If you change jobs, and you can't defer your pension or transfer your retirement benefits to another employer-sponsored fund, you can protect your benefits by transferring them to a preservation fund. We explain how these funds work.
Preservation retirement funds are one of numerous tax-efficient investment vehicles you can use to protect your retirement savings.
Many people, when they leave or change jobs, make the mistake of taking their cash payout and spending it on, for example, a new car, or using it to pay off their debts.
This is a dangerous practice because it probably means you will not have enough money for a financially secure retirement.
Preservation funds are designed to preserve your retirement savings, particularly when you change jobs.
If you belong to a defined benefit or a defined contribution pension fund, your contributions to your fund are tax-deductible and your employer's contributions are tax-free.
If you are a member of a defined contribution benefit fund, you are not taxed on your employer's contributions. But, if you change jobs and simply withdraw your money from your fund, you will be taxed on all the proceeds.
Should you change jobs, you have the following choices about how to protect your retirement savings:
1. Defer your pension
You may be able to remain a member of your retirement fund if the fund's rules allow it. You will then become what is called a deferred pensioner.
There are significant advantages to deferring your pension, including:
- Not paying tax; and
- Not paying reinvestment costs.
If you remain a member of a defined benefit fund, the fund's rules provide for how your pension will be calculated when you reach the normal retirement age. If you remain a member of a defined contribution fund (pension or provident), your savings will continue to earn investment returns.
If you become a deferred pensioner, it is unlikely that the fund's rules will allow you to continue contributing to the fund, and your former employer will certainly not continue making contributions.
2. Transfer to the fund sponsored by your new employer
The rules of most employer-sponsored funds allow you to transfer your accumulated retirement savings from the sponsored fund of one employer to the fund of another employer. You will not pay tax nor incur any reinvestment costs.
3. Transfer to a retirement annuity or a preservation fund
You should only consider transferring to a retirement annuity or a preservation fund if you cannot defer your pension or transfer it to another sponsored fund.
If the rules of your retirement fund prevent you from putting your money in a preservation fund, you will have to use another option, such as a retirement annuity, to preserve your retirement savings.
As with deferring your pension or transferring it to another sponsored fund, there are no immediate tax consequences if you transfer to a preservation fund. But there are other consequences, particularly costs, which must not be under-estimated.
The initial costs can be as high as six or seven percent and the annual costs as much as 2.5 percent. The annual costs with most sponsored funds are likely to be lower - particularly if it is a large fund - because the trustees negotiate lower asset management fees.
The main features
The main features of a preservation fund are:
- There are pension preservation funds and provident preservation funds. If you transfer from a defined benefit or a defined contribution pension fund, you must transfer to a pension preservation fund; and if you were a member of a provident fund, you must transfer to a provident preservation fund. The reason is that pension and provident funds are taxed differently when you retire.
- The rules of the fund you left apply to the preservation fund to which you transfer your savings. The implication of this is that the age at which you are allowed to retire from the preservation fund will be the same as the age stipulated by the sponsored fund. If, for example, the retirement age of your original fund was 65, you may only withdraw your pension benefits from the preservation fund when you turn 65.
- The former employer of a fund member who transfers to a preservation fund must become a "participating employer" in the preservation fund. This is simply an administrative requirement, which is met by the employer signing a declaration.
- You cannot remain a member of a preservation fund past the age of 69.
- You cannot make additional contributions to an existing preservation fund. If you already have a preservation fund in place as a result of a previous transfer, you cannot add a more recent transfer to that fund. You must establish a new preservation fund.
- When it comes to calculating the tax-free portion of any lump sum you withdraw from a preservation fund, there are two legs to the formula. With the first leg, only the number of years transferred to the preservation fund may be taken into account when calculating the lump-sum amount you may take tax-free at retirement. That is, the number of years that you were a member of your previous employer's retirement fund. The second leg of the formula, however, limits this tax-free amount to the greater of R120 000 or R4 500 multiplied by the number of years you have been a member of a retirement fund.
In this case, the years of membership referred to include the years you were a member of your original retirement fund, plus the years you were a member of the preservation fund.
- You are permitted to make one (and only one) withdrawal from a preservation fund before retirement. The withdrawal may be a portion or all of your savings in the fund. The first R1 800 you withdraw is tax-free, and the balance is taxed at your average rate of taxation.
- As with most retirement funds, you cannot take a loan from a preservation fund, nor can you use a preservation fund as security for a loan.
- Your retirement savings are protected against claims from creditors in the event of sequestration.
- Preservation funds are provided by either life assurance companies or linked investment product com-panies. The latter offer you an array of underlying investment choices and the ability to mix and match your investments on an on-going basis. Most of the underlying investments are in unit trust funds or portfolios, selected by experts, that are modelled on your investment risk profile. You do, however, have the choice of investing in life assurance capital guaranteed or smoothed bonus products if you want to lower your investment risk.
The security of your money depends on your investment choice. Be aware that you could lose all or part of your capital if you invest in a market-linked product.
- When you retire, your retirement savings are taxed in the same way as any other retirement fund. For example, if you are in a preservation pension fund, you must use two thirds to buy a pension. You are not obliged to buy the pension from any particular company, and you should shop around for the best rates.
- Investment costs can vary dramatically. It is important that you establish the costs, because in many cases, higher costs undermine your investment performance. The costs include: initial and annual costs; initial and on-going commissions; and underlying costs.
Part 27:
Group life assurance