Two-pot retirement system: Draw from your savings pot or get a loan?

The two-pot retirement system that will be implemented next Sunday, 1 September, is meant to give pension fund members access to a portion of their retirement savings in the case of an emergency. But would a loan not be a better idea? What other options do you have?

We asked Lizl Budhram, head of advice at Old Mutual Personal Finance to compare the benefits and risks of dipping into your savings pot under the two-pot retirement system with a claim of R30 000 and simply getting a personal loan for R30 000.

“The benefit of not accessing your savings pot under the two-pot retirement system is that the money is left for retirement, which is its main aim and purpose, while you avoid paying tax on the withdrawal amount. In addition, you do not run the risk of taking money out of your retirement fund at an inopportune time, such as when markets or share prices are low.

“You also avoid the withdrawal fees. A once-off withdrawal can possibly be rectified in the future, but it does create the risk of falling into the habit of making regular withdrawals from your retirement fund, seriously comprising your financial position in the future at retirement.”

On the other hand, Budhram says the benefit of the loan is that there is no tax. “A big disadvantage is the interest rate, although secured loans could have lower interest rates. Interest impact could also be reduced by repaying the loan as fast as possible.”

She made these calculations to show the difference between withdrawing from your savings pot and getting a loan for R30 000:

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Other options besides the two-pot retirement system or a loan

Are there any other options apart from the savings pot and a loan in an emergency? Budhram says the first step should be to establish the exact extent of how much cash you need and how soon you need it.

The next step would be to consider these options:

• If you have an adequate emergency fund it should be the most appropriate solution to help you weather the emergency.
• If you have an existing investment vehicle and underlying fund and market conditions allow for liquidity, you can use access to the investment to get the cash. However, Budhram says you must carefully consider the implications of early access to the investment on your bigger financial position and plan. “It is also important to investigate any further or alternative access options, such as a part withdrawal or loan against the investment.”
• If you need a lower amount of cash, consider discontinuing or reducing contributions or premiums, as the long-term impact on the financial plans is smaller than a disinvestment.
• If you have no liquid investments available, Budhram says you can consider using an illiquid investment, such as fixed property or policies, as security for a loan. Once again, you must consider the implications of interest costs carefully. “The interest cost attached to a personal loan without any security is likely to be higher than the interest cost attached to a secured loan.

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The importance of an emergency fund

Is it then important to have an emergency fund? Budhram says an emergency fund is one of the most important elements of a financial plan, as it supports your financial stability. “Emergencies are smaller financial hiccups that are bound to happen during the course of the financial planning period.”

She says if funding for such emergencies is not in place, it can seriously disrupt your monthly or quarterly budget. It can also disrupt education or retirement savings if you have to dip into these savings to overcome emergency expenses.

Budhram says setting up an emergency fund is easy. “Find a liquid investment that provides stable interest-related returns, such as a bank account or money market unit trust fund. When you unexpectedly need access to your emergency fund, access must be without tax implications, with no additional costs and not compromised by market conditions.”

She warns against using retirement annuities for purposes of an emergency fund. “The primary purpose of the retirement annuity is to save for retirement and therefore the investment should be exposed to the equity market to give good long-term returns.

“Similarly, even a tax-free Savings Investment is better used for longer-term savings or investment goals, as the benefit of the tax-free is maximised over longer terms.”

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How much should you save in your emergency fund?

Budhram says the average rule of thumb is an amount equivalent to your salary after deductions for six months, but there is no specific amount that is right for everybody.

“Consider whether you have good short-term insurance in place and what your excess amount is on this insurance cover. How old are your big appliances and your vehicles? These considerations should give some guidance regarding whether your emergency fund should have some extra provision for an emergency that may be more likely.”

She says consumers must also remember that even a small emergency fund is far better than no emergency fund. “And if you do dip into your emergency fund, make it a priority to replenish it as soon as possible.”