Don’t take the money and run!

Taking a cash payout from your retirement fund is the worst course of action when you leave your job, whether you’re going to another job or you’ve been retrenched. Yet research* shows that is exactly what 74% of job leavers do.

Given this figure, it’s no wonder that Treasury is considering introducing the mandatory preservation of pension funds.

“Unless you need your retirement savings for survival, think very carefully before cashing in,” says Jeanette Marais, director of distribution and client services at Allan Gray.

One of the drivers of this behaviour is the mistaken belief that you’ll have time to make up for the years of saving you lose when you take a cash payout. In fact, you’ll severely hamper your ability to accumulate enough savings to retire with a degree of financial security because you miss out on the power of compound returns.

In addition, the cash option attracts the most tax, reduces the tax-free amount available to you when you retire and causes the benefit that you take at retirement to be taxed at a higher rate. You also lose the benefit of investing the money you pay as tax and earning a return on it.

“Not preserving your retirement savings can cost you more years than you may realise,” says Marais. If, for example, you decide to take a 100% payout from your retirement savings at age 35 – perhaps to put down a deposit on a house – you’ll end up with 40% less to live on when you retire. Put differently, if you need a monthly pension when you retire of 70% of your final salary (increasing with inflation) your savings will run out 12 years earlier than they would had you not taken the payout.

“This is quite scary when you consider that people are living longer,” says Marais.

So what are your other options when leaving your job?

You can transfer your retirement benefit to a fund at your new employer, or defer your pension, which means staying a member of your current fund until you retire (if the fund rules allow). Another option is to transfer your benefits to a preservation fund – this is a useful if you want to make a single withdrawal sometime before you retire.

Alternatively, you could consider transferring to a retirement annuity. RAs don’t allow for pre-retirement withdrawals but, unlike preservation funds, they do allow you to make further contributions if you want to. You can contribute on a regular basis, interrupt your contributions for a period, and stop contributions at any stage, though there may be cost implications depending on your product provider.

*2009 Benchmark Survey by Sanlam Employee Benefits