This article was first published in the 4th quarter 2017 edition of Personal Finance magazine.
If you are a member of the Government Employees Pension Fund (GEPF), it’s critical to understand your options if you resign and when you retire. Many members feel trapped within the fund, but there is no reason to: you can play an active role in the management of your hard-earned nest egg.
The GEPF is Africa’s largest pension fund. It has more than 1.2 million active members, 406 395 pensioners and beneficiaries, and assets worth R1.6 trillion.
The funds are invested by the Public Investment Corporation in a portfolio of equities, fixed-income investments, property and the Isibaya Fund, which invests in black economic empowerment development projects that help to alleviate unemployment.
The fund is not governed by the Pension Funds Act, and any changes to it go through Parliament as a separate bill.
While you’re employed, you pay 7.5 percent of your pensionable salary to your retirement savings, while the government contributes 13 percent. Although the government’s contribution is regarded as a fringe benefit and forms part of your gross income, the total amount is tax-deductible.
Your accumulated wealth (referred to as your actuarial interest) in the pension fund is yours, whether you resign or retire.
How does the GEPF differ from other funds?
The pension fund is a defined-benefit fund because, when you retire, the amount you receive as a pension is based on your final salary (averaged over the 24 months prior to retirement) and calculated using a formula that includes the number of years worked and your age of retirement.
The GEPF carries the investment risk, as well as the longevity risk, and guarantees the amount you will receive for your entire retirement. (Over the past 20 years, most corporate pension funds changed to defined-contribution funds, which means that the contributors, not the employers, bear the risk of the underlying investments and the amount available in retirement.)
The GEPF doesn’t allow your retirement savings to be used as collateral for mortgages and loans, as is the case with some other pension funds.
Tax on lump-sum payouts from the fund and on monthly pensions differ from other pension funds in that the portion based on contributions made before March 1998 is tax-free.
The most significant difference between the GEPF and corporate pension funds is that, if you decide not to become a government pensioner, you need to make this decision and withdraw your funds before you reach the age of 60, which is the usual retirement age, although some departments allow you to work until 65. In effect, you have to resign to retire, to transfer your savings out of the GEPF .
What happens if you resign?
If you resign and take a job in the private sector, you have two options: receive a cash resignation benefit or transfer your savings into another retirement fund.
Members often decide to receive the cash to settle debt or, far worse, buy something they can ill afford, and in so doing reduce the capital they need to sustain a reasonable standard of living in retirement.
If your cash withdrawal amount is over R25 000, you’ll be taxed according to the South Africa Revenue Service’s withdrawal lump-sum tax table, the rates of which are steep, and you may be further penalised tax-wise on retirement if you make another withdrawal. The portion of the cash withdrawal based on pension contributions before March 1, 1998 is tax-free.
You will not be taxed if you transfer the full amount of your savings to another approved pension fund, preservation fund or retirement annuity (RA) fund. This is to encourage you to preserve your hard-earned wealth. An RA will enable you to keep contributing to your savings, but you will not have access to the money before the age of 55. If you transfer into a preservation fund, you can make one withdrawal before retirement.
What happens when you retire?
Again, you have options. You may remain in the fund as a pensioner, or resign just before you retire, transfer your funds out of the GEPF, and use a compulsory annuity to provide you with an income during your retirement.
Option 1: Remain in the fund as a GEPF pensioner
The normal retirement age for government employees in South Africa is 65, although you have the option of retiring at 60 without being penalised.
When you retire, you will receive a lump sum and a monthly pension if you have been employed for over 10 years in the government sector. If you have been employed by the government for less than 10 years, you will receive only a lump sum. The lump sums are taxed according to the retirement lump-sum withdrawal table, but the portion based on contributions before March 1998 is tax-free.
If you have been employed for longer than 10 years and are entitled to a monthly pension, it will be paid to you until you die, and if you die within five years, your beneficiaries will be entitled to the full income amount up to the end of this period, which will be paid as a lump sum and taxed at your annual rate of income. Your spouse will also be entitled to receive 50 percent of your monthly pension until he or she dies.
You may increase your spouse’s pension to 75 percent, but this will reduce either the lump sum or monthly pension amount that you receive during your lifetime. If you are not married when you die, your pension falls away.
You may retire early, with or without the approval of your employer. The usual rules apply to the lump-sum and monthly pension payments and the number of years worked, but these amounts will be reduced by one-third of a percent for each month between your retirement and your 60th birthday. You won’t be penalised if you’ve been granted permission to retire early.
On the first of April each year, you’ll receive an increase of at least 75 percent of the inflation rate of the previous year.
Very significantly, as a GEPF pensioner, you qualify for medical benefits. If you have been employed for more than 15 years, the government will pay a portion of your medical scheme membership fee if you remain a principal member of a medical scheme. If you have been employed for less than 15 years, you’ll receive a once-off payment that you can use to subsidise your medical scheme contributions. These benefits are regarded as fringe benefits and are taxed at your annual rate of income.
Pros and cons
The obvious advantage to staying within the fund and being a pensioner is that you are guaranteed a known income for life, and you don’t have to worry about things such as investment risk, market fluctuations and advice fees, although you do need to consider these when investing your lump sum.
You also have the advantage of maintaining benefits, such as contributions to your medical scheme. This is quite significant, considering medical inflation rates in South Africa were between 10.2 percent and
11 percent in 2016.
A distinct disadvantage of being a GEPF pensioner is that the purchasing power of your income may decline, because your pension is guaranteed to increase annually by only 75 percent of the inflation rate of the previous year. The decline may be significant, considering our recent downgrade by some of the major rating agencies and the likelihood of a rising inflation rate.
You also don’t have the flexibility to change the amount paid to you or to move out of the fund at a later stage.
The most significant disadvantage to remaining a GEPF pensioner is that you may have accumulated a substantial pension, but if you and your spouse do not live long in retirement, your wealth within the fund ceases and doesn’t pass on to your children.
Option 2: Resign and actively manage your pension
Many government employees aren’t aware that they have the option of transferring their funds out of the GEPF. If you want to go this route and be active in the management of your retirement savings, it’s highly recommended that you ask a financial adviser to assist you.
You will need to resign to retire, before your retirement age of 60 (or 65, depending on your employment contract). Your funds may first be transferred into a preservation fund, and from there you will have to buy a compulsory annuity with two-thirds of the money, to provide a monthly retirement income. You’ll be able to take one-third as a lump sum, and amounts over the R500 000 tax-free portion will be taxed according to the lump-sum retirement tables. Again, all amounts based on contributions before March 1998 are tax-free.
You have the option of a life annuity or a living annuity as your compulsory annuity. If you are going this route, it is likely that you will choose the latter: a unit trust-linked investment in which you take the investment risks that will provide you with an income based on the capital and returns of the portfolio. You may draw down between 2.5 percent and 17.5 percent of your capital each year, although it is generally recommended that you draw down no more than five percent initially.
Pros and cons
One advantage is that you have some degree of flexibility in that you can change your drawdown amount each year, as long as it is between 2.5 percent and 17.5 percent of the value of the fund. This works in your favour if you have other sources of retirement income that may fluctuate.
You can choose the underlying investments based on your risk profile, access to other sources of income and drawdown amount.
A significant advantage is that, on your death, any remaining capital in the fund goes to your beneficiaries and doesn’t form part of your estate or attract estate duty.
The disadvantage to choosing independence is that you ultimately bear the responsibility for the success of the underlying investments and the likelihood of having sufficient income for your retirement.
The choice whether to go on your own or remain a GEPF pensioner is a personal, although complex, decision, and best taken with professional advice. You do, however, need to be aware of possible advice bias and fees.
Ultimately, there is no way of escaping capital risk. You either take the risk of a loss of capital through you and your wife both dying soon after retirement as a GEPF pensioner, or, by resigning from the fund before retirement, you bear the investment responsibility and in doing so place your capital at risk in a different way.
Linda Graham, who has the Certified Financial Planner accreditation, is the founder of FinCommunication, a marketing consultancy for financial services organisations.