In a previous post, we highlighted a section from our book The Ultimate Guide to Retirement in South Africa which discusses why retrenchment is a major risk to a comfortable retirement.
With that as background, let’s discuss some of the main considerations when planning for retirement after you have been retrenched.
Tax – a friend or foe?
The tax saving you earn from contributing to your retirement savings is perhaps your biggest friend. You not only grow your savings immediately with the amount that you save in tax, but you also decrease your entire earnings for the tax year through your pension fund contribution, which means that you pay less tax overall.
If you decide to withdraw some of your pension fund savings because you have been retrenched, there is a very real risk that you will pay a lot of additional tax.
If you are retrenched before the age of 55 and you withdraw from your pension savings, these savings will be taxed by up to 36%. This could effectively decimate your savings and would be a very bad idea for anyone who hopes to retire comfortably.
If you are over the age of 55 and you are retrenched, any withdrawal from your pension fund will be calculated as if you are retired and is therefore based on the retirement tax scale. This means that the first R500 000 you withdraw is tax free but be aware that you only have that privilege once in your life. If you find another job and retire later in life, you will not get another chance to withdraw money tax free.
Preservation and pension funds
In the past, there was a significant difference in the way you could access your savings when you retire.
If your retirement savings were saved in a retirement fund, you can draw a third of the money in your fund in cash and you should invest the remaining two thirds in an income annuity.
In contrast, you used to be able to withdraw everything at once from your preservation fund. This changed on March 1, 2021, when the pension reforms changed the rules to be similar to that of retirement savings. This means that you are only able to withdraw up to one third of your funds and must use the rest to buy an income annuity.
Keeping it where it is
While you may have specific feelings about your employer if you have been retrenched before retirement age, it may be the best option to sit on your hands and leave your retirement funds untouched.
While you may not be able to leave your funds in your old employer’s pension fund, you may be able to move it into a preservation fund, a new company’s fund (should you be reemployed) or into a retirement annuity fund.
While you might incur some costs by moving your retirement funds, it its best not to access it until you have some clarity on your future and your cost of living.
There is also the additional consideration of any linked life insurance products. Many companies link a life insurance product to employees’ retirement savings and moving their savings, or halting their monthly contributions, which may cause that product to lapse.
If you can keep your savings intact, it would also be a great idea to continue making contributions, as your savings grow the most in the last few years before retirement. Finding a new job or freelance opportunity can prevent you from drawing on your savings too early and help you continue your contributions.
Retrenchment can be a very jarring experience and it often leads people to make panicked decisions about their life savings. If you are retrenched or concerned about this in future, be sure to find a CFP-accredited independent financial advisor to help you make decisions calmly and in the most tax-efficient and financially prudent way.
Please visit www.retirementplanning.co.za for more information on the books The Ultimate Guide to retirement in South Africa and Secure your Retirement, which was written by Wouter Fourie and his co-author, Bruce Cameron.