Retire: RA, pension or provident fund?

Carina JoosteLatest, Retire

Saving for retirement is riddled with question marks and jargon. We’ll kick off by answering one of the most-asked questions around retirement: how do we differentiate between a retirement annuity, pension fund and provident fund? All of them help you save for retirement, but they aren’t synonyms.

What is a retirement annuity?

  • A retirement annuity (RA) is an investment product you can invest in when your employer doesn’t provide a pension fund. RAs are also ideal if you’re self-employed or an irregular earner.
  • If your employer does offer a pension fund, you can invest in an RA to bolster your retirement savings. To enjoy the maximum tax benefit you can contribute 27.5% of your gross remuneration or taxable income.
  • RA providers invest in different assets, such as equities, foreign assets, property and cash, but all retirement annuities have to be Regulation 28 compliant.
  • As part of the Pension Funds Act, Regulation 28 helps to protect your retirement savings by regulating where your RA provider invests your monthly contributions. There are benefits to a more cautious approach when investing for retirement – to protect your money during the good times and the bad.

What happens when I retire?

  • Your RA will provide you with a regular income, or a regular income and a cash lump sum when you retire.
  • The cash lump sum is limited to one-third of your retirement savings and subject to lump-sum tax (but more on tax in next month’s blog).
  • Should you pass away before you retire, your RA will be distributed to your listed dependents or beneficiaries.

Not all RAs are created equal

  • Unit trust RA: Also known as next-generation RAs, unit trust RAs are nice and flexible, and they are products of the asset management industry. You can reduce, increase or cancel contributions without having to pay any penalties. You can invest direct with the asset manager, or you could pay an advisor for advice. You also don’t have to pay any upfront fees, as fees are only paid on an as-you-contribute basis. And don’t worry, the fees are much lower than that of life-insurance RAs’ notorious upfront fees.
  • Life insurance RA: Life-insurance, also referred to as normal or legacy RAs, are more restrictive as they are policy-linked, contractual and underwritten by insurance providers. If you want to transfer your life-assurance RA to a different or low-cost provider, you run the risk of paying penalties and losing your life, disability or critical illness cover. So always do the research and math before you switch. If you want to make your life-insurance RA paid up to open a new RA with a low-cost provider, you still run the risk of paying penalties.
  • For more on the costs of moving retirement products, listen to this podcast

Tax benefit

If your employer contributes to your RA, you still qualify for a tax deduction.

The fine print

  • Your RA will only pay out once you turn 55 years old and not a day sooner.
  • You’ll only be allowed to take a maximum of a third of your RA as a lump sum.
  • You need to convert at least two-thirds of your RA into a guaranteed or a life annuity, or an investment-linked living annuity.

RA Tip

In addition to your regular payments, you can contribute ad hoc payments whenever you have extra cash. The next time when the gods of the tax return smile upon you, invest the money in your RA. Your future self with thank you.

What is a pension fund?

  • A pension fund is a workplace-based retirement plan. This means it’s set up by your employer.
  • A pension fund can also provide death and disability benefits.

What happens when I retire?

A pension fund will provide you with a regular pension when you retire, or you can opt to receive a regular pension and a cash lump sum.

The fine print

  • Most pension fund contributions increase with inflation every year.
  • When your pension fund starts to pay out, you’ll only be allowed to take a maximum of one-third of your pension as a lump sum.
  • Like an RA, at least two-thirds of your pension needs to be converted into an annuity. You can either convert it into a guaranteed or a life annuity, or an investment-linked living annuity.

The benefits

  • You can get access to your pension at any age. If you cash out before retirement, you’ll be liable to pay a lot of tax (which is not really a benefit). It’s much better to wait until retirement before you cash in. In fact, just pretend you didn’t read this.
  • Although your employer contributes to your pension fund, you can also contribute to add more substance to your pension.
  • Your and your employer’s pension fund contributions are tax deductible.
  • Changing jobs? No problem. You can transfer your workplace pension fund to an RA or a preservation fund for safe keeping (and to keep on benefitting from compound growth).

Very short intro to provident funds

  • A provident fund provides a cash lump sum upon your retirement.
  • You are entitled to the full lump sum minus the tax payable.
  • A provident fund is set up by your employer and can also provide death and disability benefits.
  • Although your employer contributes to your provident fund, you can also add contributions.

The benefits

  • You can reinvest or use the money as you wish.
  • You can get access to your provident fund when you leave your employer. It can either be transferred to your new employer’s pension or provident fund or a preservation fund, tax free. You also have the option to take the cash.

The small print

  • You will need to pay tax on the lump sum (less your contributions) once it’s been paid out.
  • Only your employer’s contributions are tax deductible.

Wait, there’s another one?

Yes. We only mentioned three retirement products at the beginning of this blog, but decided to sneak in a preservation fund as well.

What is a preservation fund?

  • Basically, a preservation fund does exactly what it says on the sticker. It preserves your workplace-based retirement savings when you switch jobs, are dismissed or retrenched.
  • You can’t contribute to a preservation fund, but you will benefit from compound growth.

Preservation fund tax

  • When you transfer your pension or provident fund savings to a pension preservation or provident preservation fund, you’re exempted from tax. You also don’t pay tax when you transfer your preservation fund to another preservation fund or RA.

The fine print

You are allowed to access preservation fund via one partial or full withdrawal before the age of 55. The remaining balance, should there be one, can only be accessed when you turn 55 years old.

Saving for retirement is the biggest investment most of us will ever make. Sadly, it can also be very complicated. In this monthly blog, we try to answer some of the retirement questions we hear most often, ranging from which products are best suited to different circumstances to efficient tax treatments. Words by Carina Jooste.

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