Question

I am a school teacher and will be retiring next year after 40 years of service. One of my colleagues mentioned that the government is planning on taking part of our pension fund and using it to bail out Eskom. Should I resign now before they get a chance to strip my pension?

::Answer

I would need to know more about what these alleged government’s plans are as well as your own personal circumstances before I can give you a categorical answer.

I will, however, provide you with the framework to understand how pension funds work and help you to make you more educated decision as more details emerge.

There are two types of pension:

• Defined contribution fund

Most private pension funds, retirement annuity funds and provident funds are defined contribution arrangements. Here, you and your employer invest a fixed percentage of your salary every month into the fund. You get to choose what portfolios the fund is invested in.  As a result, you carry the financial risk if the funds do badly.  (This is why most funds have default portfolios to guide you to make better choices).  If the portfolios do badly, you will not be helped out by your employer.

When you retire, you would take the proceeds of the retirement fund and purchase a monthly pension for yourself.

• Defined benefit fund

Most school teachers belong to a defined benefit fund. A defined benefit fund typically pays you out 2% of your final average salary for every year’s service that you have.  So, in your instance, after 40 years’ service, you will receive a pension of 80% of your salary.  There are very few people who will retire with that level of pension.

A key issue to understand here is that you have a contract with the fund where you were promised 80% of your final average salary when you retire. If you work till retirement age, then that is what you would get. 

The investment strategy and any investment risks associated with providing you with that income is not your problem. That sits with the pension fund and ultimately the employer who would have to make good any shortfalls.  This is why you have had no input on any portfolios that you’re pension fund is invested in.

I therefore do not see any major problem around the issue of you getting your pension going forward. However, you could encounter problems in years to come when it comes to annual increases in your pension. If the fund is struggling financially, then you may very well find yourself getting smaller or even no annual increases.

I would recommend that you chat to a financial adviser as there are a couple of investments that you can make using your retirement lump sum which can help you supplement your income in the future and mitigate the impact of the potentially lower pension increases in the future.

Defined benefit funds will generally give you a much higher pension higher pension than the defined contribution one.  If you wanted to compare these pensions, Take the withdrawal benefit from your fund and multiply it by 5%. This would be the sustainable pension that you would be receiving each year. Compare this with the pension you would get if you retired from the fund.  You should find the defined benefit income a lot higher.

You must also watch out for the potentially higher medical aid premiums that you would have to pay as you would probably be leaving the government medical aid on resignation.

Before you do anything rash, go and see a financial adviser who can unpack the risks for you and help you make a better decision.