In our book, The Ultimate Guide to Retirement in South Africa, we list retrenchment or early retirement as one of the top 10 risks facing a comfortable retirement.
There are several reasons why retrenchment can severely affect your ability to retire well. These include purely financial considerations, but also the risks that come from the psychological impact of an unexpected end to your career.
The most obvious risk is of course the loss of additional years of saving. As you save for retirement, your savings compound, and each year’s growth is made up of both your monthly contribution and the growth that you earned through investment and through receiving dividends. Albert Einstein purportedly called compound growth “the eighth wonder of the world” and you can see why when you watch your retirement savings grow.
It is important to remember that compounding means that your savings build momentum, and it will grow a lot more in the last few years before retirement than in the first few years of work.
An early retirement puts this growth at risk because you may have to stop your monthly contribution, but you may also be tempted – or perhaps even forced owing to circumstances – to withdraw some of your funds early, which means that fewer savings remain in your retirement pool.
Another, sometimes overlooked, retirement risk stemming from early retrenchment is the loss of your tax benefit. My co-author, Bruce Cameron, and I discuss this at length in our book, but in short, the money invested in your pension grows, not only by the rate at which it is invested, but also by the amount of tax you save.
The tax saving on a pension fund contribution is really the best possible way to build wealth because you not only save that tax, but your entire annual taxable earnings decrease by the amount of money that you invest in your retirement savings. This means that you are likely paying less tax on everything you earn.
Another risk that we highlight in our book is the extra years you add to your life as a pensioner. If you decide to end your working life when you are retrenched, and you are over 55, you can buy a pension product with your retirement savings and start living off it.
Statistics have shown that people live much longer than before, which means that you will require that your pension must sustain you for much longer, while, as we discussed above, your pension is also less than it would have been had you contributed up to your official retirement age of 65 or older.
Lastly, we discuss the risk of buying a pension at a younger age. Many people opt for a guaranteed pension as part of their retirement plan. While a guaranteed pension looks like a retirement product, it is in fact an insurance product, which means that the cost is calculated on your expected lifespan.
Buying a guaranteed retirement product becomes more expensive when you buy it at a younger age. In fact, the younger you are, the more expensive it will become. This also has the risk of depleting your retirement savings.
We will discuss alternatives in the next post on your retirement options when retiring early owing to retrenchment. In the meanwhile, please visit www.retirementplanning.co.za for more information on the books The Ultimate Guide to retirement in South Africa and Secure your Retirement.