Could you please compare the cost of a purchase of service from the GEPF [Government Employee Pension Fund] versus a retirement annuity [RA]? For example, maybe someone wants to buy an additional five-year purchase of service than taking out retirement annuity because the person started contributing to a pension fund late. What are the pros and cons?
To start, I think it is important to have a good understanding of the two types of retirement funds.
Government Employee Pension Fund (GEPF)
The GEPF is a defined benefit fund, meaning that the benefits are defined in the rules of the fund, unlike a defined contribution fund where your accumulation of funds makes up your pension pot.
The benefits are guaranteed and do not depend on how much the member and employer have contributed. The benefits are calculated according to a set formula, which takes into account the number of years of service and your average salary over the last two years worked. Your benefits are made up of two parts if you retire with more than 10 years of service, namely (a) a once-off lump sum better known as a gratuity, which you can invest or take as cash, and (b) a monthly pension also known as an annuity.
If you are married or have a life partner, you can select an amount of your monthly pension you would like your spouse/life partner to receive after your death. In most cases, when a GEPF member dies, the spouse is entitled to receive 50% of the monthly pension that the member would have received. Nevertheless, this monthly pension can be increased to 75% if the member wishes. It is important to note that the effect of increasing your spouse’s pension to 75% either reduces the gratuity or annuity that you will get when you leave the fund.
Retirement annuity (RA)
A RA is a retirement fund in terms of the Pension Funds Act. It is a tax-effective investment vehicle designed for individual investors as opposed to employees who contribute to a workplace retirement fund such as a pension or provident fund.
A retirement annuity is ideal for people who are either self-employed, do not have access to a work-place pension or provident fund through their employer, or want to supplement their pension or provident fund savings.
At retirement, you may take up to one-third as a cash lump sum, subject to retirement lump-sum tax, and at least two-thirds must go towards a compulsory annuity. Compulsory annuitisation applies to fund balances above R247 500, and any amount below R247 500 can be fully withdrawn. If you own multiple RAs in one fund (for instance, you have two RAs in an Allan Gray Fund), then the annuitisation requirement considers the aggregate value of your RAs.
Purchase of service, GEPF
The older you are when you start planning for your retirement, the less time there is to make sure you have enough for your old age.
You could be facing this problem if you started working for the government late in your working life and did not belong to a pension fund before.
It can also be a problem if you have taken long periods of leave without pay during your career with the government and thereby missed making your pension contributions.
You can rectify this by paying an extra amount (that both you and the GEPF board of trustees can agree on) towards buying additional years of pensionable service.
Purchase service grants you a longer period of pensionable service, which means you end up with a larger pension when you retire. Fortunately, GEPF offers you a way to increase your pensionable service – which means a better retirement benefit.
Comparing the cost of purchase of service can only be done when a member is a contributing member at the time they apply for purchase of service. The GEPF will provide you with an individualised quotation, taking into account specific circumstances. As a result, it is not possible to provide you with an accurate comparison, but you are welcome to request such a quotation from the GEPF if you are a contributing member and your financial advisor will be able to provide you with a comparison between the two options.
The pros and cons of the two types of funds
Pros of the GEPF
All GEPF benefits are defined in the Government Employees Pension Law and rules, which is why GEPF is called a defined benefit fund and not a contribution fund. The advantage of belonging to a defined benefit fund is that your benefits are guaranteed. Irrespective of the performance of the markers or individual investments within the GEPF, a member receives a guaranteed pension on retirement, regardless of whether the investment markets rose or fell in the years before retirement. Benefits are protected against inflation. The GEPF has a solid track record in safeguarding the value of its members’ retirement wealth and in protecting its pensioners against inflation.
According to GEPF fund rules, the annual pension increase paid to its pensioners must be at least 75% of the average increase in consumer inflation from December 1 to November 30 of the previous year. The members’ pensionable interests are safeguarded as the fund has very strict rules about the kind of benefits they must pay and how they must invest. These rules are contained in the Government Employees Pension Law, Proclamation 21 of 1996, and rules issued thereunder. Your own contributions to your retirement fund, plus your employer contributions to your retirement fund, are tax-deductible up to certain limits. Tax is only payable on your benefits when you access your funds (i.e. upon resignation or retirement).
Cons of the GEPF
Retirement age is set out in the rules of the fund and you can only retire at the retirement age set by the GEPF (as opposed to a retirement annuity fund, where members can retire from age 55 and there is no upper age limit, meaning they can retire at any time from age 55). With the GEPF there is also no flexibility in how you receive your pension – you cannot increase or decrease your pension payment according to your income requirement. In addition, once you and your spouse have passed away, the benefit stops and you cannot leave a legacy to your children for instance.
Pros of an RA
If the total amount in the fund is less than R247 500, you are not limited to taking up to one-third of your savings as a lump sum. You can take the full amount as a cash lump sum, subject to tax. Therefore, no annuitisation is required if the fund is less than R247 500. The growth and income within your fund, while you’re a member of the fund, is tax-free and tax is only payable when you access your funds.
A range of investment options is offered from which you can select to suit your risk profile and growth objectives. These options also include offshore investments, subject to Regulation 28 of the Pension Funds Act. Once you retire from an RA, investment houses offer a range of income-generating solutions for the compulsory annuity portion. These have been developed to address your specific needs and circumstances. Your choice will depend on whether you want a guaranteed income, a varying income based on the performance of your investments in the market, or a combination of both.
By contributing to an RA, you will be able to reduce your tax liability annually when you submit your tax returns. Since March 1, 2016, RAs qualify for the same tax incentives as pension and provident funds.
You may deduct contributions to an RA fund up to 27.5% of taxable income or gross remuneration (whichever is higher) for tax.
It is important to note that the 27.5% limit applies to the aggregate of contributions to all funds (pension, provident and RA). The overall tax-deductible limit is R350 000 per annum.
Contributions over R350 000 may be rolled over to future years but will be subject to the limits applicable in those years. There is no maximum age at which you need to stop contributing to an RA, or at which you need to access your RA (you can only retire from an RA from age 55 onwards).
Cons of an RA
The benefits that you will receive at retirement will depend on the fund selection that you made, which means that the investment risk is placed on the member and not the fund.
From the above, it should be clear that the decision whether to purchase additional years of service in the GEPF or to contribute to an RA will depend on your personal circumstances and the lifestyle that you would like to lead one day. These are questions that a suitably qualified financial planner will be able to assist you with after taking all your personal circumstances into account.