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.
Maya what is the procedure to withdraw from your Pension fund , I’m a government employee ?
Your only option would be to resign
Good day Maya. I am 29 years old and have been working for the WCED for 7 years. My pension is on R400000. I am in the process of resigning as I am going to work abroad. I have a home loan and the balance that I owe is R450000. I would like to ask you if I should take the pension (I know I need to pay tax) and pay that money towards the home loan or should I put it into another pension scheme. Also, what pension schemes would you advised for me transfer it to? Thank you in advance.
Not really something I can answer as it would be considered advice
Hi Maya I have R833.000 in my old mutual preservation fund my retrenchment package is about to run out and do have a living annuity with old mutual and recieving R843.00 a month at 2.5% of my additional R400.000 investment.
I am also currently on debt review paying off loans from Standard bank and only have a balance of about
R55000 what would be my best option now to take a third of the money in the preservation fund and continue paying off the debt monthly or settle the debt.
I do know once I withdraw from the preservation fund it will be taxed.
I am also considering increasing the percentage on my living annuity.
There are a lot of variables here so hard to answer but it sounds like you are already at retirement age. If you have not already used your R500k tax-free amount that may still be available. If you have already used that, you can make a withdrawal from a preservation fund (usually only allowed one withdrawal before retirement). You will be taxed but if you are drawing R55k it would not be too high. It would make sense to take a small amount from the preservation fund to settle the debt than to keep paying interest. But I highly recommend you get proper financial advice. My only other comment is that if this is all you have for retirement you are going to be in trouble – you will need to keep working for some time. Avoid increasing your living annuity for as long as possible
Hi Maya,
Thanks for the insightful article.
I just have a query regarding your rule of thumb in terms of how much you should have saved after years of working. You state that, “after working for five years, you need to have saved 1 x your annual salary.”
Is this gross or net annual salary? I have been working for exactly 5 years myself and I have saved half of my current gross salary. Considering the below:
1) I started from a low base as a graduate
2) I have always contributed more than the minimum percentage for my pension (currently on 28.5% of pensionable salary)
3) I’ve changed jobs and opened preservation funds as to not ‘squander’ my future livelihood and
4) I have 2 additional retirement annuities that I contribute to monthly (1 for 2 years and 1 for 9 months);
and I understand that this a generic guideline for where one should be (everyone is different), but is this an applicable tracking indicator (even when scaled up to 10, 15, 20 years) taking into consideration the above as well as the average South African?
As an aspiring financial advisor, I am concerned that this rule of thumb may seem a bit unattainable for most (from my perspective) if the rule is based on current gross salary.
Your comments on how you got to this rule of thumb will be much appreciated.
Great question. A rule of thumb is not meant to be used to replace a proper financial plan. But to answer your questions:
These figures were provided by Sanlam and they assumed you invested 15% of your salary for five years and had a 12% growth rate
So the limitations are:
A lower growth rate, which has been the case over the last five years
Significant salary increases – the Sanlam assumption is a steady salary.
The point of the illustration is to make people aware of how much they really need. So many people think if they have R1 million when they retire it will be sufficient!
One also needs to be aware of the impact of lower returns on reaching that goal
At the age of 30 it is impossible to know what your final salary will be, but what you can control is your lifestyle and living expenses – to what extend do the salary increases lead to higher expenses vs higher savings?
If you consider that for every R1 million you can buy an annuity income at age 65 for about R5500 per month, then you can try calculate what expenses you expect to still have in retirement and how much money you need saved to meet that. Another option is to calculate based on a 5% drawdown.
Hi Maya, thanks for this. I currently fall squarely in this situation at present as I’m currently resigning from my job, moving into a new one and have a few considerations; 1) I am subject to a VSP, which is gracious and I am considering drawing down on my Pension to “top up” my tax-free threshold to R500K. My consideration for this is that I would like to settle debt, specifically a bond. 2) I have other tax-free investments, TFSAs, which I feel are enough to protect myself against the tax-free loss later on in life at retirement.
Would you consider this a good strategy considering I still have 30 years left of working capacity in me? Would love your opinion on this.
If this is part of a severance package then that does change the decision somewhat. I can’t give you advice but it could make sense to take the full R500k tax-free. BUT you do need to think about what this means to your retirement funding. I stand to be corrected but you do lose the full R500k tax-free amount on retirement which means any lump sum you take at retirement will be taxable. I’m not a fan of mixing up goals – settling a bond should be a separate goal to retirement funding.I would suggest you use this opportunity to do a proper financial plan – all your goals, objectives and what you need to be putting away for retirement.
Just for a moment, let’s just put questionable financial and investment advice aside and ignore the costs. Let’s just look at the merits of saving through a retirement fund.
Your contributions are tax free. For every R1 saved up to
All interest, dividends, rental and capital gains earned by the fund are untaxed.
When you retire, if you take only R500000 as a lump sum, this is tax free.
If you use a living annuity, you can manipulate your income as low as 2.5% to keep your taxable income low.
All interest, dividends, rental and capital gains remain untaxed.
When you die, the remaining balance of your living annuity is excluded from estate duty.
The living annuity can be transferred to your surviving spouse without any tax. If managed properly, the income will continue in the name of the surviving spouse within 1 month and is not caught up in the lengthy administration of a deceased estate.
So. IF managed properly, I cannot describe a more generous tax efficient savings vehicle as a cornerstone of every persons overall retirement plan.
thanks for the input. In addition – during your accumulation phase your pension/provident/RA do not form part of your estate on death if you nominate a beneficiary. That is significant
My take is that too much emphasis is being put on warning people against taking their pensions upon resigning however, the life reality in most situations is that money is required now for people to sustain their lives and most critically to jump-start various entrepreneurial ventures meant to exactly secure safe future financial health. Can I appeal that we try to be balanced every time we discuss these issues?
It is interesting how defensive people are about information on the negative impact of cashing in a pension. This story was based on a real person who was moving to another job. Not someone retrenched/starting a business etc, etc. People so seldom understand the tax consequences and it is important to provide this information. What I have not included is the fact that a retirement fund is protected from creditors – even more valuable if you are starting your own business. PLUS on death the payout is not subject to estate duty. The minute you withdraw you lose those benefits. It is very seldom I come across a 60 year old person who has enough money to retire, usually because somewhere along the line they have made a withdrawal. This is very big decision and you need all the facts – this is information you can add to your decision making process…
Hi my understanding is that the lump-sum will not be taxed but only the monthly annuity when you retire as gov worker. Please confirm
You receive a tax free portion on retirement but that is only R500k (assuming no earlier withdrawals). The rest of the gratuity is taxable.
Rental is good options property as that money will be growing in that asset and still give you something monthly. The key to that is the area you invest in that can make your decision not a good one.
Ideally you want a pension where you get your monthly tax deduction AND create a property portfolio. Having multiple incomes in retirement is the best option
As far as I am aware is that a Pension fun cannot be cashed in, only a third may be taken, a Provident fund on the other hand, may be cashed in fully, please correct me if I’m wrong, thanks
This article may be misleading
You are confusing resignation with retirement. On resignation you have the option to take the full value. On retirement you are correct, 2/3 of a pension must be used to purchase an annuity, but that is not the case with a provident fund
If we are continually scared of tax, then we will never achieve anything. Tax is there and probably won’t go anywhere ever! Might reduce a bit or increase. Either way, there. But opportunity which could potentially propel your financial position to even a better than what your current pension investment vehicle is doing is signs of aggressive investing that’s all. Pension funds are also not so safe.
As retired now I would take my Living Annuity capital out in a heartbeat if I could. As with my liquid capital I would transfer it all into the two fixed deposits I have. One which gives me some of my income, and the other to grow against inflation, part of which to added to my income upon maturity. I have no faith in the low performances and high risk factors of Living Annuities. During my spreadsheets for quite a few years I have come to the conlcusion that Living Annuities as locked into Government law to be drawn only a s percentage per year are safest in a Money Market fund only. And Money Market funds give significantly lower performances than leading Bank fixed deposits. So I do heavily regret in vesting 70% of my retirement input over the years into RA’s, which then takes 70% of the matured capital and puts it into a Living Annuity when one wants to draw retirement income from it, due to Government law. And of course only about 4.5% can be drawn annually in order to protect the capital against inflation and from not depleting, versus the 17.5% per annum allowed.
The obscene charges on living annuities is serious issue – fortunately there are far cheaper options as low as 0.75%. But not being in a living annuity would have tax consequences. Say for example your lump sum was R5 million and you earned 8% interest per annum. That interest of R400 000 would be taxable even if you re-invested it. You get R23 800/R34 500 tax-free interest but the rest would be taxed as per your income tax table. So much to consider and unfortunately not enough good advice out there…
Thanks, however, despite regulation currently being in place to protect prescribed assets, it appears regulation may change to fund ailing SOE’s, so Govt will be in a worse position and not be able to pay back with compounded interest? Also, is there not a good chance that the Rand will devalue more than 33% against hard currency in the short term, so why not pay the tax and invest it in less volatile vehicles?
Everyone has their views…yours is based on certain events you believe will take place. Just understand the tax consequences as they also affect your tax-free withdrawal at retirement
Maya thanks for the info. I learned something. I also thought about this before and I am still considering it. But maya can you please also look at the time value of money as well as the interest that we pay on credits that we have such as bonds etc.
Eg: If I take my money I will buy a new property and lease it then the income for the new lease will assist in repaying my current bond and other debts. Then soon I will be debt free while the income from renting out a new property will flow in for a long time and I am still working and have 25 more years to work.
I think we need to be strategic and weight the costs vs the benefit. Also look at the time value of money. Things are getting more n more expensive.
I am subject to correction.
Thank you
You have to weigh up your decisions – but take the tax loss into consideration. Also the fact that you would lose a portion or all of your tax-free withdrawal at retirement. So any retirement benefits you have at retirement will be more heavily taxed. Also property and rental have risks – what happens if your plan doesn’t work and you end up with more debt?