Many people change jobs at this time of year. If you are one of them you will have to make a decision about your retirement savings. Recently, I spoke to a group of people who had been retrenched and were wondering what to do with their retirement savings. Most had been to various financial advisers.
All these advisers had recommended that they preserve their retirement funds until the day they retire. This is sound advice because it is very difficult to recover any retirement savings later on in life. In addition, few retirement funds will provide you with sufficient money at retirement to make you financially secure. This is called the retirement gap - the shortfall between what you have and what you need.
One of the main causes for the retirement gap is that when people change jobs they spend their retirement savings on a new car or a holiday instead of preserving their funds. There can be some justification for paying off debt, but only if you then take the money you would have used to pay off the debt and invest it for your retirement.
The second reason for not spending your retirement savings when you leave or change your job is tax. If you draw the money to spend when you change jobs you will get the first R1 800 tax-free (and you only get this once). The rest will be taxed.
However, if you wait until retirement, you get the first R120 000 tax free. By not drawing the money, you are also deferring the payment of any tax. In other words, money you would have paid in tax can earn growth until you draw a pension. Remember that tax deferred is money earned.
There are a number of ways you can preserve your retirement savings and continue to defer tax until the day you retire. These include:
* Transferring to a retirement annuity. You will have to leave the money in the annuity until you are at least 55 years old. You can make further contributions to the fund;
* Transferring the money to a preservation fund, from which you are allowed to make one withdrawal before your retirement. The possibility of making one withdrawal is a safety net in case you get into financial difficulty. You cannot make further contributions to the preservation fund and there are rules about retirement dates;
* Transferring the money to your new employer's retirement fund. This depends on the rules of that fund; or
* You can leave the money in the existing fund. This depends on the rules of the fund.
It is on these last two points that I disagree with the experts who advised the retrenched people I spoke to. Not one of them mentioned the last two options. Could it be that the advisers would not receive any commissions and/or fees if their clients chose the last two options?
One of the first things you should look at when considering what to do with your retirement funds is costs. Costs can undermine your fund's performance. You can lose up to six or seven percent in costs by transferring to a retirement annuity fund or a preservation fund. So for every R100 000 you have, up to R7 000 can disappear. This is quite a significant amount to recover.
You should not be taking high investment risks with retirement savings, particularly if you are older - and to recover those initial costs will mean taking higher risks.
If your existing fund has been keeping ahead of inflation with its returns over the medium to long term, then there would be little reason to move. You should rather take what is called a deferred pension. Leave your money where it is. In the case of a defined benefit fund, it will continue to attract investment returns. With a defined benefit fund, you will get benefits paid out based on a formula.
If you are in a defined benefit fund you may be better off transferring to a defined contribution fund because the formula used to calculate your retirement benefits may not be in your favour. Most companies have both defined benefit and defined contribution funds, and give you the choice of switching to a defined contribution fund. You need to check these options with the fund managers. By transferring to the fund of a new employer you can also save on new investment costs. Not all funds permit this, however. You must check before you make any decision.
If a financial adviser does not suggest you investigate these options first, then you should seek advice elsewhere. An adviser may provide you with various sound reasons to switch to a retirement annuity or a preservation fund. If you do decide to go the route of a preservation fund or a retirement annuity, then get the reasons and details of the costs and commissions/fees (both initial and on-going) in writing.