Putting the Employee back into Employee Benefits
Employee Benefits (EB) has always been the poor cousin of the financial services industry – which I always found strange until I took a closer look. Those retirement funds have built so many the big shopping centres and business buildings in SA, and Group Benefits are often the only protection the average South African has against premature death or disablement why isn’t it held in higher regard? It was only when I immersed myself in the industry recently for a couple of projects that I realised that the word ‘employee’ left ‘employee benefits’ a long time ago. The huge insurance providers and EB consulting providers, smug in their opulent offices ( built with pension funds), perpetuate unreasonably high fees and sub-standard Group Life and Disability benefits hiding behind the Pension Funds Act, ASISA, Labour law or any other regulation that will support the practice. It is long overdue a disrupt.
Let’s have a look at the 3 main pillars of employee benefits; Medical aid, Group Life and Retirement Savings.
Tax avoidance versus Tax evasion
SARS really doesn’t like us financial advisors much, with good reason. If there is a loophole that can be exploited there will always be some dodgy broker willing to exploit it to get you a short term break. Unfortunately SARS usually catches up sooner or later and it all ends in tears. The most recent loophole to be closed, which has still to fully play-out, is the ‘excess or disallowed premium’ loophole. Basically if you contribute more than the allowed percentage to a retirement annuity in a year, those excess premiums are carried forward to the next year. If you die before those excesses are mopped up, then they are estate-duty exempt (20%) and form part of the tax-free lump sum. What people were doing is putting massive sums into these RAs (in the millions) purely as a method to escape Estate Duty. That loophole is being closed, so please stay well away from it. A scheme like this smacks not of tax avoidance (legal) but evasion (not legal).
You are entitled to structure your income in such a way as to avoid paying more tax than is required and sometimes this comes too close to evasion. Opportunities to do this are fewer every year. In March this year your premiums to income protection insurance could no longer be deducted from tax. SARs clearly did their homework. They were giving away far more in these tax deductions than they ever earned from disabled persons getting an income from this insurance. The only premium deduction still out there that is available for deduction is Retirement Annuities. Regulations around this are changing and you should be able to deduct more in future but before you rush out and add to your RA be smart…
Have you utilised your annual CGT and interest rate exemptions? An emergency fund, equal to at least 3 months after tax income for the family, will probably be in an interest bearing account. The first R23,800 of interest is tax-free. At 6% interest, this would come from a capital amount of around R400,000. Your CGT exemption is R30,000 per annum. Capital Gains is triggered when you sell or transfer an asset like a house, unit trust or share. If you’re building up a share or unit trust nest-egg, then, once a year in Feb, have a chat to your stock broker or advisor to see if it’s prudent to do some share switches and make use of that annual exemption. It doesn’t accumulate over time, and once the year has gone, so goes that exemption. “Buy-and-Hold” is a decent philosophy but it is often confused with “Park-and-Leave”. I often hear the argument that ‘it is only a loss when you sell it’ when it comes to shares that are a dog, but bottom line it is just money. If you wouldn’t buy that share now sell it and buy something with prospects. It is not a finite resource. It doesn’t have feelings.
The risk on not being physically (or even mentally) able to continue to work through to retirement is probably the biggest risk for anyone of working age. Much of the focus on ‘Life’ cover is on just that – Life. Nobody wants to be seen as an irresponsible sod leaving kids destitute if you die prematurely and leave a pile of debt behind for them to sort out while the bank puts them out on the street. The good news is that you’re not going to be around to hear the criticism. What if the event that might kill you doesn’t – it just nearly does. A stroke that leaves you speechless, and not in a good way. A car accident that writes off the car, but isn’t quite as efficient with you. Who is going to look after you, what are you going to do for money?
It’s a morbid topic, so please excuse the dark humour – anything else is going to sound like a sermon. It’s all very well to say your Mom/Girlfriend/Husband will look after you but guess what – they are under no obligation. Okay maybe your mother is, but if you’re a miserable grump if you even have a sniffle, I wonder how long a wife or husband is going to stick around.
If you have been responsible enough to take out disability insurance cover, the last thing you want is for some petty bureaucrat to tell you you’re not disabled ‘enough’ and to get your lazy ass back to work. All disability products are not created equal and rather find out those shortcomings now, when you can fix them, than when you really need them.
Group disability insurance products (that you get at work, and you pay for as a ‘fringe benefit’ and are part of that bloated Cost to Company that you never see), almost without exception, are atrocious. The wording on almost every single product is the same and based on a ‘code of good practice’ for Disability produced by ASISA, formerly known as the LOA. If you actually read that document you find that much of the small print the providers blame on ASISA or the Labour act is nowhere to be found, or is in a much diluted form. If I didn’t know better I’d say that the big insurers have actually colluded to give the illusion of risk cover when the truth is far different. I have heard excuses muttered about people ‘ripping off’ the system (which certainly occurs in the States), the fact that decent cover will increase the number of claims and the fact that the ‘risk pool’ and low premiums justify the shoddy product.
So, if you can get hold of a copy of your group policy, this what should you be looking out for:
The Passive revolution
All over the world investment fees have fallen substantially, not just as a result of lost trust in investment bankers’ post 2008, but with the massive increase in the use of ‘passive’ funds that use cheap computers instead of expensive asset managers to structure long term portfolios. In other words they just follow what the stock market is doing and don’t try and get clever and ‘beat’ the market. The losers are the ‘mutual funds’ what we call Unit trusts or collective investments here in RSA. Gone are the days when asset managers could get away with fees of up to 3%. Passive investments usually come in below 0.5%, and some even lower than 0.3% and we haven’t seen the bottom yet. Why are we in SA dragging our heels to keep up with this global trend?
One answer could lie in our much higher inflation for the fees to hide behind. If you take 3% off a 10% growth you’re still getting 7%. Factor in inflation of 6% and the real growth is only one percent. It looks very different to taking 3% off a 5% growth ( which is in line with the kind of growth they have been experiencing in the West), their inflation is still around 1%, so the nett effect is the same – but the perception by clients is way different. Basically we have been hiding behind double digit growth. Investors are happy to share in times of good growth, but when things swing down they aren’t quite so magnanimous.
The trend to lower cost passive investing has already started in earnest and clients that are following offshore trends are (rightly) insisting on these lower fees, especially for long term investments like retirement funds.
Performance fees – which are essentially hidden – are another bone of contention and the government has woken up to the problem and started to demand ‘clean’ pricing (without the dirty performance fees) for retirement funding, starting with the Tax Free Savings accounts. Performance fees have a number of issues. Firstly they are imposed on future performance based on past performance. In other words, new money coming into the fund has to pay the fee despite not having enjoyed the return in excess of the benchmark. Secondly, some collective investments build their own benchmark – making it impossible for you to compare apples with apples. It’s like doing your own performance review.
Longevity isn’t for sissies
Every year we get a greater understanding of what shortens or prolongs life. Medical research finds ways of extending life and life expectancy increases – to universal celebration. This increase in life expectancy has to be funded in the retirement years. In countries that have decent government sponsored pensions this is causing a severe problem, exacerbated by the slowing birth rate. In effect in those countries they are using pension contributions from the young to pay the old, because estimates made decades ago as to how long people would live were way out. This is all going to implode one day.
In South Africa, where most working South Africans will have to make their own provisions for retirement, and cannot rely on the government safety net, this problem is right on our doorstep. The retirement models that many financial planners use, still assume that we will live maximum 20 years past retirement age of 65. In other words 85. These models assume total capital consumption because preserving capital makes the required savings ratios out of reach for most struggling families.
Unfortunately it is much more realistic to assume that you will live 30 years past retirement. There is another growing trend that is going to impact this even more. Families are postponing having children into their thirties, and even their forties. This means they will have dependants will into the traditional ‘accumulation’ years, perhaps right to the edge of retirement. It’s an uncomfortable fact that children put a significant dent in your consumption and makes it very difficult to top up retirement savings. If couples that delay starting family are doing that high accumulation and retirement saving before children, then there wouldn’t be an issue, unfortunately most couples are consuming much of that income on travel, leisure and lifestyle assets. It is going to take 20 years for that problem to become really apparent, but if you fall into that demographic I recommend you sit down with your financial advisor and plan out a happier outcome. The good news is that the proportion of your income you need to put away is going to be fraction of what it would be in your fifties.
Wealth is what is left after you have consumed your income. So it is simple, if you want to increase your wealth, increase your income or decrease your consumption.
The good, the bad and the ugly
Group benefits – including pension and provident funds – are often ignored, even by financial advisors when coming up with a financial plan. This may be due to the fact that the average employee doesn’t actually understand what they have and what they can and can’t do with it. For the majority of South Africans, this is the only retirement savings or life cover they have and it is a crying shame that isn’t respected more. I have recently had the opportunity of uncovering some nasty excessive fee-taking in a group retirement fund that had been going on since 1998, and allowed to continue despite being transferred to a very large employee benefit specialist company (with an ‘ag sorry, but we’re too big to care’ or words to that effect).
Part of the problem is that fees in group retirement funds are not capped ( because they aren’t called ‘commission – remember that next time you moan about commission which is regulated), and are ‘acceptable’ as long as they are disclosed. That is all very well put it out there in black and white on a benefit statement, but when the employee is completely oblivious as to what an ‘acceptable’ fee is and the employee benefit consultant is too big to care, then this practice carries on unabated.