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Members need more guidance Earlier this year, National Treasury stated that the primary purpose of a retirement fund is to provide income in retirement to members.

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re you buying a guaranteed, withprofit or living annuity when you retire? For most retiring pension, provident or retirement annuity members, the question could be asked in a foreign language and they would still be hard pressed to give an informed response. Trustees of retirement funds are confronted with the difficult task of trying to advise members to make the best possible decisions when they get to retirement. For most members, the choices they make are uninformed because of the complexity. The concept of nudging people to make more appropriate decisions proposes a better way for choice architects like trustees. The concept was most notably developed in Nudge: Improving Decisions about Health, Wealth, and Happiness, a book by Sustein and Thaler. Retirees need to choose an adviser to help them identify the most appropriate type of annuity, provider and often investment. The advice and products are generally expensive and can be inappropriate. A further issue is that many retirees don’t buy annuities where they can take their whole benefit in cash. Where an annuity is purchased it is hardly ever done without advice, ASISA reported that in 2012 only 2.92 per cent of annuities were purchased without advice. Further, the costs associated with the purchase usually include an upfront fee (generally up to 3 per cent of asset value plus VAT), ongoing advice fee for living annuities (again in the region of one per cent of asset value annually), investment management fee and administration costs (which can be as high as three per cent).

Retirees invested in living annuities can end up paying high annual fees; if a person pays three per cent of asset value per annum and they need inflation protection, their investment needs to earn a return of inflation plus three per cent and then some to cover their annual drawdown. The picture for the average person trying to make the best investment choice at retirement looks bleak and is very complicated. Government has recognised this. Proposed reforms will see trustees guide members through the retirement process and select a default annuity product with prescribed features. Members will be moved into the products unless they opt out: the nudge principle in action. For this trustees will receive protection. A further potential benefit is cost savings which is in line with the latest reform papers released by Treasury. Trustees will have to consider whether they will house the annuities in the fund or choose an appropriate product. In addition, fund investment strategies will have to ensure that they are appropriately managing the various risks as members move closer to retirement.

process can be developed for retirees. The lower costs are positive for retirement capital. Other options can also be developed; for example, start the annuity as a living annuity and transition it into a guaranteed annuity when the income levels become similar. This will assist members in managing their longevity risk. The benefits of this approach are that appropriate defaults should reduce the need for advice as many members have similar needs and circumstances and, if possible, add to this appropriate education. This combination reduces the need for advice and members with special needs will know to seek advice and pay the extra fees for appropriate alternatives. Trustees taking this approach will develop more appropriate benefits and will need to develop investment strategies that see the investment time horizon extending beyond retirement age and seriously enter into the discussion on how retirement income will be provided to their members.

Although the proposed reforms have not yet come into force, trustees may want to consider introducing these principles into their benefit design and investment strategies; nudging members to make better choices when they retire. A solution available to trustees is to introduce a seamless transition into a living annuity. This practice has been in place for some time in relation to pre-retirement preservation options. Exiting members transfer to a retirement vehicle with the same investments as the retirement fund and the investor generally pays a lower investment management fee. A similar

Wayne van Rensburg, Managing Director, of 27four Individuals (Pty) Ltd. investsa

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