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Three things to consider before cashing out your retirement benefits

When you resign.

The decision to cash out retirement benefits when changing jobs is arguably the biggest contributor to many pensioners’ dire financial position.

International research suggests that millennials – the generation born between 1981 and 1996 – are most at risk since they tend to change jobs more often than previous generations and will need to overcome the urge to cash out their retirement benefits more frequently.

While there may be instances where it could make sense to cash out retirement benefits, it should be the last resort and it should only be done after carefully considering the long-term implications. Here are some things to ponder.

1. It becomes increasingly difficult to catch up

Although one may argue that at age 30 or 40 there is still a long way to go to retirement, and that you will catch up along the way, it becomes increasingly difficult to do so, due to the impact of compound interest.

Ronald King, head of public policy and regulatory affairs at PSG, says if someone starts planning and saving for retirement at age 20, the individual would need to save 12.5% of his salary. If he only starts at age 30 (because he cashed out), he would need to save 22.5%.

If the same person decides to cash out his benefits at age 40, he would need to save 42% of his salary to be in the same position at retirement, he adds.

Due to other financial commitments, most people would be unable to afford such a high contribution rate.

If someone takes his retirement benefits at age 50, and starts saving anew at that point, he would need to save almost his whole salary to maintain his living standard in retirement.

2. The tax implications of cashing out are significant

Since the regulator wants to encourage people to save for retirement, significant tax breaks are allowed for contributions to retirement vehicles. Not only can individuals claim a tax deduction of up to 27.5% of their total taxable income each year (capped at R350 000), all retirement assets are allowed to grow tax-free while inside a retirement vehicle (pension fund, provident fund or retirement annuity).

But if you cash out prior to retirement when changing jobs, the taxes are punitive.

King explains that only R25 000 of the retirement funds can be taken tax-free when changing jobs – the rest will be taxed according to a sliding scale (see table below).

Taxable Income (R)

Rate of Tax (R)

0 – 25 000

0% of taxable income

25 001 – 660 000

18% of taxable income above 25 000

660 001 – 990 000

114 300 + 27% of taxable income above 660 000

990 001 and above

203 400 + 36% of taxable income above 990 000

Source: Sars

Yet, the most significant tax impact will only become visible at retirement.

Retirement annuity and pension fund investors can take up to a third of their benefits as a cash lump sum at retirement. Provident fund members can (currently) take all their funds in cash at retirement. The first R500 000 will be tax-free.

King says the biggest problem is that those pension benefits taken as a cash-lump sum when resigning will be deducted from the amount that can be taken tax-free at retirement.

“If you take R500 000 during your lifetime when resigning, you won’t be entitled to the tax-free amount of R500 000 at retirement.”

This means that individuals can pay up to roughly R85 000 more in tax when they retire, because they cashed out when changing jobs, he adds.

3. You can now leave your pension benefits in your former employer’s fund

The introduction of default regulations for retirement funds means that funds need to offer in-fund preservation options for employees when they resign. Employees do not have to make use of it (they can opt out) but it may be an attractive option where funds offer good value for money and attractive returns.

King says most people would probably prefer not to leave their money with an employer with whom they no longer have any contact. The alternative is to transfer retirement benefits to a preservation fund or retirement annuity. The costs, underlying funds and tax benefits are the same.

The main difference is that in the case of a preservation fund, investors would be allowed to access the funds once before the age of 55. With a retirement annuity, funds can’t be accessed before this age.

King says to determine whether a preservation fund or retirement annuity will be the best choice, investors need to consider if they will be tempted to spend funds that are accessible to them.

“If there is a significant risk that you would want to use the funds to buy a new car or to improve your house, it would probably be best to transfer the funds to a retirement annuity.”

However, if you may need the funds in future because you don’t have any other income, the preservation fund will likely be your best bet, he says.

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The following statement by Ronald King from PSG can be very misleading: “If you take R500 000 during your lifetime when resigning, you won’t be entitled to the tax-free amount of R500 000 at retirement.”

This should be understood that the current maximum tax-free lumpsum from retirement benefits of R500 000, do not apply to resignations (job changes) before reaching the age of 55 (the earliest recognised age at which someone can take early retirement) and therefor do not apply in context as stated by Ronald King from PSG.

It is also worthwhile noting that where one goes on disability pension from or retires from a provident fund, it is not compulsory to take the full benefit as a lumpsum. One can also opt to just take the tax-free portion as a lumpsum (maximum R500 000) in order to invest it discretionary (preferably on a tax-friendly basis) and transfer the balance of the provident fund benefit tax-free to an insured pension annuity or to a living annuity pension plan.

Dear France,

I am afraid Ronald King is correct in his statement. If you refer to the Second schedule of the Income tax act, there was an amendment on 1 March 2009. This amendment allowed for accrual of previous lump sum withdrawals.

Example:

Mr. A decides to withdraw his pension/provident fund upon resignation, at age 50. The amount is R 600 000.00 Tax implication will be:

R 600 000 – R 25 000 = R 575 000 @ 18% = R 103 500 tax payable.

At 65 Mr. A decides to retire, and withdraw his provident fund, of R 1000 000. Tax will be calculated as follows:

Step 1: Add up the retirement AND withdrawal benefits received after 1/03/2009:
R 600 000 + R 1 000 000 = R 1600 000

Step 2: Apply the retirement rate table to the full amount:
R 1600 000 – R 500 000 = R 1100 000
R 1100 000 – R 148 500 of taxes = R 951 500

This gives you a final after tax benefit of R 1 451 500. Total tax paid: R 148 500 + R 103 500= R 252 000.

As you can clearly see, the accrual makes a big difference, and Mr. A is better of preserving his funds.

Hope this helps.

NelisBrink – thank you for the info – effect of early withdrawals understood – but surely this do not allow one to make use of the R500 000 tax-free lumpsum at resignation before the age of 55 (disablity and death claims excluded), as suggested by the article?

It doesn’t, but I think there is some kind of retrenchment tax benefit where one get such a R500 000 tax free lumpsum, and one would forfeit your R500 000 lumpsum when retiring at a later date, after you were employed again. Not 100% sure, but that’s what I recall.

Returns in recent years on the default portfolios of major umbrella funds don’t really help the cause. In some cases 3 year returns are below inflation after charges and participants are facing the power of compound real losses.
For example, see the Sanlam Accumulation Portfolio which is their default for their umbrella funds. Three year returns (as at end Mar 2018) of 4.5% gross of charges which are at least .75%. So those investors are getting well below inflation.
Depending on years to retirement one might be better off paying tax and going into a non Reg 28 fund or offshore.

The SWIX did 4.5%, the ALSI 5.3% and the ALBI 8.6% in the same period. Investing over the long term takes patience and resolve during short term periods. While not any indication of future performance, it’s worth noting that the Sanlam Accumulation portfolio that you singled out was the best performing umbrella fund default portfolio of 2017. It also received gold medal awards at the 2017 IRFA for portfolio construction. Short termism is what leads to poor outcomes. Think twice.

Indeed. What NR is also not considering is that every monthly contribution is buying a range of stock on the relative cheap. If the stocks kept going up it more expensive to buy them with your monthly contributions and you get less and less for your contributions.

That is of course if you think SA stocks will grow again. If you think SA is doomed, then you should get your money out indeed.

Stephen Nathan of 10X famously stated that most fund managers can gobble up as much as 40% of an investment over it’s life span because of high fees.
I agree with him 100% and would like to add that young people should have their own plan of action to build funds for retirement.
DO NOT RELY ON PENSION for a comfortable life in old age, it is NEVER enough. especially if you consider the Rand has devalued 40 FOLD since 1980,
and it is going to get worse before it gets better with the politburo running SA

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