Low-income earners: Can you earn too little to save?

When it comes to retirement, risk and healthcare benefits, low-income earners find themselves in a  quandary. Not having benefits in place might expose them to hardship in the near or distant future but paying for these benefits may make even the most basic goods and services unaffordable now. However, their specific needs and their entitlements to government benefits are seldom taken into account when designing employee benefits systems.

Retirement

Not saving at all may leave workers dependent on the Older Person’s Grant (OPG), more commonly known as the state pension, which is revised at least annually and was set in March 2012 at R14 400 per year for persons aged 60 to 74 and R14 640 per year for recipients aged 75 and over¹.

However, those with low levels of retirement savings may still receive a partial OPG to supplement their income, according to the means-testing rules. The OPG is means-tested in two ways².

Firstly there is an asset test, which means the OPG is not paid if the assets for each person exceed 55 times the annual OPG value. Using current OPG levels, this suggests an asset threshold of R792 000 per person aged between 60 and 74. If the assets fall below this threshold, then the income-test is applied.

The income-test involves a relatively complex formula. When the older person’s personal income is R14 400 per year or less, they receive the OPG in full. However, as soon as it exceeds R14 400, every R1 of additional income reduces the OPG by 40c. When income exceeds R47 400 per year no OPG is paid.

The income-test may create disincentives for low earners to save, since saving means giving up income during their working lives to provide for retirement, and any income derived from these savings will reduce the OPG that would otherwise have been freely received. Although saving may result in a higher combined income, the graph on the right illustrates that savers will not always be better off.

The impact of savings on the older person’s grant received

Finding the income level below which saving becomes inadvisable is a mathematically challenging exercise and a number of factors come into play, including:

• The percentage of pay that is pensionable
• Deductions from the salary for other benefits
• Costs
• Expectations of investment returns
• Salary inflation
• The future levels of the OPG
• Gender, as women’s annuities cost more than men’s annuities due to the fact that women live longer.

However, if you assume that the OPG’s real value remains constant and that pensionable salaries are set at 75% of the total income level and contribution rates are 13.5%, a 25-year-old man earning R42 100 per year and a 25-year-old woman earning R50 555 per year would have just enough income in retirement to get no OPG at all. Their own personal income secured through an annuity would be around R4 000 per month, almost R2 800 higher than the OPG on which they would have to rely if they had not saved at all. So, there are definite benefits to saving for retirement despite losing the OPG! The table below illustrates this example.

At lower levels of income, saving becomes increasingly difficult because individuals are living close to the breadline. Consideration of the municipal indigence lines suggests that people earning under about R21 000 per year should not consider any form of saving for retirement³. For young people with incomes around twice this income level, the argument for saving begins to become compelling. However, between these extremes is a grey area caused by the means-test.

High charges, particularly high fixed costs, are a key challenge for low-income savers. In funds run by employers, insurers and unions, charges are equivalent to 1% per year of total assets⁴. However, for products available to individuals, the total charges start at around 1.8% per year and increase to over 6% per year⁵. Higher than expected expenses mean that low-income earners receive less income from their own savings. This means that they may be partially reliant on the OPG despite their sacrifices during employment. It may be difficult for such savers to appreciate that they are still better off having saved for retirement and receiving some supplementation from the OPG rather than being fully reliant on the grant.

This message requires careful communication both from employers and the government to encourage savings for retirement if the income-test is to be retained. The asset test will also need to be updated over time as annuity prices increase, to ensure that those who require income-support in retirement receive it.

Risk benefits

Apartheid labour practices created a migrant labour system, which in turn created patterns of income transfers from working individuals to non-working family members. Together with the asset-test for the OPG, this pattern created a preference for cash benefits to support dependants. On average, working households earning under R60 000 per person per year support two to three other people outside the household. In extreme cases, a worker may have more than twenty dependants, including their own household⁵. This means that lower-income earners may have relatively high risk benefit needs, which may not be affordable in full.

All workers have some form of recourse to benefits if they are injured or killed in the workplace or while on duty through the Compensation for Occupational Injury and Diseases Act (COIDA)⁷. However, this may prove inadequate given that the disability or death of a low-income worker may have an impact beyond their own immediate family. This points to the fact that cost-effective risk benefits are essential and any benefits offered by an employer, union or the government sponsored National Social Security Fund must integrate with the basic government benefits. Group risk arrangements tend to be substantially cheaper for lower-income earners than retail offerings. So it makes more sense for employers to try to obtain this type of cover on a group basis than to leave it to individuals to secure cover privately.

Health benefits

Low-income earners can rely to some extent on government healthcare facilities. Primary healthcare may be within geographic reach of most South Africans, but many South Africans, particularly in urban areas, find that public primary healthcare facilities have long waiting times and are beset by drug shortages⁸. From an employee wellness perspective, this may translate to more time spent away from work to get a diagnosis and then a longer recovery time. It is perhaps unsurprising that a number of South African employers, particularly in the mining sector, run their own on-site primary healthcare facilities.

In terms of more serious ailments, Annexure H of the Uniform Patient Fee Schedule published by the Department of Health sets out the rules for receiving subsidies for treatment in government hospitals. The subsidy thresholds are set at levels that would allow for 90% of employed South Africans to receive at least some discount and so provide some protection against catastrophic health expenditure. However, earning over R72 000 per year or belonging to a medical scheme would automatically remove any subsidy⁹.

Providing low-income workers with affordable medical cover remains a key challenge for employers and the government. A consultative investigation into creating a medical scheme for low-income earners (LIMS) was launched in 2005 and while opinions differed on how to deliver a solution, the consensus was that traditional medical schemes were unaffordable for low-income earners¹⁰.  

According to the Medical Schemes Act¹¹, every medical scheme plan must include a core package, termed ‘prescribed minimum benefits’ (PMBs). The cost of these benefits means that even the lowest-cost plans would still represent a significant part of a low-income earner’s budget. This is particularly so for workers earning only slightly more than the current subsidy cut-off level of R72 000 per year. Some research suggested that some low-income families were spending about a quarter of their income on medical scheme contributions alone¹². Certain experts suggest that South African households should not be spending more than 10% of household budgets on healthcare¹³.

Lower-cost alternatives include health insurance in the form of hospital cash plans or occupational health products. These medical insurance products are not subject to the Medical Schemes Act 67 and as such, are not obliged to offer the package of PMBs. This, therefore, allows the product design to focus on essential cover, usually including basic stated hospital benefits and primary level day to- day benefits, which can be offered at much lower rates than the PMB package applicable to medical schemes. During 2012, these types of products could be bought at between R120 to R290 per month for a single member¹⁴.

These products provide a more affordable alternative to medical scheme cover. However many occupational health products can only be bought on a group basis, with cover often applicable to the main member only. This, therefore, excludes cover for the employee’s family. This could be seen as a weakness to the alternative cover, but providing cover for the employee should maintain their health for longer and more sustained periods,  thereby allowing them to continue to earn an income and support their dependents. In the absence of any cover, they may have been forced to take time off work or possibly even terminate their services due to ill-health.

Implication

The government is proposing reforms to the retirement industry. As things currently stand, these reforms may offer retirement and risk benefits to low-income earners, particularly if they use either auto-enrolment or a National Social Security Fund. However, the government needs to clarify and simplify the interplay between retirement savings and the OPG to encourage low-income workers to save. They should also explicitly deal with the complexity introduced by gender-specific annuity rates to reduce old-age poverty among women.

The government should consider removing the means test for access to the OPG, given the disincentive to save for low-income earners and the administration costs of the means test. This would mean that all South Africans above the age of 60 would qualify for the OPG. This could be made fiscally neutral by varying the income tax threshold for older South Africans with other sources of income, so that their income tax increases by the value of the OPG.

A top-up savings plan for individuals appropriately incentivised through tax or co-payment by the government, where the proceeds are exempt from the means-test, could improve the long-term savings culture among low-income earners. 

It is also critical that careful consideration is given to the income threshold if workers earning above a certain income are to be auto-enrolled into retirement funds. This threshold should not unnecessarily exclude low-income earners who should save for retirement. For people with earnings close to the poverty line, however, a  government-sponsored wage subsidy may be required to prevent the retirement funding contribution creating hardship.

Currently, products available to individuals are not cost-effective for low-income earners and employers may need to include lower-income earners on the occupational funds if they are not catered for by the government. Consideration of how to treat expense allocations for different members will be critical to ensure that lower-income earners are not bearing too high a share of these expenses. As illustrated previously, low-income earners do not always benefit from saving for retirement and so workers who are better off not saving for retirement should not be forced to join the employer fund.

The risk-benefit needs of high- and low-income earners are very different, as are the premiums that each group could be charged. Managing the benefits package and cross-subsidies will be a key issue. 

National Health Insurance may improve healthcare delivery in the public sector, but this is a long term project and employers will need to address the healthcare needs of their low-income workers for the foreseeable future. In the absence of any changes to the PMB package, access to alternative products and hospital cash plans should help to meet the healthcare needs of these employees to some extent.

References

1 Government Notice 256 (2012). Increase in Respect of Social Grants. Government Gazette 35189, 29 March 2012,
2 Annexure A of the Social Assistance Act, Act no 13 of 2004
3 Moodley (Unpublished)
4 Alexander Forbes Research and Product Development (2012)
5 Zubi (Unpublished)
6  Income and Expenditure Survey 2005/2006, author’s own calculations
7 Act no 130 of 1993, as amended
8 Plaks & Butler (2012)
9 Department of Health (2012)
10 Magennis & Van Zyl (2009)
11 Act no 131 of 1998, as amended
12 McLeod et al (2003)
13 Eighty20 (Unpublished)
14 http://www.ocsacare.co.za/AboutUs.aspx and www.essentialmed.co.za