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Why fixed contribution rates need fixing

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Having rates set in stone is ineffective, says Guy Chennells, Head of Product at Discovery Employee Benefits, here’s how to fix it.

 

How many people start saving for retirement when they are 25, and continue without hitch or pause until the day they retire?

I’m guessing you don’t know many.

This is what makes a fixed contribution rate in retirement funds so absurd. Despite being designed for an ‘ideal’ retirement fund member – which makes it inappropriate for almost everyone – the vast majority of employees remain with the default contribution structure, year after year.

Why? Because most people assume that if they just follow the company default, they’ll be alright. This is a dangerous assumption that will leave many with woefully inadequate retirement provisions.

Respond to savings setbacks

Many retirement fund members have experienced setbacks to their savings over the past two years, compounded by a few common factors:

  1. Investment return shocks: investors are no strangers to the unsettling jolt felt when opening a statement, only to discover the value of their portfolio has dropped or grown slower than expected. This has been especially true in the last six years, including a period of intense return volatility during the pandemic.

  2. Contribution holidays: The economic impact of lockdowns has led to some employers negotiating periods of reduced contributions for their members, because so many were under financial strain. While a welcome relief, payment breaks like these can negatively impact a savings journey.

  3. Withdrawals due to retrenchment. In industries particularly hard hit by pandemic lockdown measures, there’ve been unusually high retrenchments. If retrenched individuals can eventually restart their retirement fund contributions, the chances are that they’ve used their accumulated savings to survive the period of unemployment and will need to entirely reconfigure their savings plans.

  4. Insurance cost increases: The insurance industry has not been immune to increases. Depending on the way benefits are structured, this can reduce the net amount that goes towards a member’s retirement or reduce their take-home pay. Either way, it puts pressure on their savings affordability.

The current default fixed contribution rate system positions retirement fund members poorly to respond to setbacks like these. Members are unlikely to understand their impact and won’t be given personalised, remedial actions to take.

Concerns for the industry

I worry that, despite the indefensible status quo and the confluence of factors making a change more urgent than ever, we will still not see progress quickly enough. Simply making all contribution rates flexible will have limited impact, due to:

Investor apathy and inertia: most people aren’t motivated enough to change the norm, especially when the shift requires sacrifice, like saving more.

Their present bias: this refers to the common human inclination of preferring a smaller present reward (like more disposable income) to a larger later reward (like more security in retirement).

A lack of personalised knowledge of what to do: many investors have good intentions but not enough knowledge or confidence to take the next step.

Simple affordability.

In addition, many employers don’t see the urgency to change. It’s been this way for decades, so why change it now? The reason is that there are now ways to avoid disaster retirement outcomes for most employees that simply weren’t possible a few years ago. It was never a good system, but at least now there is a viable alternative.

What’s the fix?

I believe the industry needs to move towards fully flexible contributions, coupled with behaviourally designed robo-advice tools that give people actionable options to close their gaps, and compelling incentives to do so.

We offer this kind of new age solution at Discovery Employee Benefits and are already observing very encouraging shifts in behaviour. It’s my hope that in 2022, the rest of the industry will move in a similar direction – for the sake of all South African savers.