When changing jobs there is always the temptation to cash in your retirement fund and use it to settle your debt. The feeling of not having those debt repayments each month is hugely liberating. But does it make financial sense?
Someone posed this question to us. He is about to resign and has nearly R900 000 in his retirement fund. Does it make sense to take his pension, settle his short-term debt and mortgage and start life again debt free?
His first consideration is tax. He could find himself facing a tax bill of over R140 000. That is a lot of money to pay over to the taxman when it could be used for his retirement income.
To put that in perspective, if his retirement investment doubled every seven years, within fourteen years the true cost of that tax bill would be R560 000 as he would have lost out on the potential compounding growth.
Any amount he withdrew now would affect his tax-free withdrawal of R500 000 at retirement. If he withdrew the R900 000 he would have no tax-free withdrawal at retirement.
He also needs to check if he has enough for retirement. As a rule of thumb, depending on how many years you have been working, you should have the following saved:
- After working for five years, you need to have saved 1 x your annual salary
- After 10 years, 2 X annual salary
- After 15 years, 3 X annual salary
- After 20 years, 4 X annual salary
- After 25 years, 6 X annual salary
- After 30 years, 7 X annual salary
What most people find when they cash in their retirement fund to settle debt, is that five years later they are back in debt with no retirement savings. It is about learning to manage your money on a day-to-day basis, rather than relying on windfalls.
Rather stick to a budget, create a debt repayment plan and pay in extra to your debt each month instead of using your very valuable pension assets – a large percentage of which would go to the taxman.