By: Gerhardt Meyer CFP®, Head of Technical Support, PSG Wealth
Most of us will experience some unforeseeable crisis during our lifetimes. Life is, after all, riddled with uncertainties, as is evident from the current pandemic. If you should lose your job or have your income reduced considerably, how do you plan on making up the shortfall? Without an emergency fund or access to investments, you might be eyeing your retirement savings to close the gap. But there are serious pitfalls to raiding your retirement fund prematurely. Here is what you need to consider.
Think about the tax
One immediate consequence of an early withdrawal from your retirement fund is the tax you’ll have to pay. For example, the lump sum you take from your preservation fund will be taxed at the following withdrawal benefit tax rates:
|Taxable income||Rate of tax|
|R1 – R25 000||0%|
|R25 001 – R660 000||18% of taxable income above R25 000|
|R660 001 – R990 000||R114 300 + 27% of taxable income above R660 000|
|R990 001 and above||R203 400 + 36% of taxable income above R990 000|
The long-term impact on your overall financial plan could be severe. Consider the following scenario that illustrates the different outcomes you could face.
Let’s compare Tshepo and Charles. Both are 45 years old and apart from having current employee benefits in their respective jobs they also have their own preservation fund investments from previous employment with a fund value of R1 900 000 each.
Tshepo has appointed a financial adviser and together they have set short-, medium- and long-term financial goals. Tshepo made provision for any short-term cash flow needs by having an emergency fund and a short-term voluntary investment.
Charles decided not to set out clear goals or make short-term provisions and only has his existing employee benefits and his own preservation fund investment for his retirement.
In April 2020, their respective employers started operating within national lockdown regulations and their working hours were reduced significantly. They both suffered a pay cut and now need to supplement their income to meet financial obligations, such as bond repayments, car payments and household expenses.
Tshepo, who planned ahead, has the necessary liquid funds to top up his income. Unfortunately, Charles has no available funds, but he can make a once-off withdrawal from his preservation fund before he reaches 55. He decides to take R900 000 to help him meet his payments for the next few months. He takes such a large amount because the future feels daunting and uncertain, and having used his one allowable withdrawal, he knows he can only access his funds at retirement again.
Despite having to pay tax of R179 100 (leaving him with only R720 900), he withdraws the funds, leaving much less for when he retires.
Assuming both Tshepo and Charles retire at age 65 and have an investment return of 9% per annum (after fees), these are the results of their actions:
|Preservation fund value at present||R1 900 000||R1 900 000|
|Less withdrawal benefit taken to cover immediate need||–||(R900 000)|
|Amount to keep invested for retirement for the next 20 years||R1 900 000||R1 000 000|
|Preservation fund value at age 65 (in nominal terms)||R10 648 380||R5 604 411|
Making a withdrawal from your retirement fund can make a big dent in your provision for retirement. You’ll have to work longer, contribute more, or be content with much less income at retirement. The better alternative is to plan and save smartly.
How to avoid a reduced retirement income
Take the time to set out your financial goals and work out a plan to reach them. The earlier you start, the better, although it is never too late. Make sure you have short-, medium- and long-term savings that form part of different savings pools, and which allow different levels of access. Should you need to make use of your short-term, emergency savings funds along the way, remember to top up your savings pool again. A qualified financial adviser can help you work out which product is best, and which is right for you.
The current pandemic has proven how important it is to have savings to fund your short-term needs and to prevent the need to loot your retirement fund when a crisis looms. By structuring your savings and investments with care, and planning for short-term uncertainty, you can work to prevent one crisis creating another, bigger one when you need to retire one day.