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|
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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