Are preservation funds worth preserving?

Retirement experts are divided on their responses to the longer term future of preservation funds.

Currently, preservation funds are used by employees of a company who are no longer eligible to be members of an occupational pension or provident funds, either due to retrenchment or a job change. Such employees have the option to move their pension fund or provident fund assets to a preservation fund.

'Currently, there are two special features of a preservation fund', explained veteran financial advisor and Managing Director of Fundamental Investments, Ian Dodds. 'The most important of these, in practice, is that the number of years a person has contributed to the occupational fund is 'embedded' in the preservation fund.'

'This is important, because the higher the number of annual contributions, the greater the  tax deductible portion of the lump sum,' he said.

'In addition, members of preservation funds are permitted one withdrawal from the assets in this fund,' he said. This is not the case with Retirement Annuity Funds, where members contributions can only be withdrawn in the case of disability.

'But there are two changes that suggest that we should re-evaluate the benefits of preservation funds,' he said.

'The first is that the Minister of Finance had proposed a new flat fee based formula for calculating the tax deductible portion of the lump sum. It is proposed that the first R300 000 is tax free, the next R300 000 at 18%, the next R300 000 at 27% and the balance at 36%.'

'It is clear that there is no acknowledgement of number of years contribution in this formula,' said Dodds.

'The second is that SARs (South African Revenue Service) is looking at introducing one single retirement date, which will apply to all retirement vehicles, including occupational funds. Currently, Preservation Funds 'preserve' the rules of the occupational fund, such as the earliest retirement date,' he said.

'But in most cases, people changing jobs or being retrenched might be better off in a Retirement Annuity Fund, or vehicles discussed in the Pension Funds Amendment Bill called Independent Pension Plans', he said.

However, not all experts agree.

The major advantage a Preservation Fund has over a Retirement Annuity, under current legislation, is that fund members are permitted one withdrawal from their pension fund, before they reach retirement age.

Many people would therefore choose a retirement vehicle that provided for one withdrawal from their retirement savings, as preservation funds, currently allow. Under current law, a Retirement Annuity does not offer this facility.

However, this problem could be solved by standardizing the rules of occupational funds, retirement annuities, pension funds, provident funds, preservation funds and independent pension plans.

A further aspect of the case for or against the continued use of Preservation Funds is that the National Pension Policy proposes that it should be compulsory for all employees who swap jobs, to invest their pension fund assets in a Preservation Fund.  Most drafts of the pension funds amendments bill documents have drawn attention to the fact that too many South Africans spend their pension fund savings after moving jobs or being retrenched.

Proposed legislation attempts to block the leaks in the system. A compulsory preservation of retirement fund assets could therefore increase the use of preservation funds.

'But compulsory preservation need not take place in a fund with the same rules at the current Preservation Funds,' said Dodds.

Dodds said that National Treasury should congratulated on their efforts to simplify pension fund legislation, and broaden access to more South Africans.