3 reasons why you should never cash in your pension fund
South Africans change jobs on average 7 times in the working phase of their lives and 95 percent end up without sufficient funds when they retire. The main reason is that they cash in their pension funds instead of preserving them every time they move jobs.
Every time you cash in your pension fund you blow a huge whole in your provisions towards your financial freedom in the future. Financial freedom takes place when your investments can provide you with a sustainable income for the rest of your life. Your pension is the most important contribution to this as it is probably the biggest investment you’ll make over the longest period of time.
Cashing in your fund has dire consequences that you should be well aware of:
It costs you more than you realise.
Assuming you save with 30 years to retirement and you cash in after the first 10 years. The monthly amount needed to catch up to the same value at retirement is 3 times. If you cash in after 20 years, the amount needed to catch up is R10 times. You also give up tax payable to SARS which if left in your fund boosts the compounding effect on your money. The bigger the amount the bigger the compound over time.
Cost of living
If you cancel your pension to pay off debt then you just are kicking the can down the road. Having too much debt in the first place is a result of you living beyond your means. Cashing in your pension is effectively turning off your income at retirement. If you cannot afford your lifestyle now whilst you are earning a salary you certainly won’t afford to live when you retire. You have to bite the bullet and pay off your debts with the income you earn after savings. It’s the only way to arrive at financial freedom into the future.
Protected investment
Retirement funds are inalienable. Which means your creditors cannot touch the money. This is a useful consideration for those wanting to go into business for themselves and intending to cash in their pension
fund as an investment into their business. You would do well to use the banks money instead of yours. You get the best of both worlds. You retirement funding stays on track and if the business goes bust then you still have your funds for the future.
It stands to reason that cashing in your pension fund is not the first thing you do when you leave your job. On the contrary it should be a measure of last resort.
The wise choice would be to move your Pension Of Provident money into a preserver account.
What is a preservation fund?
A preservation fund is a retirement fund in terms of the Pension Funds Act. It is a tax effective investment vehicle designed for individuals who wish to invest the proceeds of their company-sponsored retirement plan in a tax-efficient manner.
You may transfer the proceeds of your pension or provident fund to a preservation fund in the event you are dismissed, retrenched, or you resign. Doing so preserves both your accumulated savings and the attached tax benefits.
You can invest the proceeds from different pension or provident funds in either one or multiple preservation funds. You cannot however split the proceeds from one pension or provident fund across different preservation funds. You cannot make contributions to your preservation fund from other sources.
Your investment will thus only grow in line with its net investment return.
Tax benefits.
The state has a vested interest to stop you cashing in your retirement asset early and provides tax incentives, to keep you saving. Your transfer to a preservation fund is tax exempt provided you move your savings from a pension fund to pension preservation (or RA) fund, or from a provident fund to a pension or provident preservation (or RA) fund. You also do not pay tax on the returns earned by your preservation fund and when you do draw your savings on retirement, you are taxed at favourable rates. These concessions fall away if you cash in early.
Why preserve?
The primary objective of your pension or provident fund is to build sufficient wealth to sustain you once you retire. This wealth is built through your contributions and the return earned by your investments. To build sufficient wealth, you need to save diligently over the course of your entire working life. If you fail to preserve, you not only forgo your savings to date, but also the return these savings would have generated up to your retirement date.
Investment returns compound over time, turning even modest savings into sizeable amounts after a few decades. In the context of a diligent 40-year savings plan, the first thirteen years of saving will fund approximately half your pension. The corollary to this: if you cash out after thirteen years, you risk cutting your retirement pension in half!
Accessing your preservation fund: You can make one partial or full withdrawal from a preservation fund, prior to age 55. After that, the balance can only be accessed at retirement, from age 55 onward. Your withdrawal is taxed per the withdrawal lump sum tax table below. You are allowed one early withdrawal in respect of each transfer to a preservation fund.
You can retire from your preservation fund(s) from age 55 onwards. You do not need to retire from your employer to do so. For a pension preservation fund, once your balance exceeds R247,500, you can take a maximum of 1/3rd of your investment as cash (subject to tax); with the balance you must purchase either a compulsory annuity (Guaranteed Annuity or a Living Annuity) which will pay you a regular pension.
For a provident preservation fund, you can take the full investment as cash (subject to tax) or you can choose to receive your investment partly in cash and to convert the balance into an approved compulsory annuity.
In terms of proposed changes to the Income Tax Act, the annuitisation may also apply to provident and provident preservation fund balances from 1 March 2018. This would however, exclude any “vested rights”. The “vested right” is your provident (preservation) fund balance on 1 March 2018 and subsequent returns on that balance. If you are a provident (preservation) fund members older than 55 on 1 March 2018, your entire fund will remain exempt.
On death, your benefit will be allocated by the Fund Trustees according to the rules set out in the Pension Funds Act. The Trustees must ensure that all your financial dependents are considered. You can assist them by listing all such dependents in your beneficiary nomination form.
If you do not leave any financial dependents, the Trustees will allocate the benefit according to your beneficiary nomination form. If you do not have any financial dependents and you fail to complete this form, the money will fall into your estate and will be distributed according to your will. Any lump sum payment on your death will be taxed as a retirement benefit as though it had been received by you prior to your passing.
Transfers: You can transfer your preservation fund tax-free to another preservation fund, or to an RA, or to your employer’s retirement fund. Currently, you cannot transfer a pension preservation fund to a provident or provident preservation fund.
If you would like to chat about various options to preserve your pension / provident fund money or any other form of retirement provision, then give me a call, Warren Basel on 082 490 5182, email warrenb@oraclebrokers.com. Website : www.financial-planning-sa.net
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