Issue: July/Sept 2010
Back to basics 4

Different types of group retirement funds

Joanne Miller

In need of a refresher? Joanne Miller of InvestmentWise, which specialises in trustee training, sets out some fundamentals.

There are two different types of group retirement funds:

  • Pension funds, and
  • Provident funds.

The main differences between them are in the taxation of contributions made to the fund and in the benefits taken on retirement.

  • Employee contributions to pension fund a are tax deductible up to a certain level, whereas employee contributions to a provident fund are not tax deductible. (The reason for this difference is to encourage membership of pension funds, as government would prefer fund members to receive a steady monthly income on retirement rather than take their benefit as a lump sum.)
  • Only one-third of the retirement benefit in a pension fund may be paid to the member as a cash lump sum. The balance must be taken as a pension. In a provident fund the full benefit may be taken as cash on retirement.

Pension funds are therefore more tax-efficient for employees than provident funds. However, the retirement benefit is more restrictive in pension funds than in provident funds i.e. the member of a provident fund can invest or spend his benefit as he wishes.

Irrespective of whether a person is a member of a pension or provident fund, the fund’s administrator is required to withhold tax from the retirement benefit (the lump-sum payment and the monthly pension).

  • The first R300 000 of the cash lump-sum retirement benefit will be exempt from tax. Amounts above this are taxed according to a sliding scale. Any contributions that were not previously tax exempt (i.e. member contributions to a provident fund) will be added to this R300 000 tax-free portion;
  • The monthly pension amount received by the member is subject to tax according to PAYE tables.
  Pension fund Provident fund
Taxation of contributions Employee contributions of up to 7,5% of employee’s pensionable salary will be tax-free or R1 750 (whichever is the greater). Employee contributions to the fund are not tax deductible.
  Employer contributions of up to 20% of the employee’s pensionable salary can be claimed by the employer as a tax deduction. Employer contributions of up to 20% of the employee’s salary can be claimed by the employer as a tax deduction.

For example

In the case of a member who earns R10 000 per month and is contributing 7,5% of his salary per month to a group retirement fund:

  • If he belongs to a pension fund, the employer will deduct R750 from his monthly salary before calculating PAYE on the net amount (after the deduction) of R9 250;
  • If he belongs to a provident fund, the employer will still pay R750 over to the fund on the member’s behalf, but will calculate PAYE on his full salary of R10 000 per month.
  Pension fund Provident fund
Retirement benefits A maximum one-third of the benefit amount may be taken as a cash lump sum, with the balance (i.e. at least two thirds) of the retirement benefit being paid as a lifelong pension. The member is entitled to take his / her entire benefit as a cash lump sum on retirement.

For example

In the case of a member who retires with a fund value of R900 000:

  • If he belongs to pension fund a , he can take a maximum of R300 000 of this retirement benefit as a cash lump sum and will be required to take the balance as a monthly pension;
  • If he belongs to provident fund a , he will be entitled to take the full R900 000 as a cash lump sum.