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Pension Funds - Provident Funds - Retirement Annuities. What’s the difference?

Saving Money • by Creditgenie • 14 January 2019

Pension Funds - Provident Funds - Retirement Annuities. What’s the difference?

When people discuss how they plan on spending out their golden years of retirement, they often talk of Pension Funds, Provident Funds or Retirement Annuities interchangeably. In South Africa all retirement funds are governed by the Pension Funds Act, but they are structured differently and serve different needs. In this article, we highlight the differences.

 Pension Funds and Provident Funds

Pension and provident funds are more commonly known as ‘’workplace’’ funds. If you become employed by a company that offers one of these funds and you are eligible to join, then joining the fund would most probably be a condition of your employment.

 The purpose of both pension and provident funds is to provide employees or their dependents with an income upon retirement. Currently, the South African Revenue Service (SARS) 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. In many cases you do not have the freedom to decide on your monthly contributions, which will most likely be determined by your salary and post level.

 The main difference between these two retirement plans 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 benefits 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).

 Although both plans forbid the employee from withdrawing the money before the age of 55 there are three exceptions:

  1. If the funds are less than or equal to R7 000
  2. If you are declared permanently disabled, and
  3. If you emigrate.

 Retirement Annuity

 Traditionally, workplace funds were limited to either pension or provident funds but many companies are switching to Retirement Annuities (RAs) which offer flexibility and choice for their employees - who are the ultimate owners of their individual RAs. There are several differences between the products, but all of them allow you to take a maximum tax deduction that is the greater of 27.5% of total gross taxable income or 27.5% of total gross remuneration (subject to an annual ceiling of R350 000). You may also withdraw 100% of your investment at retirement if your total is below R247 500; above that different rules apply for each product.

 Retirement Annuities are also an option for individuals who are self-employed, or whose employer does not offer a workplace fund. Presently, you can claim a contribution of 15% of non-pensionable income for tax purposes. You must use at least two-thirds of the fund to purchase an annuity when you retire. Unlike a pension/provident/preservation fund, you cannot cash in a RA before retirement (minimum age 55).

 Retirement Annuities can be taken out in the employee’s personal capacity so an employee could therefore have more than one of these plans. A benefit of an RA plan is that you can personally decide what your monthly contribution will be, whereas an employee usually does not have this choice with a pension or provident fund.  RAs also give you a tax benefit.

Creditors may not, under any circumstances, have access to funds within your RA and you may continue contributing to the plan, even when moving to another company. However, an important rule to remember is that you may not withdraw the money before you turn 55.

Which Plan is Better?

Since March 2016 the South African Reserve Bank no longer distinguishes between the respective plans. Although Pension Funds and Provident Funds have pros and cons, each employee’s savings plan is determined on its own merits. Should employees be given a choice – which is not always the case – it is important to consult an experienced Financial Advisor who is focused on your best interests and who looks at your retirement savings as part of your overall financial plan.

Creditgenie Members has access to telephonic financial counselling via the Financial Counselling Programme of our 4-in-1 Plan.

 The information supplied in this article does not constitute advice as defined by the Financial Advisory and Intermediary Services Act, 37 of 2002.