Why You Should Think Twice Before Cashing in Your Retirement Savings

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In the event of retrenchment, resignation or changing employment the majority of South Africans choose to opt for cash payouts from their retirement funds as  opposed to preserving these hard earned savings. So much so, that National Treasury is considering making the preservation of retirement savings mandatory in the aforementioned instances. 

There are various reasons consumers opt to cash out their retirement savings, the most common being: 

  • Over-indebtedness
  • Short-term gratification
  • Lack of knowledge as to the options available

[tip title=”moneysmart tip”]While dire circumstances could warrant dipping into the proverbial cookie jar, the rule of thumb is that if you don’t need to use your retirement savings, don’t.[/tip]

Taking the cash payout in most cases is the worst possible course of action.

Options available to you at retrenchment, resignation or changing employment: 

  • Withdraw a portion of or full Pension or Provident Fund value (has tax consequences).
  • Transfer to a Preservation Fund or to a Retirement Annuity (tax free).
  • Defer your pension, which allows you to remain a member of your current retirement fund until you retire (dependent on the retirement fund rules).

Further details with regards to products to which you can transfer your retirement benefits:

 

 Retirement Annuity

*Pension Preservation Fund

*Provident Preservation Fund

Withdrawals

No withdrawals allowed before retirement. One withdrawal is allowed before retirement. One withdrawal is allowed before retirement.

Contributions

Regular or lump sum contributions are allowed. No additional contributions allowed. No additional contributions allowed.

Rules at retirement

One third of the total fund value is allowed to be taken in cash, the remainder must be used to purchase a **pension-providing annuity. One third of the total fund value is allowed to be taken in cash, the remainder must be used to purchase a **pension-providing annuity. The full fund value can be taken in cash.

*Pension Preservation Funds are used to preserve transfers from Pension Funds and Provident Preservation Funds are used to preserve transfers from Provident Funds. 

** Financial products designed to pay out a stream of income to individuals throughout retirement.

Reasons why you shouldn’t cash in your retirement savings: 

  • Limits your ability to meet your retirement savings needs due to the fact that you cannot fully take advantage of compound interest.
  • Reduces the tax-free amount available to you when you retire. 
  • Results in the benefit that you take at retirement being taxed at a higher rate. 
  • Lose the benefit of earning returns on money you pay as tax.

The following example illustrates the difference between opting to cash out your retirement savings when changing jobs as opposed to preserving it.

For the purpose of this example the following is assumed: 

  • Both clients change employment with R400 000 saved up in their retirement funds.
  • After changing employment they each save up an additional amount of R545 000 in their new employer’s retirement funds before retiring. 

Client

Mr. Smith

Mr. Jones

 Total amount of retirement capital withdrawn when changing employment   R400 000  Zero (transfers full fund value to a preservation fund)
 Tax paid at withdrawal   R67 950  Not applicable
 Total retirement savings available at retirement   R545 000  R945 000
 Tax paid at retirement   R126 450  R141 750
 

Total tax paid

 

 

R194 400

 

R141 750

As a result of the withdrawal made earlier in Mr. Smith’s career he loses out on a large portion of the R315 000 that can be received tax free at retirement (as per the Retirement Lump Sum Benefits Tax Table) and ends up paying R52 650 more in taxes.

The reason for this is that withdrawals from retirement funds before retirement age (55) are taxed differently as opposed to withdrawals at or after retirement as can be seen below:

Lump Sum Withdrawal Table (pre-retirement):

Taxable portion of withdrawal

Rates of tax

R0 – R22 500: 0% of the cash lump sum
R22 501 – R600 000: 18% of the cash lump sum exceeding R22 500
R600 001 – R900 000: R103 950 plus 27% of the cash lump sum exceeding R600 000
R900 001 and above: R184 950 plus 36% of the cash lump sum exceeding R900 000

 

Lump Sum Retirement Table (post-retirement):

Taxable portion of withdrawal

Rates of tax

R0 – R315 000: 0% of taxable income
R315 001 – R630 000: R0 plus 18% of taxable income exceeding R315 000
R630 001 – R945 000: R56 700 plus 27% of taxable income exceeding R630 000
R945 001 and above: R141 750 plus 36% of taxable income exceeding R945 000

It’s worth noting that it isn’t necessary to take a cash withdrawal at retirement and that the full retirement benefit accumulated can be transferred tax free to a pension-providing annuity such as a Life or Living Annuity.

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For all your financial planning and consulting requirements email Raul Jorge.

References:

Marais, J. (2011). Think twice before cashing in retirement savings before you retire. Available: http://www.equinox.co.za/article_2748.html. Last accessed 4th September 2013.
Van Rooyen and Raath. (2011). Double tax liability for early withdrawal of retirement benefits. Available: http://vanrooyenraath.co.za/financial-literacy/double-tax-liability-early-withdrawal-retirement-benefits. Last accessed 4th September 2013.

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About Author

Raul Jorge is a CFP® professional at PSG. He specialises in estate, investment, retirement and risk planning. Prior to joining PSG, Raul completed his BSc (Honours) in Business Administration through the University of Wales and more recently completed his Postgraduate Diploma in Financial Planning through the University of Stellenbosch.