Where to invest retirement funds when leaving your job

My wife is leaving her current job to start her own business. How can she invest it her retirement fund? What is the difference between a preservation fund and a retirement annuity? asks Charles.

Maya replies:
There is always the temptation to cash in your pension fund when you change jobs, especially if you are starting your own business and you need the money.

The impact of this decision on your retirement funds is enormous, not only because of tax but because the funds will not benefit from compounding growth over time.

An interesting fact: a quarter of your final retirement lump sum comes from your first five years of retirement savings—so if you cash that in you will reduce your final retirement savings by 25%.

Some people argue that depending on the value of the retirement fund, it may be worth taking the funds, paying the tax and then investing it a lower cost, more flexible structure.
What is important to remember is that there is no capital gains tax or tax on interest income in a retirement fund structure—this equates to a considerable tax saving after 20-odd years!

Preservation Fund vs Retirement Fund

  • A preservation fund is a savings vehicle that preserves your retirement savings until retirement and therefore there is no tax paid on the amount transferred to a preservation fund.

  • Unlike a retirement annuity, you cannot add further amounts to the fund but it does provide greater flexibility as you can make a once-off cash withdrawal before retirement. This would, however, attract tax and would affect the tax-free lump sum available on retirement.

  • A retirement annuity is a good option for self-employed people. Your wife can transfer her pension into the RA and then continue to make tax-free contributions of up to 15% of her income. However, on retirement, two-thirds of the lump sum has to be invested in an annuity to provide income on retirement.

  • Costs of retirement products are often raised as a concern, but there are now many cost-effective RAs on the market with fees no higher than investing in a unit trust, for example. Just make sure that you understand all the costs and commissions.

Risk cover

One thing your wife needs to keep in mind is that she will lose the life and disability cover provided by her company. She could select an RA that includes some of this cover or alternatively her employer’s insurer may allow her to keep her policy without undergoing further medical testing.

Your wife should speak to her current company’s retirement fund provider who would be able to provide her with more detailed advice.

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