Members of the Government Employees’ Pension Fund (GEPF) are being approached by financial advisers to consider resigning before retirement.
Their proposal is that they should resign from the fund and transfer their benefits – tax-free – to an approved preservation pension fund. A member then retires from the preservation fund, usually taking a third of the fund as a withdrawal and uses two-thirds to purchase a living annuity.
The rules of the GEPF provide that the first five years of the annuity are guaranteed. This means that, if the member passes away within the five years, the beneficiaries will receive the balance of the annuity payments, up to the end of the five-year period, as a lump sum. However, after five years, only the spouse will receive a spousal pension, unless there are children who are younger than 22.
While it may appear attractive to use a living annuity to provide an inheritance, it is important to fully understand the consequences of this decision:
- A living annuity cannot guarantee your income for life. As a living annuity invests in an investment portfolio, the income will be determined by market returns. Poor market performance can result in a drop in income compared with the guaranteed income offered by the GEPF.
- There are significant costs related to living annuities that could reduce your retirement benefit. An upfront advice fee of up to 1.5% may be charged by the adviser over and above the product fees.
The adviser can also charge an annual fee of 1% – again, over and above the product fees. This creates a perverse incentive for financial advisers to recommend living annuities. On a capital amount of R1 million, an adviser can earn up to R15 000 upfront, plus R10 000 a year for every R1 million of value. When combined with the product fee, it is not unusual to see living annuities costing as much as 2% a year – or R20 000 per R1 million invested.
- To not run out of money, it is only advised to draw down 5% of your capital from a living annuity. The adviser should provide a full comparison between your GEPF pension income and a 5% withdrawal rate from your living annuity – the net of costs.
You will probably find that you receive a better income from the GEPF due to the cost savings.
- If you decide to opt for a higher withdrawal rate, the adviser must show you a graph to indicate at what age you will run out of money. According to the Association of Savings and Investments SA, if you withdraw 10% a year, your income will start to reduce by year five.
- You will lose your GEPF benefits, which include a spousal pension and funeral benefits.
- You will lose your state medical aid subsidy if applicable. If your dream is to leave your children a legacy, then you could invest the gratuity.
For example, if you received R500 000 as your lump sum benefit and invested it for 20 years with an average return of 4% above inflation, it would be worth R1.1 million at today’s value. You do not have to opt for an expensive living annuity to provide your children with a legacy.
READ: Retirement clarified
Some members plan to resign before retirement to access the full cash value of their retirement fund. If they do this, not only do they lose the benefits of the GEPF, but they also pay a significant amount of tax.
For example, a member who resigns with a cash benefit of R3 million could pay R832 500 in tax. The member would still need to invest the money to generate an income, but now their income would have significantly reduced due to the lower capital value.