/ 19 August 2010

Moving pensions

Richard says: At 64 I have been advised that our defined benefit fund may be liquidated as there are only four members. I wish to work beyond 65. My equitable value is about R3-million.

My options are

  • Invest capital in an RA to allow future tax-efficient contributions by company.
  • Ring-fence the amount in a preservation fund and start a new RA for future company contributions.
  • Transfer the amount to the company provident fund and continue contributions.

Which would be most cost-efficient while being most flexible?

Maya replies: This is a very important decision you are making and it is a good idea to get sound advice and also fully understand what the options entail.

Dave Crawford is a financial educator who works with fund members to understand their retirement options. He makes the following points:

Age of retirement: If you continue to work with the same employer it is a negotiable matter between employer and employee. Most modern defined contribution pension and provident funds permit members to remain after mandatory retirement age by agreement with management. It is very important because it means that the member continues to receive employer contributions into his fund even after normal retirement age.

Invest existing capital into an RA with continued company contributions: This is a reasonable proposition unless the retirement annuity is loaded with costs.

If it is a retail retirement annuity there will be commission, administration fees and, of course, high management fees on the investment. Even if done directly via one of the asset houses, their investment fees can be relatively high.

If you can satisfy yourself that the costs are minimal then it’s a proposition because an RA, after all, is just a pension fund. Unless negotiated down, initial commission on R3-million at 2,5 % will be R75 000. Bear in mind that with any such product the investor’s fortunes will rise or fall by his choice of investment portfolios.

Ring-fence the amount in a preservation fund and start a new RA for future company contributions: Again, costs play a big role but it is a decent proposition as well. The effect will be pretty much as above subject to costs. However you may be able to better negotiate costs if you opt for one product. Neither retirement annuities nor preservation funds have mandatory end dates any more.

Transfer the amount to the company provident fund and continue contributions: This is an interesting option. If, as I think is the case, the defined benefit fund is a pension fund, there is a complication in transferring funds from a pension to a provident fund.

With a pension fund members get tax relief on their own contributions up to an amount equal to 7,5% of their pensionable salaries per annum. At retirement they can never take more than one-third out in cash and the balance must be invested in a pension for life.

With a provident fund, member contributions are not tax deductible (they are taxed in the company’s hands). At retirement from a provident fund the member’s tax free amount is increased by an amount equal to the sum of all his or her own contributions (as opposed to the company’s). And a member may take the entire amount in cash at retirement or any combination in cash and or pension.

When transferring from a pension fund to a provident fund the sum of member contributions that enjoyed tax relief will be taxed as income.

The amount remaining, i.e. own contributions minus tax, then becomes an additional tax-free amount for the member to draw at retirement.

However, the tax deduction does reduce the amount of money in the provident fund.

If you choose this route you will then have the choice at retirement of taking the entire amount in the fund at the time in cash, or investing all of it in a pension, or having any combination of pension and cash.

The tax-free amount at retirement will be R300 000 plus the net after tax amount of member contributions at retirement.

As a rule large company pension funds tend to have lower costs than retail retirement products, so it would be more cost-effective than moving to an RA or preservation fund.

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