Shaun Harris
Taking Stock
There is a clearly discernible shift in the job market towards self-employment. It comes in various guises – people deciding to work from home, those starting up their own companies, or those going the route of the increasingly popular “consultant” – but the end result is a growing number of people leaving formal employment.
The trend is likely to accelerate as both the private and public sectors seek to cut costs through retrenchment. Affirmative action programmes and the introduction of quota systems will also erode sectors of the market, typically the middle-aged, middle management level.
This means a large number of experienced, skilled people looking for work in a tightening employment environment. Self- employment is an obvious (sometimes the only) answer.
Exiting the conventional employment sector, however, entails some critical decisions. One is what to do with your pension or provident fund benefits, often accumulated over a number of years. The temptation to withdraw the cash can be overwhelming, but should be strongly resisted. Apart from being taxed on the bulk of your benefits and therefore losing considerable value on what should be your retirement nest egg, it’s also just too easy to spend the money on non-essentials.
Peter Strydom, a director at SG Frankel Pollak Financial Services, points out a startling statistic: “In South Africa, the average length of membership of retirement funds is 15 years. The problem is that many people tend to withdraw their money from the fund and blow it.”
Under current employment conditions in this country it seems likely that the average length of membership will decrease even further. What needs to be stopped is the alarming habit of withdrawing retirement fund benefits. Preservation funds, available in many forms from most of the large life companies, banks and financial product shops, are the most sensible solution.
Strydom says a person leaving a fund, whether they are resigning or have been retrenched, has three options – take the money (and pay your average tax rate on all the capital after the first R1 800), transfer the benefits to another approved fund (fine for those joining another company), or transfer the benefits to a preservation fund.
The third route will almost certainly be the best option for those leaving a company and starting their own business. Perhaps the greatest benefit of a preservation fund is the flexibility it offers, not only to choose how you want your money invested and managed, but also to choose your own retirement date between the age of 55 to 70.
“If a person chooses a preservation fund,” says Strydom, “the second decision is how you want your money invested.”
This depends largely on the individual’s risk profile and age, but there are basically two broad types of preservation funds – the more conservative, guaranteed- type fund, run very much like a typical pension or provident fund, and the linked- fund that lets the investor choose to a large extent the underlying portfolio.
“If you are about five years from retirement you want to go the safe, guaranteed route,” Strydom says. “Between five and 10 years from retirement you start to have choices, and a linked preservation fund could be most suitable if it suits your risk profile. More than 10 years from retirement and a linked fund will in most cases be the best option.”
The benefit of the linked preservation fund, particularly for a younger person who has sufficient time before retirement to structure an aggressive portfolio, is the growth potential of the fund.
But you can also manage the underlying portfolio, typically in unit trusts but also wrap funds, through switching at minimal costs. That means you can adapt your fund to changing market conditions or as your risk profile changes.
Chris Busschau, financial services training manager at Standard Bank, says a person around 40 can probably afford to set up an aggressive portfolio. “Then as one gets closer to retirement you can make the investment more conservative, through sliding capital increasingly towards safer funds, say money market funds. In the final few years before retirement, the fund can be structured towards a low or zero risk profile.”
Another benefit of preservation funds, though it should only be used prudently and if absolutely necessary, is that the investor is allowed to make one withdrawal from the fund before retirement.
Ideally your retirement money should not be touched. But changed employment circumstances often bring financial strain and the need for capital, probably the reason why so many South Africans withdraw their retirement fund money when they leave a fund.
Rather than withdraw the whole lot, work out how much you need, and be ruthless in only taking out the minimum required. If you are still fairly young and can afford to structure your preservation fund aggressively, there’s a good chance you can replace the capital you have withdrawn by the time you reach retirement age through capital growth of the fund.
It’s a useful facility for a person starting up on their own. Part of your fund money can be withdrawn as seed capital for your business, with the chance to replace it before retirement. If you do this, however, make sure you have a good business plan. And it’s preferable to transfer all the money into the preservation fund – a withdrawal can always be made at a later stage if there’s a real emergency.
Busschau says there are a few pitfalls to watch out for. One is the R1 800 people often withdraw from their retirement fund because it is tax free. If this is done it will be deemed your withdrawal from the preservation fund, which means you cannot make any further withdrawals later on.
Another is that in some cases, though fairly rare, rules set by the employer or trustees of your previous fund will still apply to the preservation fund. These could prohibit any withdrawals, even though your money has been transferred to a preservation fund, and possibly even change your retirement age.
So check out the rules of your pension or provident fund before you transfer the capital to a preservation fund. It’s most sensible to get professional advice, probably from your financial advisor.
Busschau also cautions that preservation funds may not be suitable for people who belong to a government or quasi-government fund. These funds often have benefits, for example larger amounts of the fund are tax free, not applicable to private sector funds. It is possible that these benefits will be lost if retirement money is transferred to a preservation fund, so once again check out the rules of the fund very carefully.
For government employees falling into this category, Busschau suggests a single premium annuity retirement policy as an alternative.