off into the future for many, while gaining access to cash is immediate gain for anyone.

This intersects with an “exponential growth bias”, in which people find it hard to understand how much work compound, tax-free, growth in a retirement savings vehicle will do for them in the long run.

Together these and other biases can make it very difficult for people to prioritise this intangible long-term savings goal.

The temptation of accessing that one pot of money, simply because it’s now easier to access, is going to be so much greater than it was before. As more people inevitably succumb to this temptation, it may undermine what the government has set out to achieve.

To counteract this, we believe it is essential to also have a mechanism in place to help employees stay on track to achieve their savings goals.

By far the largest contributor to people having at least one break in their retirement journey is that there is no sense of loss at the point that they decide to take part of their retirement savings in cash.  

What we’ve done at Discovery is to reward people who stay invested with significant boosts to their retirement savings. This helps incentivise people to adopt behaviours that are shown to have the best long-term outcomes for themselves. But there’s a caveat: the boost will only vest at retirement — withdraw early and you lose it.

This works because we know that loss aversion is powerful. This is another cognitive bias — the observation that people experience losses more acutely than they experience gains. In fact, the loss doesn’t need to be as big as the gain for this to be effective.

If someone knows they will lose the boost (their added savings incentive) if they take the cash, this significantly changes the decision-making dynamic. Now it’s both an immediate gain and an immediate loss.

The other thing that’s going to become more relevant as more people inevitably cash out along the way to retirement is that contribution rates are going to need to be dynamic. The simple, standardised, contribution rates that we too often see in the industry are appropriate for precisely no-one.

What we do is help clients understand what their retirement savings goals are by calculating what their potential retirement income will be, at a given rate of savings. We use a tool to visually illustrate this and show clients how they are progressing along their path towards a dignified retirement and encourage them to make small course corrections that have a huge eventual impact.

Most people have a sense of fear and trepidation about retirement. But when they can see what their retirement income will be, and that they are on track to get there, uneasiness tends to be replaced with: “I’m funded for retirement, and that feels great.” This in itself forms a behavioural protection against decisions that take one off course again.

Incentives and enablers are vital to complement a pragmatic regulatory environment so that more people make it to dignified retirements. 

* Chennells is the head of products at Discovery Employee Benefits.