WHAT IS THE DIFFERENCE?
Around 41% of South Africa’s economically active population is estimated to have no retirement plan in place and only 6% of South Africans are on track to retire comfortably (meaning their pension will be at least 70% of their last salary).
This article provides high-level information for retirement fund trustees and retirement fund members to understand the different types of retirement funds.
Types of retirement funds:
Pension fund: A member employee and their employer pay monthly contributions during the employee’s working life. At retirement the money invested (including the income earned on it) allows the member to receive an annuity (also called a ‘pension’) for the remainder of their life in monthly or quarterly instalments. It may also pay an annuity to the member’s surviving spouse or child, if applicable. The fund usually allows a member who is about to retire to take up to one third of the capital value of their pension savings at retirement, in the form of a lump sum. The remaining balance will be paid to the pensioner in the form of an annuity for the remainder of their life.
Provident fund: Allows a lump-sum benefit of all of the retirement savings capital (instead of a pension and a possible lump sum) to be paid to a member when they reach retirement age.
Retirement Annuity fund: This is a retirement fund usually used by members who are not employed by an employer and to which a member may make a single or several contributions during their working life. It is a pension fund which means that the member may elect to take up to one third of the capital value of their pension savings at retirement in the form of a lump sum. The balance will be paid to the pensioner in the form of an annuity for the remainder of their life.
Preservation fund: This is a fund to which a ‘contribution’ is made by a member from their retirement savings, which is transferred from their previous retirement fund after leaving their place of employment due to resignation or dismissal from their job. Those retirement savings are then invested by the preservation fund for the member until they reach retirement age (any date after the member reaches 55 years of age) although the rules may allow a member to make one withdrawal from their retirement savings before they reach that age.
Beneficiary fund: Should a member of a retirement fund die and there is no parent or guardian to look after the financial interests of the member’s minor children, the fund can make a distribution of that
deceased member’s pension savings into a beneficiary fund which will invest those savings and pay for the child’s education, healthcare, clothing and household expenses until they reach the age of 18. Any remaining funds will then be paid out to the child.
Defined Benefit versus Defined Contribution:
Important to note is that the calculation of the final pension benefit a member will receive upon retirement will be determined, to a large extent, by whether the type of retirement fund they contributed to was a defined benefit fund or a defined contribution fund.
Defined Benefit fund: Provides a guaranteed pension benefit on retirement which is calculated based on the member’s final average salary multiplied by the years of their fund membership as an employee. The rate at which the employed member contributes to the fund is usually fixed as a percentage of their remuneration. The employer’s rate
of contributions is usually calculated by the fund’s valuator who works out the rate at which the employer will need to contribute to the fund to enable the fund to pay the member their guaranteed pension benefit after retirement. The employer carries the risk of the fund having to guarantee the member’s pension after retirement.
Defined Contribution fund: Provides a pension benefit on retirement which is calculated based on the accumulated contributions made to the fund by the member (and/or, if applicable, the member’s employer). The returns earned on the investment of those contributions, less deductions of the costs of running the fund and providing for death and disability benefits, are added to the pension benefit. The rates at which the member and employer contribute to the fund are fixed or defined as a percentage of the member’s remuneration. Importantly, the amount of the member’s pension is not guaranteed, but is rather based on the contributions made combined with the fund’s investment performance. This means that the member carries the risks and rewards of their final pension amount.
SUMMARY OF THE KEY FEATURES OF DEFINED BENEFIT AND DEFINED CONTRIBUTION FUNDS
Source: Understanding South African Financial Markets (5th edition), ‘Retirement Funds’
- Understanding South African Financial Markets (5th Edition), ‘Retirement Funds’, p. 165-167
- Pension Funds & Climate Risk, Annexure 1. Available: https://justshare.org.za
- Pension Funds Act, www.fsca.co.za