After glancing at your payslip each month, you notice that your salary isn’t exactly your salary. This is due to a couple of nasty contributions called a provident or pension fund. What are these exactly and how do we tell them apart?
Pension Fund In a Nutshell
If a pension fund member retires, they will receive a third of the total benefit in a cash lump sum. The remaining two-thirds will be issued to them in the form of a monthly pension, for the rest of their lives.
The advantage of a pension fund is that, although a smaller amount, you will receive a monthly income for the rest of your life. And, there is no risk of spending it all in one go with a lump sum payout.
Provident Fund In a Nutshell
With a provident fund, the member has more flexibility and is given the entire cash lump sum all at once. According to the Labour Guide, the advantage of a lump sum payment is that you avoid all the problems in getting a private pension every month.
“Insurance companies and other pension funds will pay a private pension into a bank account, if you have one. Or else, send a cheque to your home address, or to your old employer who will then pass on the payment. But, if you have no bank account, or live in a place where the postal system is very unreliable, you might have great difficulty receiving and cashing your pension cheque every month. A lump sum will help to avoid all these problems.”
Tax Contributions Differ
The other main difference between a pension and provident fund are the way tax contributions are handled.
Only the employer will benefit from a tax deduction for provident fund contributions. Which puts workers at a disadvantage at retirement.
If an employee were to contribute to their provident fund in their own capacity (i.e.: not as a salary sacrifice), then this money would be returned back to them at retirement. The tax deduction would be added to the final cash payout on retirement.
Trade unions usually favour provident funds as they believe pension funds are outdated and do not take the interests of the worker into consideration.
With a provident fund payout of R30 000 or less, it will be tax-free.
With a pension fund, the employer can claim up to 20% in tax deductions and an employee can claim up to 7.5% back on their contributions to tax.
How Does a Pension Or Provident Fund Work?
Salary contributions from both employers and employees are fed into a fund. The money gains interest when the insurance company invests them.
Money can go out of the fund to pay for benefits and also for the expense of running the fund. According to the Labour Guide, the money belongs to the fund and not to the people who contribute.
Pension and provident funds exist for the benefit of their members, who are workers and pensioners. It is usually compulsory to become a member of a fund. It is up to the employer when choosing between a provident and pension fund. This means that a worker does not choose whether to belong to the fund or not.
Types Of Fund Benefits
A worker receives money from a fund through four types of benefits, these include:
- Withdrawal benefits: paid to workers who resign or are dismissed.
- Retrenchment benefits: paid to workers who are retrenched.
- Retirement benefits: paid to workers when they retire.
- Insured benefits: including benefits paid to a worker who is disabled and benefits paid to the dependents of a worker who dies.
It is important to note that not all funds provide all these benefits and there may be a difference between a pension and provident fund that does not suit your lifestyle or financial situation.
To understand how any fund works, the member must read the rules of the fund.