Pension and Provident Fund - Decide Now How to Live Your Golden Years

The Weekender/Business Day - 02/03 Dec 2006

Pension and Provident Fund Differences: If you are a director or employee of a company, chances are that you belong to either a pension or provident fund. Even though this makes up the bulk of most people’s retirement provisions, few people know the difference between the two.

Depending on the investment strategy and cost structure, a retirement fund is the best way for many investors to save towards their retirement.

The purpose of both pension and provident funds is to provide employees or their dependents with an income upon retirement.

Employers may deduct up to 10% of the remuneration of an employee or a higher amount approved by the taxman for pension and provident funds. Currently the taxman allows employers to deduct up to 20% of the contributions made for an employee. For pension funds, an employee may deduct the greater of R1 750 or 7,5% of remuneration.

The main difference between these retirement funds is how you receive your fund benefit at retirement.

If you are a member of a pension fund, you may elect to receive up to a third of your retirement benefit as a cash lump sum, with the remaining two-thirds being paid monthly. This monthly income will be taxed at your average rate of taxation in retirement. If no cash lump sum is taken, your full benefit will be paid monthly, resulting in a higher monthly pension.

If you are a member of a provident fund, you can choose to take your entire retirement benefit as a lump sum. A portion of this may be tax-free, but you will be taxed on the portion which is not exempt from tax.

Few individuals remain with the same employer for the whole of their working lives. If you resign or are dismissed, you may transfer your provident fund benefit to a “preservation provident fund” and your pension fund to a “preservation pension fund.” These vehicles are specifically designed to safeguard your retirement savings.

You won’t be taxed on transfer of your savings to one of these vehicles and you are also allowed one withdrawal prior to retirement.

You also have the option to withdraw all the cash when leaving a company before retirement. However, this lump sum will be taxed (except the first R1 800, which is tax-free).

Resist the temptation to blow this money on something like holidays as you will more than likely need it to fund your income later in life when you can no longer earn a regular salary.

If it is wisely invested, you may enjoy satisfactory returns. An investment of R100 000 in a preservation fund outperforming inflation by 4% a year for 25 years will have grown to R271 377 in present-value terms.

This boosts your pension by about R15,694 a year, assuming a drawdown over a 30-year period and a return of 4% above inflation.

It is important for you to determine how your pension or provident fund intends investing your contributions. Bear in mind that these funds are merely a legal entity or vehicle used to hold your contribution. The underlying investment funds can be the same for both the pension and provident fund. For example, both may be invested in the same balanced fund.

Certain funds allow their members to choose how their contributions are invested. If your fund offers you an investment choice, consult with your financial planner to ensure you make the correct investment decision.

Another consideration to be aware of is whether your pension fund or provident fund offers death or disability cover. In the event of your death, the retirement fund will pay your beneficiaries all the contributions you have made to your retirement fund plus the growth on your investments and the group life assurance amount.

You should also consider whether you are a member of an approved or unapproved pension or provident fund. If you are a member of an unapproved fund, your beneficiaries will receive a tax-free payout on your death. However, if you are a member of an approved fund, your beneficiaries will not receive a tax-free payout.

In general, provident funds offer greater flexibility and allow members to contribute more to their retirement savings than pension funds.

My advice is to engage an independent fee-based certified financial planner who is focused on your best interests and who looks at your retirement savings as part of your overall financial plan.

Visit the Financial Planning Institute website, www.fpi.co.za, to select a qualified certified financial planner.

Debbie Netto-Jonker, CFP™, is founder of Netto Financial Services and was financial planner of the year in 2001.