Compound interest is why employees must keep retirement savings invested between jobs

Millions of South African employees rely solely on the money saved in their employers’ retirement fund to earn an income in retirement. However, for most, this money is insufficient to sustain them. 

Alexander Forbes Member Insights 2021 reveals trends and statistics on close to one million members and their saving for retirement. It was published in October, highlighting that only 6% of members can expect to replace the generally accepted target of 75% or more of their final salary when they retire. This means that the majority of individuals are not expected to achieve an income in retirement needed to sustain their standard of living.

Low replacement ratios at retirement

Low preservation rates of savings on changing jobs and low contribution rates are two of the main reasons for members not achieving being able to sustain their standard of living in retirement.  

The minimum rate members need to contribute over a 40-year period to achieve a 75% replacement ratio is 17%. However, only 6% of our total membership can expect to achieve this. Members aged 60 and above have the worst projected replacement ratio outcomes: only 2% of these members have a projected replacement ratio of above 75%.

A total of 65% of members aged between 20 and 30 are expected to have a replacement ratio below 60% of pensionable income. The average member’s shortfall in rands between the required fund credit as a multiple of salary and the actual average fund credit as a multiple of salary was R833 179.

Why preservation rates are so low

Only 9% of members preserved their retirement savings when changing jobs. Financial distress is one of the reasons, with almost 20% of millennials having loans in default.

However, a common reason given by members for not preserving their retirement savings is that they are too low to warrant the trouble and expense of a preservation fund. A total of 58% of those who chose not to preserve had retirement savings of between R0 and R25 000. People need to be aware of the longer-term impact of not preserving even relatively modest amounts when they are younger because of the power of compounding.  

The reality is that the amounts contributed in the early years of accumulation add the most to your benefit at retirement. Thanks to the impact of compound interest the first 10 years of your savings can contribute as much as half of your savings at retirement. 

What can be done to improve retirement outcomes?

Regulations have been put in place to improve low preservation rates. Default preservation rules will automatically allow retirement savings to be made paid up in the fund when a member leaves their employer and doesn’t make a payment election. Our experience is that funds that members have benefited from the default rules being implemented.  The number of members preserving has increased from 8.8% in 2019 to 9.6% in 2020The proportion of assets preserved has remained almost unaffected at 48%, despite the challenges in 2020 in relation to the Covid-19 pandemic.

Retiring at 65 rather than 55 can almost double your replacement ratio. 

Members should review their retirement savings to see if they are on track by seeking retirement benefit counselling or meeting with a certified financial adviser, and making additional contributions if required. In addition, they should preserve their savings when changing jobs to increase their probability of meeting their retirement goals.