Due to the high number of queries received in recent weeks, we have compiled this communication to explain how the withdrawal benefit calculation works. We explain how the Minimum Individual Reserve (MIR) works, how it is impacted by the Earnings Yield, as well as how the calculation is done.
The EPPF is governed by the Fund Rules, pension fund legislation and the regulator, the Financial Sector Conduct Authority (FSCA). These rules and legislation prescribe how we operate, including how we calculate members' benefits.
The Pension Funds Second Amendment Act, 2001 provides for a minimum benefit to be paid to members leaving the Fund prior to retirement in circumstances other than liquidation.
The MIR defined
The Fund’s cash withdrawal benefit, being the benefit payable when a member resigns, is dismissed or retrenched, is equal to the member’s accumulated contributions with interest.
This benefit must be tested against the MIR as prescribed in the Pension Funds Second Amendment Act, 2001.
In other words, the withdrawal benefit is the greater of A and B, where:
A = The member’s accumulated contributions with interest; and
B = Minimum Individual Reserve (MIR) calculated by using the fair value equivalent of the present value of the members’ accrued deferred pension, based on certain prescribed assumptions.
How is the MIR calculated?
The MIR (B) is the calculation of the pension that the member has accrued up to the date of exit, converted into a capital value at their normal retirement date, and then represented in present day values at the date of exit by discounting the capital value back to the exit date with a prescribed investment return assumption (Board Notice 35).
The 3 steps in calculating the MIR are as follows:
Step 1 - Calculate accrued pension at date of exit;(the formula for this is contained in the Rules of the Fund)
Step 2 - Convert it to a capital value at normal retirement date, using a factor provided by the Fund’s actuary
Step 3 - Then this value is presented at present day values by discounting the capital value back to the exit date using an investment return assumption
The value of a member’s MIR is therefore not influenced by the Fund’s own investment performance, but rather by several factors outside of the Fund.
As can be seen above, the investment assumptions used by the Fund will influence the MIR calculation.
Since 1 July 2004, when the Pension Funds Second Amendment Act, 2001 came into effect, the EPPF uses the 40% of Earnings Yield method for its investment assumptions.
The Earnings Yield is a value based on the equity market level of the All-Share Index as published by the Johannesburg Stock Exchange. The FSCA obtains these rates and publishes the 40% of Earnings Yield at the end of every month.
The MIR fluctuates from month-to-month, as the Earnings Yield moves up and down all the time.
How does the Earnings Yield affect the MIR?
When the Earning Yield rate increases, the value of the MIR decreases and vice versa. This is as a result of the mathematical mechanics of discounting. The logic goes something like this:
If you want to save so that you will have R100 in five years’ time and there are two interest rates to choose from, 2% and 10%, then you know that if you choose a 2% interest rate that you have to put away more money now in order for it to grow into R100. On the other hand, if you choose a 10% interest rate, then you know that you don’t need to put that much money aside now because your money is going to grow at a higher rate of return (you will get more interest on your money). This is why when the Earnings Yield rate increases, the present value of your MIR decreases. When the Earnings Yield rate decreases, the present value of your MIR increases.
Click here for a breakdown of the MIR calculation and practical examples of how the calculation is performed.
The MIR value for a member is expected to grow over time as salary and service period increases. However, when there is underlying volatility in the earnings yield (up and down movements due to investment market conditions), it can result in significant changes in the MIR values. The Earnings Yield is a rate based on the performance of the local equity market, and therefore it does have the potential to be quite volatile from time to time. Some members mistakenly think that the MIR is a pot of money which is growing with investment returns over time, and that it works like a savings account. Members should remember that the EPPF is a defined benefit fund, and the MIR is not influenced by the Fund’s own investment performance, but rather by the Earnings Yield as published monthly by the FSCA.
The Fund strongly urges members who are seriously considering leaving their employer or have already resigned to request their MIR from the Fund. The Fund's Retirement Fund Consultants will be conducting various road shows, and these engagements will cover the above subject matter. Please be on the look-out for invitations to these sessions. Remember, if in doubt, speak to the Fund experts first about your concerns.
For any queries, please contact us via our Retirement Fund Consultants – click here for their contact information – or our Call Centre by calling 0800 11 45 48.
Eskom Pension and Provident Fund