Two-pot retirement system: rather set up a separate emergency fund

Just more than a month after the two-pot retirement system was implemented, fund managers have started sharing what people said they wanted to use the money for: from paying off debt to home improvements instead of using an emergency fund.

The two-pot retirement system aims to combat immediate as well as long-term hardship by allowing limited access to retirement funds, while enforcing preservation to improve retirement outcomes and ensure that people have enough money to retire on, says Tebogo Marite, communications specialist at Allan Gray.

However, Marite says, while access to the savings component may provide welcome relief for people in dire need of extra cash, it is vital for retirement fund members to remember the unintended consequence of unnecessary early access, which can prevent you from reaching your long-term investment goals.

“Your retirement savings are intended for a very specific purpose: funding your income in retirement. Despite getting access to the savings pot or component of your retirement funds for emergencies, it is important to guard against thinking of your savings component as your emergency fund.

“Depleting your savings component annually will result in you having one-third less when you retire,” she cautions.

ALSO READ: Here’s why you need an emergency fund – and it’s not to buy new golf clubs

How to set up an emergency fund

How do you go about setting up an emergency fund and how much money should be available in this fund?

“Aim to accumulate at least three times your monthly salary. You should invest the money in a low-risk unit trust, such as a money market fund or an interest fund, which will preserve your capital over the short term and offer easy access when you need it.”

Ultimately, she says, you should aim for your emergency fund to be big enough to buy you enough time to manage and recover from a crisis without the need to dip into your long-term investments, such as your retirement fund.

“It is not prudent to rely on long-term investments, including the savings component of your retirement funds, as they are specifically intended to meet long-term goals and are typically invested accordingly, with relatively high equity exposure.”

However, she reminds investors that while equities are the best way to ensure your portfolio beats inflation over the long term, you must expect market ups and downs. “This means that equities are not well suited for short-term savings or emergency funds, because if you need cash during a market downturn, you may be forced to sell at a low price, locking in losses.

“An appropriately invested emergency fund can help you avoid this scenario.”

ALSO READ: How to build your emergency financial safety net

Avoid using emergency savings for other expenses

But how do you then avoid temptation to withdraw for non-emergency purposes? Marite says withdrawing for reasons other than financial distress can cost you more than you think down the line in terms of losing out on growth as well as paying more tax.

For example, if you are about to turn 40 and decide to withdraw R30 000 from your savings pot or component to fund your birthday party, thinking that you are only going to retire at 65 and can easily replenish the amount, you must also consider:

• You may only be withdrawing R30 000 today, but assuming above-inflation returns of 5% per year, your withdrawal is just above R100 000 of your future retirement savings, in today’s money terms.
• You are unlikely to receive R30 000 in your bank account. The funds will form part of your gross income for the tax year and will be taxed at your marginal tax rate, which means you will only receive the after-tax amount.
• You could be pushed into a higher tax bracket for the year of assessment.

“By setting out clear investment objectives and building emergency reserves that are separate from your long-term investments, you can preserve your long-term investments for their intended purpose, while having enough to protect you against the unpredictability of life,” Marite says.