One of the main reasons many people do not have sufficient savings when they retire is because they do not preserve what they have already saved when they resign or are retrenched or dismissed. The money is paid out, taxed and spent. There is considerable evidence that some people resign from their jobs so they can get their hands on their retirement savings.
The average South African changes jobs at least seven times in his or her lifetime, so the potential for substantial damage to be inflicted on their retirement savings is great.
When you leave or are dismissed from your job, you have a number of other, better choices than taking the money and spending it. These choices enable you to preserve your savings for the purpose for which they were intended - your retirement.
Option 1. Early retirement
If you are 55 or older, the law allows you to take early retirement. However, you must also check that the rules of your pension fund allow you to take early retirement.
Taking early retirement has significant tax advantages, particularly where your lump-sum payout is concerned. The tax-exempt portion of your lump-sum payout on retirement is R120 000, while on early withdrawal it is R1 800.
There are a number of factors you must consider before taking early retirement. These are:
- Whether your pension fund imposes any penalties on early retirement, particularly in the case of defined benefit (DB) funds. If you are a member of a DB fund and you retire early, the benefits are reduced by the number of years between early and normal retirement (as defined by the rules of the fund).
- Whether your retirement is genuine, and, if it is, whether you will have sufficient money to ensure a financially secure retirement.
- What is called the opportunity cost. If you retire at 55 instead of 60, you are losing five years that you would have spent generating an income. When you retire early, you stop contributing to your retirement savings and instead start living off your retirement savings.
- All the tax consequences, both of the taxation of your retirement benefits at retirement and the income (pension) generated by your retirement savings.
- Whether or not you will lose your medical scheme benefits. You are likely to retain your medical scheme subsidy if you take early retirement, but not if you resign.
Option 2. Defer your pension
You may be able to remain a member of the pension fund if the fund's rules allow for this. If you can, you become what is called a "deferred pensioner". You take normal retirement when you reach retirement age in terms of the rules of the fund.
If you are a member of a DB fund, the rules provide for how your pension will be calculated when you reach your normal retirement age.
If you are a member of a defined contribution fund (pension or provident), your savings will continue to earn investment returns until you reach your normal retirement age.
If you become a deferred pensioner, it is unlikely that you will be allowed to make further contributions to the fund, and your former employer will definitely not make any further contributions on your behalf. You will also lose any group death and disability benefits.
Nevertheless, there are significant advantages to remaining a member of your pension fund. These include:
- You avoid any tax consequences as you do not receive a payout; and
- There are no reinvestment costs, which may be more than six percent of your accumulated retirement savings, when you transfer your money to a preservation fund or retirement annuity (RA). Although you may think that six percent is not much, look at it this way: six percent of R500 000 is R30 000. And it does not stop with that initial deduction - there are on-going higher costs. At a return of 10 percent, you would have received R3 000 in growth in the first year on the money you have paid out in investment costs. If you are 10 years away from retirement, you will lose a total of R48 520 with growth compounded at 10 percent a year. That is a lot of money to give away.
Option 3. Transfer to a new sponsored fund
The rules of most employer- or industry-sponsored pension funds allow you to transfer your accumulated retirement savings from a previous sponsored fund to another sponsored fund you join. You pay no tax or reinvestment costs for doing so.
Option 4. Transfer to an RA or a preservation fund
As with deferring your pension or transferring to another sponsored fund, there are no immediate tax consequences if you transfer your savings to an RA or a preservation fund. However, there are other consequences, particularly costs, which you should not underestimate.
Many unscrupulous financial advisers - who have their eyes on the commissions, fees and luxury trips they can get by encouraging you to transfer your retirement savings to an RA or a preservation fund - do not tell you about options one and two.
You should only consider transferring your savings to an RA or a preservation fund if you can neither defer your pension nor transfer your savings to another sponsored fund.
You must try to negotiate for lower costs if Option Four is the only choice open to you. Normally, there is little scope for negotiating lower costs in the case of an RA, but, in the case of a preservation fund, you may obtain reduced costs if you go directly (not through an intermediary) to the product provider.
Next week:
The main features of RAs and preservation funds