If you are a government employee, you need to be wary of advisers who recommend that you resign in order to access your pension before retirement.
Many commentators have attributed the spate of government employee resignations, just before retirement, as a result of the recent changes to how provident funds are treated on retirement.
The changes in fact have no impact on Government Employees Pension Fund (GEPF) members and are not the reason for the resignations, which are driven largely by changes in the way the fund has been valued post April 2012, combined with opportunistic behaviour by unscrupulous financial advisers.
To put the GEPF into context, it is important to understand that the fund is unlike any other pension fund in the country. Despite being the largest pension fund in South Africa, it is not governed by the Pensions Fund Act and any changes to it have to go through parliament as a separate bill. Secondly it is a defined benefit fund, not a defined contribution fund.
The GEPF has more than 1.2 million members and more than 391 000 pensioners. The total fund is worth around R1.7 trillion.
Defined contribution vs defined benefit
Most corporate retirement funds that one reads about are what we call “defined contribution” – that means the amount you receive in retirement is based purely on how much you contributed and the growth on that contribution.
A “defined benefit” fund is one where the level of the benefit a member receives on retirement is calculated by a formula based mainly on the member’s salary and years of service.
Until around 20 years ago most corporate retirement funds were also defined benefit funds, but companies became concerned about the investment risk they were carrying on behalf of their employees – they have to guarantee the retirement benefit irrespective of market conditions. By moving to defined contribution, the investment risk now sits with the employee.
GEPF has continued as a defined benefit fund which means that the market performance of the fund is really irrelevant to the members who retire from the fund as their retirement benefits are still guaranteed irrespective of investment performance.
If, as has happened in the past, the fund underperforms, then the government, albeit with taxpayers’ money, is required to make up the difference to meet the formula. Fortunately for taxpayers since 1995 the fund has performed in excess of the required level which has allowed the fund to pay annual pension increases above the guaranteed level.
Change to valuation of withdrawal benefits
Prior to April 2012, as a defined benefit fund, when a member took cash upon resignation or was paid out due to disability or death, the GEPF used a formula based on a fixed rate of 7.5% growth per annum, years of service and the salary as set out in the rules.
Considering that the fund’s market-related returns have in most years exceeded 12% per annum, members were being disadvantaged by the lower fixed rate used for the calculation. Members of a defined contribution fund’s benefits would have reflected the actual fund returns, so this put GEPF members at a disadvantage if they did not hold the funds to retirement.
From April 2012 a new calculation was used which took into consideration the underlying share of the member in the total value of the fund. This applies “floating factors” which take into consideration certain variables or assumptions within the fund such as the expected returns and inflation in the long term (economic factors) and the rate at which members exit the fund be it through death, disability and retirement (demographic factors).
The outcome was that fund benefits for the majority of members improved by up to 300% overnight. Suddenly members received a statement showing that their pension, if taken on resignation, had tripled.
This became very tempting for members, and has led to unscrupulous advisers using this as an opportunity to encourage employees to resign the day before retirement so that they could access their pension as a lump sum rather than waiting for retirement when they would receive a lump sum equivalent to a third of their pension plus a monthly income for life, increasing with inflation.
“The members are then encouraged to invest the money with the advisers in investment vehicles that attract a handsome fee for such advisers,” says Abel Sithole, principal officer of the GEPF. In other cases, the members use the money to start a business, which most often fails, leaving them with no money in retirement. In the worst cases, advisers would convince the members to invest in illegal pyramid schemes.
Sithole explains that the situation has been exacerbated recently as the market performance has negatively affected members’ benefits on resignation. Remember, GEPF members are not used to the fluctuations of market-related returns, as until 2012 they always received a fixed formula which increased with years of service and earnings.
Since 2012 the market and therefore the GEPF investments have increased, but last year members saw their benefit estimates fall, mostly due to a downward revision in expected long-term market conditions which are expected to be far weaker. “The temporary reduction in the floating factors reduces the overall size of the fund, so members’ individual benefits, being a share of the fund, are also reduced,” explains Sithole.
This gave advisers further leverage to convince members to resign, even though the weaker market performance only affects their resignation benefit and not their retirement benefit, which is guaranteed.
Understand the benefit difference between resignation and retirement
As the GEPF is a pension fund it pays an income on retirement. If a member, at retirement, has fewer than 10 years of service, they will receive a once-off lump-sum cash payment equal to their actuarial interest in the Fund. If, however, a member has more than 10 years of service, they receive a lump sum equivalent to one-third of their retirement benefit, as well as a guaranteed monthly pension.
If an adviser is recommending resigning just before retirement to access your pension, make sure any product comparison they are offering matches the benefits provided by the GEPF:
- If a member had to take the equivalent amount of money as a resignation benefit to purchase an annuity, they would be subject to tax and retail costs and would receive less income than provided by the GEPF which does not have to pay those costs as they receive the rates wholesale. Make sure any quote is net of all costs including annual fees which would not be payable in the GEPF.
- Members receive a guaranteed pension which will increase by at least 75% of the official inflation rate. If the underlying investment performance exceeds that, pensioners will receive higher increases. According to the GEPF 2014 annual report, between 2003 and 2013 the average annual pension increase was 5.87%, either matching the average CPI or surpassing it.
- The annuity provided by the GEPF includes a spousal pension of 50%. This means the spouse will continue to receive 50% of the member’s annuity income should the member pass away first. There is an option to increase that spousal pension to 75% of the annuity income.
- The annuity is guaranteed for the first five years which means that if the member passes away within those first five years, the beneficiaries receive the balance of the five-year annuity payments as a once-off cash lump sum.
- All current members of the GEPF as well as pensioners of the fund receive funeral benefits for themselves, their spouses and eligible children.
Is your money invested wisely?
Over the last two years there have been media reports of controversial investment decisions by the Public Investment Corporation (PIC) which manages the assets on behalf of the GEPF.
Questions were raised around whether undue influence by government drove the decisions to invest into certain businesses whose owners are politically connected, such as a R3bn investment in Carmac Energy (now Erin Energy), the R3.9bn buyout of ArcelorMittal’s share of Kalagadi Manganese, as well as a stake in Independent Newspapers.
Critics have also argued that the GEPF, and members’ retirement money, was being used by government to bail out our failing electricity supplier and to keep Sanral afloat amid the e-toll crisis with the PIC’s purchase of Sanral and Eskom bonds.
Sithole refutes this, saying the fund’s mandate is to preserve capital and provide a good return relative to liabilities (payments) and only those investments that meet the mandate will be considered.
The GEPF is the largest pension fund in South Africa at R1.7 trillion and as such it accounts for around 17% of the total value of the Johannesburg Stock Exchange. “With this amount of money to invest, the fund has exposure to the whole South African economy and one has to look at its investments in that context,” explains Sithole who defends the decision of the fund to buy Eskom and Sanral bonds as they meet both the criteria of capital preservation and returns. As both Sanral and Eskom bonds are guaranteed by government, members’ funds are not at risk and the bonds offer attractive interest rates if held to maturity.
“We are very exposed to the economy as a whole through our investments on the JSE. If Eskom collapses, that is a systemic risk to the economy and therefore all our investments,” explains Sithole.
The investment in Sanral was R18.6bn which is certainly a great deal of money, but Sithole says in the context of the GEPF makes up only 1% of the fund’s total investment portfolio and is therefore not a significant investment. “The GEPF is not the only fund that invests in Sanral and Eskom; many others do too,” says Sithole.
Ian Cruickshanks, chief economist at the Institute of Race Relations, says that while members are not unreasonable in raising concerns, at this stage the fund has performed very well compared to other pension investment companies in the private sector.
“So far it seems that the PIC has utilised strict investment criteria; the concern, however, is that as government finances come under strain they may be tempted to use government employees’ pension money to fund government projects that are not justified from an investment point of view. We need to be vigilant.”
Cruickshanks explains that under the previous regime, the government pension fund was used to provide cheap sources of funding for government under the prescribed investment mandate. This occurred in the 1980s due to the continued isolation of South Africa after Prime Minister PW Botha’s infamous “Rubicon” speech. South Africa’s international funding dried up and the economy grew at less than 1% per annum over a decade. “This has happened before and people are understandably concerned that it could happen again,” says Cruickshanks.
Current investment profile
The PIC invests around 75%- 80% of the fund in passive funds which track the average return of the markets, assisting in keeping the costs of the fund low. The remainder is allocated to active fund managers to provide enhanced returns. The PIC also takes direct stakes in non-listed assets including property.
The fund may invest up to 10% of its equity exposure offshore – this is substantially lower than the 25% limit on other retirement funds. Currently 5% is invested in Africa outside South Africa, and 5% abroad.
In 2010 the GEPF launched the Developmental Investment Policy which adopted a four-pillar approach to developmental investing: economic infrastructure; social infrastructure; environmental investments; and enterprise development (including black economic empowerment and job creation).
This includes supporting black economic empowerment fund managers and the development of an incubation fund for new black fund managers.