Don’t rob your future self - think twice before raiding your pension fund
That is the power of compounding that you lose by not preserving.
As waves of economic pain wash over South Africa, retirement savers are urged to pause and consider what they will lose before cashing out their entire savings pot.
Cashing out savings early denies investors the benefit of compound interest, the magnifying force that increases the value of an investment significantly in later years, as the attached graph illustrates.
10X Investments’ third annual South African Retirement Reality Report (RRR20), which was released last month, describes the premature cashing out of retirement savings as a major contributing factor to South Africa’s retirement savings crisis.
The RRR20 acknowledges that cashing out savings is often the result of economic hardship and that more than half of the survey’s respondents indicated severe financial stress. It is based on findings of the 2020 Brand Atlas Survey, that tracks and measures the lifestyles of the universe of 15,1 million economically active South Africans.
It points out that cashing out savings is not always a choice: “For many who have lost a job, pension savings can be the only source of cash”. It also notes that the lack of understanding about the effects of cashing out pension savings is a contributing factor for many.
“When you leave a job and cash in your pension you don’t only lose your accumulated savings, but also the return you would have earned on those savings for the rest of your working life,” says Asavela Gwele, Client Relationship Associate at 10X Investments. “Over 20 or 30 years that amounts to a significant loss.”
She adds that it is very difficult to make up this shortfall in later life. Those years’ worth of saving are essentially lost forever.
“Your pension savings pot might seem like an obvious emergency cash fund, but it is not,” Gwele says. “Cashing out your savings is tantamount to borrowing from your older self, who will quite probably be less able than you are to weather the storm of not being able to pay the bills.”
There is no doubt that these are difficult times for many people, but if people knew what they stood to lose by cashing out early it seems that many would fight to preserve at least some of their savings.
The RRR20 notes that while Covid-19 and the lockdown have magnified South Africa’s retirement saving crisis by pushing people “who were teetering on the brink of disaster over that edge”, it has also been a wake-up call to many about how unprepared they are for a crisis.
The report also makes it clear that corporate membership should be an opportunity for education as it found that more than half of those respondents who had a retirement savings plan had at some time belonged to a corporate retirement savings fund.
According to the RRR20, being part of the formal retirement saving system should mean that these respondents had been exposed to some structured information and training about their fund, retirement saving in general, and options available when leaving employment. Yet, the proportion of people who said they had cashed out their savings when they had a chance suggests otherwise.
It revealed that 62% of those survey respondents who had left their corporate fund had cashed out their savings, rather than preserving some or all of it. It makes it clear that a much better choice would have been to take their savings to their new employer’s fund or ring-fenced them (and the associated tax benefits) in a preservation fund.
While highlighting how the global pandemic has magnified an already difficult situation in South Africa, the RRR20 also makes it clear that various game-changing factors remain within the control of individual savers. Not cashing out savings when changing jobs is one of the key factors.
This is not just a South African issue. In a note released in August, the World Economic Forum said: “Extra freedom has been allowed in some countries to draw from pension pots early, but this is like robbing Peter to pay Paul.”
10X’s Gwele said that even if you find yourself in financial difficulty and feel you have no choice but to dip into your retirement savings, it’s better to cash out only a small portion and save the rest for the long-term.
Cashing out will also expose you to tax. Only R25 000 withdrawn before your retirement date is tax-free; anything more is taxed at 18% or more.
For more information about what you could save by preserving, run your numbers through 10X’s online preservation fund calculator.
For more information and the full Retirement Reality Report click here