Cashing out your retirement fund might seem like a good idea, but this can leave you in a difficult position when you reach retirement age. When Thabiso Mokoena* resigned from his job after six years, he was excited about the prospect of starting a new chapter in his life. His plan was to take a break for a few months while looking for another job. Knowing he could cash-out his retirement fund gave him security, as he didn’t have to worry about income in the meantime.
“I no longer felt fulfilled at my previous job and taking the decision to leave took a long time. But at least I knew I would still be able to fulfil my responsibilities when it came to taking care of my family, as I knew I could use some of the money from the retirement cash lump sum,” he says.
STARTING FROM SCRATCH
But Thabiso (32) soon realised that cashing-out his retirement fund was not the best decision he could have made, as it meant he had to start from scratch to build it back. “When that money came in, there were other expenses that I didn’t foresee. Things such as school fees and my car had a mechanical breakdown, which was quite costly,” he says.
He also admits splurging on things that he now sees were unnecessary expenditures. “There were things I spent money on that were not a priority, such as spoiling my kids, entertainment and buying home appliances for my family. We could have waited and budgeted for these things,” he says. Thabiso is one of many South Africans who find themselves in this position.
According to a recent study by Sanlam, on average, South Africans change jobs about five to seven times during their working lives. The study found that 77% of people who quit their jobs took their retirement savings out as lump sums. Around 63% of those people used the money to pay off debt, and 57% used it to cover living expenses while looking for a new job.
Thabiso says he doesn’t regret spending the money on his family. However, he regrets that he now has to start from scratch to build his retirement fund “I’m happy I did everything that I needed to do for my family. But I could have used the money more wisely, like making a good investment that would continue to generate more income for my family,” he says.
Client relationship manager at Allan Gray Noluyolo Betela says people should carefully consider the longterm implications of withdrawing their retirement fund. “You may believe you'll have time to make up for the years of saving, but not preserving will cost you more years than you may realise,” Betela says.
“Not only will you have to start again, you will also miss out on the full power of compounding. Often referred to as the ‘eighth wonder of the world’, compounding means you earn interest today on the interest you earned yesterday, over and above the amounts of money you contribute.”
Depending on your circumstances, she advises that the best thing to do may be to transfer your savings into a preservation fund or a retirement annuity fund. “A preservation fund is specifically designed to invest your pension or provident fund savings,” she says. This is a good option if you have built up a substantial amount over the years.
FNB Wealth and Investment spokesperson Preenay Sathu says even when you are cash-strapped it is not advisable to withdraw your retirement savings. And even when you have few other alternatives, cashing out your retirement fund should be the last resort, Sathu recommends. In most cases, people are forced to tap into their retirement savings due to a loss of income. Betela says in cases such as this, you need to be cautious.
“If you have no choice but to tap into your savings, rather take only what you will need until you start working again. If you have already lined up a new job or have other sources of income when you leave your company, avoid taking a cash lump sum for ad hoc spending,” she says.
“Rather transfer your savings to your new employer’s retirement fund or a retirement annuity, pension or provident preservation fund. By doing this, you keep the tax benefits of your original fund and your investment returns are not taxed.”
Head of Financial Education at Old Mutual John Manyibe says cashing out your retirement fund is risky as it leaves you at a disadvantage. “Cashing out your pension fund when you change jobs or resigning to access your pension fund may seem like a quick cash-flow fix, but in actual fact you are crippling yourself,” Manyibe says.
The government wants people to preserve their retirement savings so they can take care of themselves when they’re older and no longer working. “The tax rules strongly encourage you to preserve your retirement savings,” Betela says.
“Every South African gets a tax-free benefit at retirement of R500 000, which means the first R500 000 you take as a cash lump sum at retirement will not be taxed.
"But if you make any withdrawal before you retire, it will affect that R500 000 and you’ll have to pay more tax when you decide to take a cash lump sum at retirement.”
GET BACK ON TRACK
Rebuilding your savings will not be an easy task, but with a bit of focus and planning it is possible. “As soon as you start working again, you should increase your contributions to your employer’s fund.
It’s a good idea to consult with an independent financial adviser to help you calculate how much more you will need to contribute so that you can still enjoy a comfortable retirement when the time comes,” Betela says.
She adds that if you are fortunate enough to have a second income, such as a small business or freelancing, you should use the additional income to top up your retirement savings. “Alternatively, you could also delay retirement. In this way, you can get a ‘boost’ in your retirement savings through additional years to contribute and compound interest – where the interest on the investment earns even more interest,” she says.
Sathu also suggests seeing a financial adviser to put a financial plan together, which you'll have to review at least once a year. “Ensure you don't reincur the debt you've settled. Increase your savings to your retirement funding and stay