This is the sixth article in the series on swapping from a defined benefit to a defined contribution retirement fund.
There are two very important details you need to establish before swapping from a defined benefit pension fund to a defined contribution fund. These details are what is called your actuarial value and if you will receive a percentage of the fund surplus (if there is a fund surplus).
Both issues are extremely complex and are a major reason why you need to get expert advice to ensure you are not being short-changed.
Last week the column dealt with the importance of the surplus. This week the subject is the actuarial valuation, also known as a liability of the fund.
Actuarial valuation is a complicated affair which takes many factors into account including age, gender, period of employment, expected length of retirement, death before retirement, the number of dependants, income, interest rates and inflation. The complexity of these calculations is one of the reasons why becoming an actuary is so difficult.
Most funds will transfer your full actuarial value from your defined benefit fund to your defined contribution fund if you decide to swap. The question is what is your actuarial value.
An important point in the case of a defined benefit fund is that what you pay and what your employer pays into the fund is not the starting point.
It is the consequence of what you could receive as your retirement benefit or withdrawal benefit if you leave the fund before retirement date.
Actuaries work out how much both members and their employer should be paying into the fund to give the capital growth to provide the pre-determined pension.
In other words, they take expected benefits of all members at retirement and then effectively work backwards to establish the contributions. The figure may be equal to 15 percent of every member's income.
But this does not mean that 15 percent of your income will automatically be put towards your benefits every month even though you will pay a fixed percentage of your income every month until you retire.
Your accrued actuarial value grows at different rates as does the required contribution rate to the fund for you as an individual. The 15 percent is an average allocation over the length of your membership of a fund.
Because you may leave your job or die before retirement age the actuaries take a different approach.
They attribute different amounts to you as an individual at different times. Sometimes this may be an amount equivalent to as little as 6,1 percent of your income when you first start work going up to as much as 42 percent when you retire.
This all seems very confusing. It is. And to make it worse there are other issues which affect values over which actuaries are in continual debate.
In writing this column I had long discussions with two Sanlam actuaries, George Rudman, who is the chief financial officer, and Joubert Ferreira, senior actuary: Sanlam Group Benefits, on how a member should look at the accrued value in working out whether to switch from a defined benefit to a defined contribution fund.
The conclusion was that you should consider your end benefits rather than what the actual amount of the accrued value is now or is likely to be.
The only real exception is if you expect rapid promotion with comparatively large salary increases in the short term. This would result in more rapid growth in your accrued value and it could then probably be preferable not to make the switch.
Ignoring this exception, it is only by considering your end benefits that you can make a proper comparison.
The table below shows how you should do the calculations (for the purposes of these calculations commutation to a one third lump sum has been ignored).
A conservative real rate (after deducting inflation) of growth is assumed. The rate of increase in salary and investment returns are variable. You can decide on these figures when doing the calculations but it is advisable to be cautious.
We have chosen three percent on the basis that it is better to have too much money rather than too little money at retirement.
You may need your fund to calculate these figures for you. In fact you must insist on a similar calculation if you are to make a valid decision.
For the purposes of these calculations tax has been excluded.
DEFINED
BENEFIT
ANTICIPATED
RETIREMENT BENEFIT
EXAMPLE
YOURSELF
80% annual retirement salary
..% annual retirement salary
R40 773 a month
R............. a month
DEFINED
CONTRIBUTION
ANTICIPATED
RETIREMENT BENEFIT
EXAMPLE
YOURSELF
Transferred Actuarial
Value:
R204 431
R................
Portion of surplus
R40 886 (20%assumed)
R................
Sub Total
R245 317
R................
Future contributions at 15
percent of your income assuming increases of 10 percent a year
R859 125
R................
Investment growth of all funds
(Assumed 3 percent compounded)
R4 259 877
R................
Total
R5 364 319
R................
Purchase of an annuity:
73% annual retirement salary
..% annual retirement salary
R37 252 a month
R.............. a month.
(Get your figures from your fund)
Calculations:
Sanlam Group Benefits
Assumptions in
example:
* Person
currently earning R100 000 a year;* Current age 45; * Retirement age 65;* Membership of
fund 20 years.