New regulations in terms of the Pension Funds Act, effective 1 March 2019, require all retirement funds to make a default annuity strategy available to members at retirement. This blog is going to briefly answer a few questions about the proposed annuitisation for provident funds and its impact on retirement funds.
What is the difference between pension funds and provident funds?
Employees have the choice to select their type of annuity provider or opt for the default option offered by the employer. Depending on the employer fund and benefits, members can choose between a pension fund or a provident fund.
Upon retirement, pension fund members receive one-third of the total benefit in a cash lump sum, with the two-thirds in the form of a pension annuity over the rest of their lives. The pension fund money is paid for life until the member dies, which is a preferred option for employees who want the certainty of receiving monthly income after retirement. This security prospect is the main advantage of the pension fund.
By contrast, provident funds are more flexible. Provident fund members can receive the full benefits paid in a cash lump sum at retirement. However, receiving all retirement benefits in a cash lump sun has its advantages and disadvantages. For example, retirees can invest part of the lump sum by buying into a private pension or purchasing investment property.
Furthermore, the tax benefits are different for members contributing to pension funds as opposed to provident funds. An employee’s contributions to a pension fund are deductible for tax, unlike the contributions to a provident fund. This is important, as the tax benefits may improve depending on the employee’s income bracket before retirement.
What is the proposed annuitisation of provident funds?
The proposed annuitisation of provident funds requires all provident fund members, upon retirement, to purchase an annuity with two-thirds of their fund value, in the same way as the retirement annuity fund and pension fund members. Annuitisation will then become compulsory for all members of retirement funds.
The new legislation is looking to minimise the disadvantages of provident fund members drawing the full cash sum and spending it recklessly, not leaving enough funds for the rest of their lives, as not everyone may be able to invest the lump sum wisely. If funds are depleted, the retiree can only apply for a state pension as a last resort.
While employees need to understand their options available for retirement and their consequences, employers offering retirement fund options as part of the employment benefits must be fully aware of the latest amendments to the Pension Funds Acts, and how to implement and administer it correctly.
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