What is a Pension, and How Do they Work?

What is a Pension, and How Do they Work?

A pension is designed to help provide an income to an employee during their retirement – we explore how pensions are paid out, and how else you can supplement your income.

What is a pension? 

A pension, or ‘pension plan’, is a fund into which a sum of money is saved during the course of a person’s employment. In South Africa, these contributions are typically made monthly. 

Pensions can largely take three different forms – a standard ‘employment’ pension is designed to create wealth through which a retired person can access an income once they are no longer able – or no longer wish – to work. 

A state or ‘social’ pension is designed for citizens or residents of a country to provide income when they are unable to work or retire, and may be collected through taxation.  

Lastly, a disability pension is designed to provide an income for a person when they are injured or disabled, and are no longer to perform either their previous role, or work generally. 

In most cases, pensions are planned to generate enough income (matching either the entirety or a portion of an employee’s final working salary) to last until the end of their life. 

What is a pension fund? 

The total amount of money that a person contributes towards during their working years is referred to as a pension fund. Pension funds are usually administered by a person’s employer or an institutional investor, and largely invest in private or public enterprises depending on their nature. 

Pension funds are set up to gain interest as a conventional investment would – meaning that their value would grow cumulatively over many years. 

Can my employer contribute to a pension fund?  

Certain employers may opt to contribute towards an employee’s pension fund by either making a payment in full every month, or by offering a co-payment where the remaining balance of a contribution may be deducted as a benefit from an employee’s monthly salary. This is designed to ensure that employees – and later, retirees – are able to access a form of income when they are no longer able to work. 

How can I use my pension in retirement? 

There are specific requirements as to how an employee might use their pension payout that determines how income can be accessed. In South Africa, a pension fund member may access a third of their total payout upon retirement as a lump sum, while the remaining two thirds are to be used to generate an income for the rest of the employee’s life.  

What happens to my pension if I resign from my company before retirement? 

In decades past, employees may have chosen to remain with the same employer for many years or decades – meaning that administering a pension fund was relatively uncomplicated as both contributions and pension payouts would be handled directly by an employer. 

However, should employees in the modern day wish to change employer, it is now commonplace for employers to administer their own pension fund or rely on a third-party institutional investor to manage a pension on their behalf. In that instance, is law that an employee has the right to move their invested pension funds between employers or pension fund managers when they resign their position in favour of another. 

While these funds cannot be accessed until retirement, this ensures that an employee does not lose their accumulated pension funds over time. 

How else can I build savings for retirement? 

While pension funds have been a traditional and recognized way to save for retirement, a pension payout may not be enough to reliably provide a sustainable income to an employee as they grow older. 

For that reason, several other means of generating wealth exist – such as making regular investments, purchasing property, or setting up interest-bearing saving accounts. Our guide can help you identify how much you should save to use in your retirement. 

What is a provident fund? 

While pension funds are typically administered by a person’s employer, a provident fund is similar in design but is instead managed by a government. In this instance, a government will not only collect contributions, but may further outline how these funds can be used and how they should be invested. 

What is a retirement annuity? 

Unlike a pension plan or provident fund, a retirement annuity is a voluntary scheme which a person may contribute to as and when they wish. Retirement annuities allows investors to make contributions towards their retirement, upon which they may receive their investment similarly to how they would receive their pension. 

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