Rich granddad, poor granddad
Are you destined to live out your final decades in luxury or in poverty? It all comes down to your pension. Here are some critical mistakes to avoid
Pop quiz: How much will your pension be when you retire? If you said 70% of your last paycheck − you’ve flunked. That means you last checked the state of your pension savings about a decade ago, and you’re oblivious to all the changes since. To put it bluntly: You don’t have a clue what’s happening with your pension and need to figure it out quickly.
Dozing off will probably cost you dearly. Probably, not maybe. Life expectancy is increasing by a year and a half every decade. This means for every decade you’ve dozed, you’ll need another year and a half of money to live on. Women, with all the fuss over the privilege of retiring at 62, already face an average retirement of almost 23 years. Men, retiring at 65 plus, face 18 years.
For simplicity’s sake, let’s look at the simpler case: 18 years times 12 months times needed monthly income − let’s say NIS 6,000. Including the interest you’ll earn on your savings, you’ll need NIS 1.2 million put away. For perspective, an average apartment now costs NIS 1.1 million. So your pension costs at least as much as a new home.
Here’s another pop quiz: Will you have NIS 1.2 million? Do you have the money to buy another home? Most likely no, and you’re in deep trouble.
In general, Israelis are in trouble with everything that has to do with their pensions. Pension funds currently pay out NIS 3,600 a month on average, an estimated 50% to 60% of a retiree’s last gross salary. The Finance Ministry estimates that future pension savings will enable retirees to receive a bit more − 50% to 70% of their last gross salary, or 70% to 80% of their last net salary − but that’s only if you don’t do something foolish along the way.
Unfortunately, almost everyone does dumb things that could leave them impoverished in their old age.
The following are the top 14 foolish mistakes to avoid at any cost if you want to retire in dignity. The list is based on discussions with several senior industry executives and some of the country’s top private pension consultants, including Alon Landau of Bank Leumi.
1. Not seeking advice
Retirement savings are the largest and most important savings in your life: They will be your main − or only − source of income for two decades. People generally do their homework before buying a home, including surveying the mortgage market and choosing the best option. What homework have you done on your pension, and when was the last time you reviewed the various savings plans?
The sad truth is that Israelis don’t take their pension savings seriously and don’t bother seeking advice. There’s no market for individual pension consulting here, despite the complexity of the subject. Well, it actually does exist, but most people aren’t aware of it. Banks offer free pension consulting and there are private advisers as well, but few use their services − a tragic mistake that could wind up costing you your entire pension.
Advice is critical, especially before retirement. How to withdraw your money − whether in payments or in full, and from which savings vehicle − could determine the fate and size of your pension. Don’t even consider retiring before consulting an expert.
2. Consulting an insurance agent, pension manager or employer
By law, pension advisers are obligated to act in the client’s best interest. They receive the same commission from all pension funds, so they’re neutral and can choose the best deal for the client.
Pension marketers, agents and managers, however, receive different commissions from different pension funds, meaning they have a vested interest. They earn more from selling life insurance, for example, and even more from selling a specific company’s life insurance policy. They don’t have the client’s best interest at heart − just their own.
True, there are professional agents. But when their vested interests don’t correspond with yours, their advice can’t be trusted. Go to pension consultants and pay them for their services; don’t just rely on your insurance agent.
Your employer’s interests are also different from yours. For example, your employer wants to minimize fuss and prefers a certain set of pension funds or life insurance plansaccordingly. To save trouble, the employer usually refers all pension matters to a pension manager who is in practice an agent for one of the insurance companies and whose interest is manifestly biased. So don’t depend on your employer. Even if he means you no ill, he’s not necessarily looking out for you.
3. Starting to save later in life
You’re young, you have a mortgage, you’re busy raising children, and you can’t make ends meet anyhow. Saving for retirement in another 40 years seems like your last concern, and it’s easy to put off. That’s a grave mistake. Joining a pension fund early is critical for two reasons: The compounded interest, which can triple and even quadruple your savings if given enough time, and the insurance coverage.
When you’re younger, you’ll receive better, cheaper disability insurance and life insurance, including full coverage for all sorts of illnesses. Later, after you’ve already suffered several ailments, you won’t be able to buy coverage against them.
4. Not saving at all
This isn’t a joke. It’s a bitter fact in Israel, especially among the self-employed. “Whenever I enter a cab, I ask the driver if he has a pension plan,” says Landau. “Few cab drivers have pension savings. They throw lavish weddings for their children and even help them buy a home, but they themselves are left with a National Insurance ` at retirement.”
The self-employed, like the salaried, receive tax benefits designed to encourage pension saving. But while an employer automatically saves for employees, the self-employed need to pay for themselves out of their monthly income − and most can’t be bothered.
Paradoxically, there are large employers who pay for their employees but not for themselves. When they finally start saving, when they’re older and after several illnesses, they don’t stand a chance of qualifying for reasonable insurance coverage or accumulating enough savings for a respectable retirement.
5. Not buying insurance
Another mistake by the self-employed − those who do save − is that they usually do so through provident funds. The main drawback here is that the funds don’t offer insurance coverage. To get insurance, the self-employed need to turn to an insurance company.
Those without insurance coverage could find themselves in tragedy − they could lose their ability to work, or the main breadwinner could die prematurely and leave the family with no one to support it.
6. Not saving enough
This is one of the biggest mistakes. Employees generally pay in − along with their employers − 17.5% to 18.3% of their salary. Consultants tend to agree that this simply isn’t high enough to reap reasonable pension benefits relative to your salary. Savings must be higher − period.
The law lets you save more. Both employer and employee can allocate a higher percentage of salary and enjoy the ensuing tax benefits, but in practice this doesn’t happen. Although it’s hard for employees to insist that their employer pay in more than required under the agreement or contract, they can certainly do so out of their own wages.
Raising pension provisions from 5% to 7% of your monthly salary will improve savings, and your disposable income will drop just 1.4% thanks to tax benefits.
7. Opening too many pension plans and forgetting about them
This is a typical mistake by employees who give in to the employer’s demands to save via one specified fund. When changing jobs, old pension accounts are suspended and new ones are opened. Each time this happens existing insurance coverage is lost and new, more expensive coverage is bought under inferior conditions. Age takes its toll. Even worse, if you have multiple savings plans scattered about, you could forget some − and that could mean losing them.
8. Pulling out severance pay
This is one of the most common and worst mistakes. The law says severance pay withdrawn between jobs is tax exempt, and pension funds say people often take advantage of this. “The employer informs the departing employee that severance pay is being released as decreed by law,” says a senior official in the industry. “The employee immediately checks what this is all about, hears that he has NIS 30,000 available to withdraw for free, and gets excited: ‘Come on: Pull it out.’”
This approach will cost employees about 40% of their pension savings, simply because they can’t resist the temptation and let the money accumulate until they’re 65. True − there are hardship cases, like when someone loses his job, can’t find employment for months and needs the money. That’s exactly what severance pay is for − but it doesn’t mean you should withdraw the entire amount.
If you need money to cover living expenses, you should arrange with your pension fund for periodic withdrawals of the severance money − for example, a monthly benefit − until you find a job. Pension funds often don’t like the hassle, but it’s your right and they have to honor your request.
A few years ago the Finance Ministry’s head of capital markets, insurance and savings proposed legislation that would have done away with separate severance funds, throwing the money into regular pension savings and allowing the unemployed to withdraw monthly benefits. It’s a pity the Histadrut labor federation objected.
9. Withdrawing your pension savings
This, unbelievably, happens too. About NIS 1.6 billion was pulled out of pension savings last year through early withdrawals, according to the insurance commissioner. About NIS 1 billion of this was from severance funds, but the rest was actually pulled out of pension benefit funds. A withdrawal like this before you’re 65 is very costly − you lose 35% of your savings.
Still, many people do this. “They call when they leave their job,” says a source at a pension fund. “They’re told they have NIS 40,000 to their credit, and if they pull it out they’ll get NIS 30,000 in cash. These are young people who, when they smell NIS 30,000 in cash, can’t resist pulling it out.”
It can’t be stressed enough how irrational and dangerous this is; it simply shouldn’t be done. Again, anyone who seriously needs money to live on would be better off taking out a loan against his benefit funds from his pension fund or insurance company. Such loans could be on relatively easy terms: Pension savings managers will do almost anything to keep a customer. In any case, whatever interest this would cost is better than losing 35% of your savings.
And another good thing to know: If you desperately need a large sum, for urgent medical treatment, for example, you can apply to the special committee that’s part of every pension plan and receive permission to pull out pension savings without a fine. This could rescue one-third of your savings.
10. Stopping working and stopping saving
A woman gives birth and goes on extended maternity leave; a worker leaves his job and is looking for another. In each case there is a risk of lost pension savings, especially insurance coverage. Anyone who misses five straight months of deposits loses coverage and all accumulated benefits. As noted, renewing insurance coverage is almost always more expensive and involves worse conditions, such as only partial coverage.
Women on maternity leave for up to six months are supposed to remain covered by employer contributions, and you should verify that your employer is doing so. Men between jobs should simply maintain insurance continuity via monthly payments. An arrangement can also be made with the pension fund to continue paying into the insurance by drawing down accumulated savings.
11. Abandoning good savings plans
Switching from a good savings plan to a much inferior one is a mistake that happens when you don’t consult the right people or when you blindly follow foolish advice from insurance agents. Some good plans offer guaranteed state-subsidized returns; others may have an assured life expectancy factor − meaning benefits won’t decrease even if life expectancy rises.
Take action on your pension only based on professional advice. In any case, great care should be taken with any insurance policy, or even a provident fund, from the 1980s.
Anyone with life insurance from before 1991 might be holding a treasure − a policy with a guaranteed return. A policy bought between 1992 and 2001 doesn’t have this, but it probably has good life-expectancy coefficients. Never abandon these instruments before getting solid advice.
But this doesn’t mean you can sleep soundly just because you have an old life insurance policy. The policy may have guaranteed returns or good life-expectancy coefficients, but this doesn’t mean it can’t have serious flaws like a very expensive insurance component. These too should be checked with a consultant.
12. Not haggling over management fees
Management fees should also be examined; they’re negotiable. Every percentage point in returns will eventually raise pension savings by 17%, so it’s important to haggle over every fraction of a percent. Leading consultants have said that anyone with pension savings of more than NIS 100,000 has leverage vis-a-vis a fund in threatening to pull out. They say management fees for provident funds can be negotiated down to 0.8% of cumulative savings, and in pension funds down to 3% for the premium and 0.35% for the accumulation. But with life insurance, you still can’t finagle a discount.
13. Not checking statements for errors
You get statements, but you often throw them out without opening the envelopes. You don’t need a math Ph.D. to open the envelope, peek inside and check a few simple things. For example, compare the opening balance with the closing balance in the previous quarter to see if there were any calculating errors.
Pensions can contain hundreds of mistakes; any number of problems could crop up in the chain between the employer and the pension fund manager. Perhaps the employer forgot to pay in for several months, the balance was reported incorrectly, or the future pension was calculated incorrectly. Every mistake can be corrected − if it’s caught in time.
14. Getting caught up in panic
A hard and fast rule in the capital market applies to pension savings too: Mull your investment options and don’t make rash decisions. A large majority of pension savers slack off and remain in a general savings track − something that doesn’t really suit anyone, especially the very young or old. “We also advise people financially,” says Landau. “It always amazes us that there are savers who invest in the stock market and know exactly what’s happening in their portfolio, but when you ask them where their pension money is invested − a much larger sum − they don’t have a clue.”
You should have a clue what investment track your pension money is in and sensibly choose the most appropriate one. This is especially true during a market crisis like in 2008 and the one probably awaiting in 2012. People made a bad mistake in 2008 by shifting their pension savings elsewhere and locking in double-digit losses.
Don’t make this mistake. Investments are for the long term, certainly in pensions, and a young person has no reason to panic and flee stocks. But older people facing retirement are better off switching to a solid investment track before the 2012 debacle comes around.
This article was originally published in TheMarker Magazine’s December issue in Hebrew.