What is a Pension Fund?

For many of us, it is difficult to worry about things that are too far into the future. There are so many day-to-day concerns in our lives that we just can’t be bothered to worry about things that won’t begin to affect us for years. Unfortunately, this is the mentality that a lot of people have when it comes to their pensions.  Because retirement seems so far away, concerns over our pensions are often overlooked or put on the back-burner. Conversations about plans, schemes, and funds come across as boring and tedious, so we tend to ignore them.  But maybe we shouldn’t. The choices that we make now can have drastic repercussions in the future and seemingly minor decisions about a pension fund today may end up influencing your entire life at some point down the road.   With this in mind, maybe we should ask ourselves a couple of questions, like – What is a Pension Fund? How does it work? And how much should it pay out anyway?

A Pension Fund is a type of collective investment scheme which pools retirement savings, invests the money in a range of assets, and then provides payouts to employees once they retire. 

In other words, instead of just taking your retirement contributions and leaving them in the bank, a pension fund combines the contributions of employees and invests them in various assets so that the value will grow over time. Then, when you retire, you can receive payouts from the fund based on the structure of the plan. 

What is a Pension Fund?
What is a Pension Fund?

How Does a Pension Fund Work?

There are two main types of pension funds that each function in slightly different ways, they are – 

  • Defined Benefit Plans – With this type of scheme, pension funds agree to pay you a fixed monthly income when you retire, regardless of how well (or how poorly) the actual investments are doing. In this case, the pension fund is taking on the majority of the risk because it needs to pay out the benefits to retirees even if the investments are doing poorly. 
  • Defined Contribution Plans – In these instances, the payouts that retirees receive are not fixed and are instead dependent on the performance of the investments. In other words, your monthly payouts under a contribution plan are more risky, they can either be higher than normal if the investments are doing well, or lower if the investments turn sour. That said, many contribution plans will allow members to choose their own investment options to some extent. 

Can you Lose Money in a Pension?

Yes, you can. Besides the aforementioned issue of poor investment choices, you may also lose money from your pension due to instances of corruption. It should be noted, however, that there are various laws and regulations which protect beneficiaries from these problems to some extent and causes of widespread losses are quite rare. 

Additionally, certain charges of misconduct or fraud may result in pension losses. For example, if you had to steal money from your company and you were found guilty, your employer may request that some of the money is held back to make up for the damages suffered. 

What is a Good Pension Amount?

In an ideal world, you’ll want to have around 75% of your pre-tax income when you retire. You won’t need to make exactly what you were earning when you were employed because many costs are normally removed when you retire, but you’ll still want enough to live comfortably in your retirement years. 

At the end of the day, the best amount for you to retire with will be dependent on your personal circumstances and the standard of living you wish to maintain. If you’re willing to cut a lot of costs out of your life when you stop working, you’ll need less money in your pension to make things work. 

Just remember, the earlier you start saving, the less you’ll need to put away each month. In other words, a person who starts contributing towards their pension when they’re 20, will need to add much less money each month than someone who only starts when they’re 40. 

What is the Average Pension Payout?

If 75% of your pre-tax income is far out of your reach, don’t panic! You’re not alone. Right now, the average pension payout for South Africans is only around 30% of their pre-tax income. 

What is a Pension Fund?
What is a Pension Fund?

What is the Purpose of a Pension Fund?

Pension plans exist to grow the money that is contributed by employees and employers over the years in order to provide a retirement income in later years. 

If retirement funds simply stored the money they received and then paid it upon retirement, it is unlikely that the value of the contributions would be able to keep up with the rate of inflation. In other words, the R10 000 that you put into the fund when you were 20 would be worth much less when you retire at 60. 

To deal with this issue, retirement funds make various investments with contributions to ensure that the resulting value will outpace the rate of inflation. 

On the other hand, some pension plans invest in riskier assets which can potentially provide a larger payout if things go well. 

What is the Difference Between a Pension Fund and a Provident Fund?

Until March 1st 2021, pension funds and provident funds used to work similarly except for one major difference – pension funds limited the amount of money you could access in cash as a lump sum while provident funds allowed you to access the full amount upon retirement. 

Now though, reforms have been put into place which has caused provident funds to act in the same way as pension funds. This means that you will no longer be able to withdraw your full retirement benefit in a lump sum upon retirement. 

Do Relatives Receive Retirement Benefits if a Member Dies?

It depends on the specifics of the retirement plan. Some plans may make payouts to specific beneficiaries (to a spouse, for example), while others will not. Alternatively, some may allow the member to choose their beneficiaries while they’re still alive. 

Additionally, the percentage of the benefit that the beneficiary will receive will also be predetermined by the plan in question. Some plans may pay the full amount while others may only pay a portion. 

What is a Pension Fund?
What is a Pension Fund?

In Conclusion – What is a Pension Fund and How Does it Work?

Pension Funds are investment vehicles that pool the contributions of members before investing them in various assets. These investments are generally considered to be quite safe as the main purpose of most pension funds is just to outpace inflation and thus provide a retirement income to its members. 

Pension funds are usually split into two main categories: Defined Benefit Plans and Defined Contribution Plans. 

  • Defined Benefit Plans place most of the risk on the pension fund rather than the members as they are normally expected to make monthly payments based on the member’s final salaries regardless of how well the investments do. 
  • Defined Contribution Plans, by contrast, provide payouts that are determined in part by the performance of the investments. In other words, much of the risk is shifted onto the members as they may receive higher or lower payouts depending on how well the investments are doing. 

While there are many laws and regulations which work to protect pension fund members from severe losses; mismanagement of funds, corruption, and theft can end up losing you money from your pension. 

Ideally, you will want to be able to retire on monthly payments of around 75% of your pre-tax income prior to retirement. Most people will not require the exact same level of income that they had while working because various costs tend to disappear during retirement. That said, you will still need a healthy flow of income if you wish to maintain your current standard of living. 

It should be noted, however, that most South Africans are well below this level and only receive around 30% of their pre-tax income. 

When contributing towards your pension, it is important to remember that the earlier you begin investing in it, the less you’ll have to pay in each instance. 

In other words, a person who has been putting money into their pension since they were 18, will have to put in less money each month than a person who only begins at 40. 

Beneficiaries can receive retirement benefits if the original member dies, but only when it is stipulated by the fund’s contract. Some funds will pay benefits in full while others will only pay them partially. Likewise, some funds will only pay to certain beneficiaries while others will pay to those chosen by the member while they were alive. 

Disclaimer Finance101: All of our posts are for research purposes only. Finance 101 aims to assist its readers with useful information on the laws of our country that can guide you to make financial decisions that will enable you to become more financially independent in the future. Although our posts cite the constitution in many instances, they are intended to assist readers who are looking to expand their knowledge of the law & finance-related queries. Should you require specific legal/financial advice we advise you to get in touch with a qualified financial expert.

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  1. April 4, 2022

    […] provide benefits to members upon their retirement. They are most easily understood when compared to pension funds. While the latter pools and invests money from multiple employees, the former is not tied to an […]

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