PENSION-saving is an emotional, difficult subject. Fundamentally, forgoing present consumption to ensure a comfortable retirement is unpleasant. Behavioural scientists have shown that we overly discount the future — we think consumption in the present is worth it, even if the costs to us in the future are high.
That same human foible is at the heart of consumption-based borrowing, just as it is in savings decisions. As a result, we borrow too much and save too little, making lots of money for lenders, while leaving ourselves financially vulnerable in future.
The Treasury has been trying to change that pattern of behaviour for South Africans. Its approach is through a combination of rational choice incentives and paternalism. In some respects, it wants to ban certain behaviours that are bad for us, while in others it wants to encourage good behaviour with the right tax incentives.
There is a deep tension between these — if we assume people are rational consumers, we should allow the incentives to do all the work, even in overcoming our natural biases. But some of Treasury’s moves show it does not quite trust the rationality of consumers.
Its latest confrontation with unions brings this into stark relief. The furore is over a set of amendments to tax laws passed late last year to standardise the way different forms of retirement savings — pension funds, provident funds and retirement annuity funds — are treated from a tax point of view. That has pros and cons for individual savers, depending on which form of saving they are using.
The changes affect the way provident funds, which are the main form of savings used by low-income workers, work.
Some of these are positive — contributions to provident funds will now be treated like contributions to retirement annuities and become tax-deductible. But because about half of provident fund members earn below the tax threshold, this doesn’t make a difference to many.
The bigger effect is on withdrawals from savings on retirement, and with that the ability to use the benefits as security. Currently, provident fund members can draw the full amount on retirement, which means a much larger amount is available to use as collateral to borrow against up to that point.
The new rules specify that only one-third of savings can be paid out as a tax-free lump sum, with the balance used to purchase an annuity that will pay a monthly cash amount until death (subject to various limits). This change is intended to prevent retirees from blowing their savings too quickly and getting into too much debt before then.
Unions have reacted strongly to these restrictions, and I don’t blame them. Currently, provident fund members have more flexibility than they will once the changes kick in on March 1 (although they won’t affect savings accumulated up to that point). This removal of flexibility is a cost that can be valued as a type of option. The rational choice analysis would be to measure up the cost of losing this option against the benefit of the tax deduction provisions. For the lowest income workers, there is a clear net negative outcome.
While an annuity is a sensible option for many retirees, ensuring they have the monthly income needed to meet their expenses, the government’s move to make this compulsory smacks of paternalism. While the government thinks its tax incentives will drive the right behaviour as people rationally respond, it does not think the decisions of a retiree will be rational. This is inconsistent.
Treasury has tried to placate concerns by setting a fairly high limit for the one-third rule to kick in of R247,500. So, for all but the youngest and relatively highly paid workers, the changes will make no difference at all. Treasury’s calculation seems to be that if as few as possible union members are affected, there won’t be enough resistance to stop the reforms. But the unions are promising a spirited fight.
Treasury could place more trust in consumers and rely on incentives to drive behaviour. A principle of the “nudge” approach punted by behavioural scientists is that you don’t alter the choice set of consumers, but shift the probabilities of their choices within that set. Let retirees take their savings, but use the tax rates on withdrawals and the architecture of the decision to discourage it.
While Treasury may think consumers will make poor decisions, ultimately no one is able to understand individuals’ objectives and choices other than those individuals. Giving them flexibility provides a higher probability they will be able to meet their goals. That is all unions are asking for.