Demystifying retirement funding

Let's try to break this all down into phases of your life, and look at the various terms which will apply to those phases.

PRIOR TO RETIREMENT

PENSION FUND:

A pension fund is registered by a company as a perk for employees to try and assist them in building up sufficient retirement capital during their working life.

Normally a company contributes 50% of the contribution or premium, while the employee pays the balance. This structure could vary from company to company, and also depends upon your position within the company, so is not a hard and fast rule. The maximum contribution pa = 10% of pensionable salary (excludes car allowances etc) by employer and 7,5% by employee. These contributions are tax deductible in yours and the companies hand's.

This fund cannot be matured under normal circumstances until age 55 at the earliest, at which stage the employee can then elect to "retire" from the fund (see "at retirement" further on). The only way that it can be accessed would be through death or disability, or if you left the company and elected to cash it in and pay the tax on the capital.

PROVIDENT FUND:

Very similar to a pension fund in that it is set up by the company for the same reasons. However, the contributions made by you are NOT tax deductible, so in many cases, contributions will be paid 100% by the employer as they get the tax deduction. The other major difference is in the way it pays out at retirement ( see "at retirement" further on).

RETIREMENT ANNUITY:

This falls under the pensions act, and is regarded as a "private" pension fund that anyone can take out to supplement his or her pension or provident fund. Premiums are tax deductible based on the greater of:

  • 15% of any salary that is deemed to be non-pensionable (e.g. your car allowance, or if you are self employed with no pension fund, then your full earnings);
  • R 3 500 less all fund contributions;
  • R 1 750 if you are on a pension fund.

You thus need to perform a small calculation to determine your tax deductible amount that you can claim. 

PRESERVATION FUND:

This slots in between all of the above, and only becomes relevant should you elect to leave the company or become retrenched BEFORE retirement age 55. It is simply an extension or continuation of your pension or provident fund.

Note that at this juncture in your life (leaving the company etc), you are entitled to either cash in your pension or provident fund, which will be fully taxable (after the first R 25 000 is deducted) in your hands OR you can transfer the funds, free of tax, into a preservation fund. This fund allows you access of up to 100% of your funds ONCE between the time you invest into the preservation fund and retirement age.

A very important note regarding this "accessibility" - many advisors/brokers will recommend that you take the R 25 000 tax free portion and transfer the balance into a preservation fund. This will negate the accessibility, as the receiver deems that R 25 000 to be your one draw - be aware !

DEFERRED COMPENSATION:

A glorified endowment policy which is set up by a company on behalf of an employee, primarily as a tool to retain their services (or a reward for long service). Has a different tax structure to the above ( see "at retirement" further on). Company normally pays full premium.


AT RETIREMENT

Once you have reached this magical age (and in today's age of health care, it is still a wonderful age, so enjoy it!), a whole myriad of options open up for you, and the decisions become quite critical. We need to look at these in depth.

PENSION FUND and RETIREMENT ANNUITIES:

A pension fund allows you to withdraw up to 1/3 of the fund value in cash. This sum will have a portion that is tax free. For now that portion is R 500 000 for all pension products on retirement. Once you have extracted this "cash" portion, you can obviously do with it as you please.

However, for the balance of 2/3, you HAVE TO purchase an ANNUITY of some sort - not to be confused with the RETIREMENT ANNUITY into which you may be paying a monthly premium!

This is where the problems creep in - not many people are aware of the variations within the term "Annuity" and the problem is that, once committed, you cannot change your mind! It is thus imperative that you know what you are buying up front. Herewith a few definitions:

NIL GUARANTEE LIFE ANNUITY:

Bought from an insurance company. Secures a GUARANTEED income for the life of the annuitant, and ceases on their death with NO further benefits for spouse or heirs (lose the capital). Generally will pay the highest income. Only really applicable to those who have no dependents or need to support anyone else;

5/10/15 YEAR GUARANTEE AND LIFE THEREAFTER:

Bought from an insurance company. Will pay a guaranteed income for the guaranteed period selected (5, 10 or 15 years) should the annuitant die before that period expires. Will cease upon death of the annuitant AFTER that period with no further benefits for heirs. Income is affected by the length of the guarantee;

INSURED ANNUITY:

Bought from an insurance company. Same as a Nil Guarantee Life Annuity above, however, part of the annuity income pays a life policy which will insure the capital, thus allowing the heirs to receive the original capital sum upon death of the annuitant;

"LIVING" ANNUITY:

A fairly new innovation that allows the capital to be invested and managed by the annuitant (investment advisor), from which he/she can select their own level of income between 2.5% and 17.5% of the capital sum per annum. Probably the best option IF the capital is wisely invested and IF the annuitant selects his/her income at a prudent level (recommended at no higher than 7.5% pa);

I stress again that it is imperative that you obtain quotes and review ALL the options. We at Brantam tend to lean towards the LIVING ANNUITY as this does have the facility of preserving the capital for your heirs and offers the annuitant flexibility in income choices, but it all needs careful consideration before committing.

PROVIDENT FUND:

One of the so-called "plusses" of a provident fund is that the full value can be commuted as cash at retirement, without being stuck with the 1/3 - 2/3 rule. I struggle to actually see the benefit of this, as ultimately at retirement you need to "buy" some income, so you will be cashing it in, paying your taxes, and then be back to square one with looking around for ways of generating a monthly income.

The recommendation is to rather look at transferring the fund value into one of the above mentioned annuities free of tax the same way as you would a pension fund.

PRESERVATION FUND:

As mentioned, a preservation fund is really a continuation of your pension or provident fund, and will thus be treated the same as for those products.

DEFERRED COMPENSATION:

As mentioned, this is a glorified endowment, however with one big difference:

Because the fund was instituted by a company, and the company (in 99% of the cases) owns the contract, only the first R 30 000 will be free of tax, with the balance being taxed at your average rates. Thus if you have been paying in for 30 years and have accumulated R 500 000, a full R 470 000 will be taxed at as much as 36 % !!

Once you have matured this and paid the tax, the funds become yours to use as you see fit.


This has been a rather long winded diatribe on retirement funding, but a very important one. No-one expects you to remember all of this (that is what we are here for), but it will hopefully provide you with a clearer insight into the pitfalls which may present themselves. Print it and keep.

* * * HAPPY RETIREMENT ! * * *

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