While defined contribution fund members, particularly those with market-linked investment portfolios, may be sweating a bit in the current investment market volatility, those people who stayed with defined benefit funds can continue to sleep well.
Not only are they less at risk as individual members because their benefits are guaranteed by their employers, but also because the restrictions placed on the funds by the Financial Services Board (FSB), makes it less likely that your employer will be placed under financial stress in making up a possible shortfall.
Peter Milburn-Pyle, the chief actuary at the FSB, says the way in which the assets and liabilities are valued leaves sufficient leeway to absorb dips in the investment markets.
There are two ways to value the assets of the funds. The first way is for a market value to be placed on the assets. The market value must be conservative, say 80 percent or 85 percent of actual market value.
This method is still vulnerable to market volatility. Milburn-Pyle says another method, which is rapidly being adopted by retirement funds, is based on the cash the assets are expected to generate and how much is flowing in from contributions.
This total is then placed against the amount needed to pay the benefits of retired members now and in the future. The calculations also take account of current and expected inflation rates.
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On the subject of retirement, let this tale be a warning against the type of bad advice that some financial advisers more interested in their commissions than clients' security continue to dish out.
An international accounting office in closing down its operations in Kimberley had an investment adviser come in to advise its employees. One of the employees was a widow who wished to go on pension. She had contributed to a number of different retirement funds over the years, most importantly a provident fund and a defined benefit fund.
However she did not want to buy annuities that would result in her capital disappearing into the hands of the insurance company. She wanted to leave something to her heirs.
It was recommended that she:
* Invest both her provident and defined benefit pension fund money in a compulsory annuity; and
* Take out a life assurance policy to cover her for the total capital amount.
What was wrong with that?
* She is 69 years old. At her age almost one third of the pension from the compulsory annuity would have gone to pay for the life assurance policy. This is a classic back-to-back structured product which Personal Finance has repeatedly warned is a bad bet. The financial adviser would have scored big by picking up two commissions;
* Unless a provident fund has obscure rules, which does not seem to be the case, there is no need for anyone on a defined contribution provident fund to invest in a compulsory annuity; and
* She was left with no clear documentation or copies of what she signed.
Her better bet, if she wanted to leave money for her heirs, was to invest in what is called a living annuity.