Retirement option

The reader belongs to the Government Employees Pension Fund (GEPF), which is what is called a defined benefit fund. The retirement benefits are therefore defined with regard to the reader’s salary at retirement and the length of service at their employer.

Let us consider the two options that the reader has presented in more detail:

Receiving an annuity for life

The reader will receive an annuity, for life, which begins at R27 414 per month. On death, the spouse would continue to receive 50% of this annuity for the remainder of her life.

Pension increases are also usually granted annually by the GEPF in line with their policy which targets 100% of CPI. The reader is also entitled to a gratuity lump sum at retirement of R1.2 million.

Under this scenario, the GEPF, assumes the investment risk. In other words, the member will continue to receive their pension, irrespective of how the underlying investments perform.

The GEPF also assumes the longevity risk, or the risk of the member and their spouse living longer than expected. As an extreme example, if they both lived to 120 years, they will continue to receive their pension. On the other side of the coin though, if they both pass away shortly after retirement, no further payments will be made and any children dependants will not receive any lump sum payment.

Taking the lump sum and investing it

The reader states that they are entitled to R5 047 648 as a resignation benefit. For purposes of this comparison, the impact of tax on this amount has not been considered as this could vary by individual.

Let us assume that this money will be invested into a living annuity-type structure in order to provide a retirement pension. Under this scenario, the lump sum is invested and a pension is drawn from this balance for as long as the balance is positive.

To put it simply, this operates similar to a bank account. The account increases with investment returns and reduces by any amount that the reader withdraws in the form of a pension.

It is important to realise that the reader will be assuming both the investment and longevity risk under this scenario. Poor investment performance will impact on the amount of pension that the reader may be able to withdraw. Additionally, if the capital is fully eroded while the reader is alive, no further pension will be payable. However, on death, the balance of the account can be paid out to the spouse or other dependants.

Comparing the two

If we consider this reader’s particular circumstances, in order to match the R27 414 per month pension from the GEPF, they would need to draw 6.52% per annum from the living annuity balance.

For illustrative purposes, we assume that the account balance would grow at 10% per annum and that the reader would require the annual pension to increase in line with inflation at an assumed 6% per annum. Under these assumptions the investment growth on the account will exceed the pension being drawn for around nine years. After that the capital will start to be depleted and will be fully eroded after about 22 years.

Assuming that the reader is 60 years old, it is estimated that the capital will be fully eroded by age 82. If, on average, the account grows by less than 10% per annum, this amount will be eroded sooner. Thereafter, no pension will be available. This illustration demonstrates the investment and longevity risks the reader faces.

In essence, most pensioners, even those that are not members of the GEPF, are faced with a similar decision at retirement. They need to choose between investing in a guaranteed annuity which will be payable for life, or investing in a living annuity from which a pension can be drawn for as long as account has funds.

The choice of retirement vehicle is a complex one. The following is not an exhaustive list but includes some considerations that would need to be taken into account by anyone in this situation:

1)         Attitude towards risk.

2)         The level and nature of their base expenses in retirement.

3)         Tax considerations of the various options.

4)         Level of investment expertise and ability to obtain advice on choosing      portfolios that will be able to generate sufficient returns.

5)         Views about their health and longevity.

6)         Bequest motives. The living annuity framework lends itself more easily to     providing an inheritance to children on death, provided that there is a positive balance in the account. However, in this particular case, the reader will receive a gratuity of R1.2 million on retirement from the GEPF. Should they wish to leave an inheritance to their children, this amount could be invested and left to dependents on death.