When times are tough, it can be tempting to look at those retirement savings that have been piling up for years and think about how much easier life would be if that cash were available. Old Mutual warns that although the soon-to-be-launched two-pot retirement saving system will give access to a small portion of these savings, using retirement money to fix your immediate cashflow problems could lead to a financially difficult old age.
There are millions of elderly South Africans who spend their retirement years wondering if their money will see them through to their last days. Far too late, they have realised that short-term convenience can have harmful long-term penalties, says John Manyike, Head of Financial Education at Old Mutual.
“The two-pot system, which will be launched on September 1, consists of two portions. One-third of future savings will be credited to a ‘savings pot’, and the two thirds’ contributions will be credited to a ‘retirement pot’. All the money in the savings pot can be withdrawn before retirement, but only one withdrawal per tax year will be allowed.” Any unspent savings pot will be a members lump sum at retirement.
“It may sound like a great solution, but tax will be payable on the withdrawn money. This tax will be equivalent to your normal tax rate. So, if you have a tax rate of 25%, the taxman will deduct this from the amount taken out. So, if you access R 10 000, Sars will want R 2 500.”
Some retirement funds may also charge administration fees, further reducing the amount available.
Also lost when money is taken out early, are the chances to benefit from potential fund growth, dividends, and interest that could be earned if the money stayed in the retirement account.
For example, if you saved R 20 000 for ten years instead of being moved from a fund, compound interest would make it worth about R 35 817 (For illustrative purposes for this calculation, an annual interest rate of 6% compounded annually was used).
Other negatives Manyike believes should be considered include:
- Reducing retirement savings means that as inflation and everyday costs increase, you will be faced with the reality that your retirement income is restricted and cannot keep pace with price changes.
- Having a smaller pension will mean tapping into other sources of cash, resulting in personal savings and other investments being used to close the income gap. This will make you poorer as you get older.
- If you withdraw too much from your retirement fund, you may have to work longer to try and earn some extra money so that you can enjoy the retirement lifestyle you want. Majority of South Africans will struggle to maintain the same standard of living when they retire, and this is the current reality before the two-pot system.
- Taking money out of a retirement account once a year as allowed can become a habit that is used to constantly sort out cashflow. This could rapidly deplete the ‘savings pot’ and impact long-term financial security.
- Dipping into retirement funds when you are older. When you are in your 20s and take money from your savings pot, you have time to replenish your funds. When you are in your 40s and 50s, it becomes much more difficult.
“One of the main rules for financial management is ‘never to use long-term money to meet short-term needs’. This is because using long-term savings to, say, buy a car (a short-term need) sees the value of the car decreasing, while the benefits that could have seen the long-term savings increase are gone forever.”
“What is needed to avoid the temptation of draining retirement funds”, says Manyike, “is being money-aware and following simple rules”. These rules include:
- Not living beyond your means.
- Too many South Africans spend more than they earn. This leads to debts eating into income and ends with you having to borrow more money to stay afloat. You may feel envious when seeing friends driving better cars than you, but thinking about the huge instalments, interest and insurance premiums they pay and what you have in the bank will make things better.
- Knowing the difference between what you want and what you need.
- Buying just what you need and avoiding splashing money out on unnecessary luxuries will boost the money you have available for savings and investments.
- Having a budget and following it.
- There are various formulas that people use when budgeting. For example, the 50-20-30 strategy would see 50% of your income is spent on necessities, 20% on short and long-term savings, and 30% on lifestyle choices. The skill lies in finding and sticking to a formula that works for you and guarantees a financially sound future.
- Begin planning, saving and investing for retirement when starting your first job.
The earlier you start with financial planning, the cheaper it will be to achieve your goals and the higher the returns.
Getting professional advice.
A qualified, registered financial adviser will help you plan for the different stages of your life by assisting you to make informed decisions about your personal finances. Before making an early withdrawal from a pension fund, it's advisable to consult with a financial adviser so that the full picture and pros and cons can be thoroughly discussed and thought through.
“Like most things that look appealing when they are first considered, it is always worth understanding what terms and conditions apply. Taking a deep breath, getting the right advice and not rushing into that tempting short-term financial solution, could become the best thing you have ever done,” says Manyike.
PERSONAL FINANCE