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41. Tread carefully and do your homework on pension funds and early retirement

Question: I am turning 55 soon and will be taking early retirement. I have been in the civil service for 26 years. I have a retirement annuity. My financial adviser suggests that I transfer my pension payout to the retirement fund. Is this good advice, when I will be forfeiting my capped-leave gratuity and medical aid?

Answer: This is a massive decision with a number of moving parts that you need to manage. I cannot give you a categorical answer without knowing more about your personal situation, as well as details of the pension fund benefits that you are entitled to. However, what I will do is run through some of the issues you should consider when making a decision like this.You should look at:

  •    Medical aid benefits;
  •    Pension benefits;
  •    Spouse’s pension; and
  •    Future increases in pension.

Medical aid

When you retire, one of your biggest expenses will be your medical aid. Medical aid increases are usually higher than the normal inflation rate, so you will find that medical costs will become an increasingly bigger part of your budget when you retire.If your employer subsidises the medical aid for pensioners you need to understand how much you will be sacrificing should you resign in order to access the retirement benefits in the way in which your financial adviser suggests. (Note that in order to access these benefits you would typically need to resign just before your retirement date.)

Pension benefits

There are two main types of pension fund – defined benefit and defined contribution. Many of the civil service funds are defined benefit ones.A defined benefit fund will typically give you a pension of a percentage (usually 2%) of your final salary for every year you have worked. So, if you earn R20,000 a month and retire with 26 years of service, you would get a monthly pension of R10,400 (assuming there was no penalty for early retirement).With a defined contribution fund, you and your employer would pay monthly contributions into the fund and when you retire, you would use the value in the fund to purchase a pension. You would typically draw a percentage of this capital each year.The recommended drawdown rate for a 55-year-old is 4%.To get a monthly pension of R10,400 at a drawdown rate of 4%, you should have R3,120,000 in retirement savings.Remember, with a defined benefit fund, the pension fund is taking the longevity and investment risk. It will continue paying you a monthly pension even if you live to 100 or the stock markets collapse.If you have a living annuity, the value of the living annuity investment will be available to your heirs should you die. If, for example, you have been diagnosed with a terminal illness and have a shortened life expectancy, a living annuity may be a better option to pass your pension benefits on to your heirs.

Spouse’s benefit

Many of these government pensions have a 50% spouse’s pension. This means that, should you die, your spouse would get half of your pension till he or she dies.There may be instances where this benefit may not work for you. You may be single, or you may want a larger spouse’s pension. This is where a financial planner can draw the necessary quotes and help you quantify the value and cost of this benefit.

Future increases

This is an important factor. I have come across many retired civil servants whose pensions have not kept up with inflation. This can lead to financial hardship in your later years.You mentioned that you had a retirement annuity. I would recommend that you keep the retirement annuity going for as long as possible. When you find that the increases that you are getting on your civil service pension are not sufficient, then you should mature the retirement annuity and use the proceeds to supplement your pension.

There is no easy answer to your question. What I would recommend is that you do the calculations under each of the headings below. This will give you a good framework to help you make the right call.