When you leave your employer, subject to fund rules, you can transfer your retirement benefits to a fund with your new employer, transfer them to a retirement annuity or preservation fund, or take a cash payout, says Thandi Ngwane, head of direct distribution at Allan Gray.
Other options include taking early retirement (provided you’re 55 years old) or deferring your pension and remaining a member of your current fund until you retire.
One of the biggest problems in South Africa is that people don’t transfer their retirement savings when changing jobs, instead withdrawing them to supplement living expenses or fund extravagant purchases.
Many believe they will recover lost ground at a later stage, but they’re wrong. ‘It becomes increasingly difficult to make up the gap later,” says Kenny Meiring, head broker, sales and marketing, of Metropolitan Employee Benefits. ‘If you don’t preserve your benefits when you leave a pension fund, it’s the equivalent of your younger self taxing your older self,” he says.
Traditionally you would start saving at 25 years of age, stay with the same fund until the mandatory retirement age of 65 years and retire with an income replacement ratio of between 75% and 85%. But nowadays you change jobs frequently to get ahead in the dog-eat-dog corporate environment.
An individual who changes jobs three times in his (or her) working life — and withdraws 50% of his retirement benefit each time — will reach retirement with a replacement ratio of only 30%.
Ngwane agrees: ‘Taking a cash payout is the worst course of action. Not only does it attract the most tax, it also severely hampers your ability to accumulate enough savings to retire with a degree of financial security later on. You miss out on the power of compounding.”
If you’re retrenched or you’re changing jobs, your best option is to preserve the retirement savings you’ve already built up. If you don’t, you may not be able to retire with enough money to live on. It’s difficult advice to follow because the financial hardship that accompanies retrenchment often forces the individual’s hand.
Why preserve? Withdrawing your retirement benefits reduces the capital amount available at retirement. Rather than withdrawing your benefits as cash, you should transfer them from your current employer’s pension or provident fund to a pension preservation fund, a provident preservation fund or a retirement annuity (RA).
This enables you to sidestep the tax that would otherwise be levied on an early withdrawal. If you choose to withdraw your benefits as a cash lump sum only the first R22 500 is tax free. The remainder will be taxed according to a sliding scale ranging from 18% to 36%, depending on the amount.
Which vehicle should you choose? Preservation funds offer the flexibility of a single withdrawal before retirement, whereas an RA doesn’t allow for any further withdrawals before retirement.
If you hope to make further retirement contributions to this vehicle then you’re best served by an RA, as preservation funds don’t allow this. ‘An RA allows you to contribute on a regular basis, to interrupt contributions for a period and to stop contributions at any stage,” says Ngwane.
Once you retire, you’re allowed to withdraw all your capital in cash from a provident fund, whereas with an RA the maximum cash withdrawal allowed is one-third of your capital. The remaining two-thirds must be used to buy an annuity.
Old Mutual’s Retirement Funds Survey 2010 contains some shocking statistics. Mkuseli Mbomvu, service executive at Old Mutual Corporate, says that 99% of the 17 272 people who resigned from umbrella funds in 2009 opted for cash over preservation. Only 170 of these preserved their retirement savings.
‘While 93% of stakeholders surveyed agree that preserving retirement savings is important, when exiting their existing pension or provident fund, the majority of South Africans are not doing so,” he says.
Why do members prefer not to preserve their funds? Common reasons include the desire to access cash, high awareness of the cash-payout option and a lack of understanding of the long-term consequences of the decision. Financial hardship also plays its part.
Retirement savers who lose jobs through recession are under severe financial stress and the cash from their retirement savings proves to be a godsend. Retirement savers also view the cash windfall as start-up capital for small business ventures.
Mbomvu describes it as the ‘triple-T” syndrome — the use of pension-fund payouts to buy taxis, taverns and tuckshops — and it is another contributing factor to the country’s woeful
funds preservation record.
The major challenge is to encourage savers to take greater responsibility for their retirement. Industry stakeholders must improve levels of education to enable retirement savers to make the right decisions.
They must be taught about the importance of preservation and the alternatives to withdrawing cash. In an environment where savers refuse to take responsibility for their retirement , the government might have to intervene.
Analysts expect that the government will address preservation concerns by introducing some form of compulsory preservation in its proposed national social security plan.