What is a preservation fund plan?
A preservation plan is an investment fund which is used as a place to "park" the pension or provident fund payout you get when you resign from your job before reaching normal retirement age.
You do not pay tax on your pension fund payout when you transfer it to a preservation plan.
The biggest attraction of preservation plans is that they do not tie up all your payout money. You are, generally, allowed to make one withdrawal - of any amount - before the age of 55.
Retirement annuities (RAs), on the other hand, don't allow you to withdraw any money before age 55 (although there are a few exceptions, such as in the case of disability). If you were a member of a provident fund with your former employer, then you will transfer your payout to a preservation provident plan.
Similarly, if you were a member of a pension fund, then your cash will be transferred to a preservation pension plan.
The rules governing your preservation plan are affected by the rules of your ex-employer's retirement fund.
For example, there may be a limit on the size of withdrawal you can make before you reach the retirement age of 55.
Rob Carr, financial adviser at consultancy Fincorp, advises that while preservation plans outsell RAs, they may not be the best for you tax-wise.
Carr explains one of the significant benefits of a preservation fund is that, unlike an RA, it preserves the number of years you have been a member of your former employer's pension fund.
This is important because the more years you have been a member of a retirement fund, the bigger your tax-free lump sum on your final pension fund payout when you eventually retire.
The current tax treatment of an RA is that you are paid a R120 000 tax-free lump sum (or R4 500 multiplied by the number of years you have had the annuity, whichever is the greater).
It is this difference in tax treatment that makes an RA more suited to some investors, says Carr.
The tax difference.
Carr cites the example of a man aged 50 who is changing jobs after being on the company pension fund for 15 years.
If he invests in an RA, the tax-free lump sum he would get from the RA at retirement aIf anyone has queries ge 60 would be R120 000.
However, had he invested in a preservation plan the tax-free lump sum would be only R90 000.
If we change the figures in this example so that the man has been a member of the pension or provident fund for 30 years, then the tax-free lump sum on retirement from the RA at age 60 would be R120 000, as opposed to R180 000 on the preservation plan.
Carr's conclusion is that, generally, if you have been a member of your pension fund for fewer than 20 years or so, there is not that much to preserve and, from a tax point of view, you are better off buying a RA than a preservation plan.
But after 20 years of membership in your company's retirement fund, you will be better off, tax-wise, buying a preservation plan.
But this general conclusion may not apply if your annual salary is less than R60 000, warns Carr as the lower your salary the more likely that you will have a greater tax-free benefit from an RA.
Tax, however, is just one of the issues you need to consider when choosing between the two options.
There are other advantages of a preservation plan.
Peter Stephan, manager of legal services marketing at Old Mutual says the following advantages of a preservation plan over an RA may outweigh the heavier tax burden.
If you are already in a provident fund you can transfer into a preservation provident fund and receive a lump sum on retirement, but if you put your money into a RA, then you will get only one third of the capital as a lump sum.
The rest will be paid out as a monthly pension.
You can transfer the money in your preservation fund to your new employer's fund if you wish.
This way, the preservation fund acts as a holding fund for an interim period only.
By contrast, you cannot transfer the money with a retirement annuity.
However, an advantage of retirement annuities over preservation plans is that they allow you to make top-up contributions over the years, whereas preservation plans do not allow this.
So, what do you do at the end of the day? Draw up a list of all the pros and cons that are relevant to you.
Weigh this up with the difference in the tax bill before deciding whether an RA or a preservation plan is best for you.
