Retirement investors need compound returns on early savings

As too many retirement investors in SA cash out their pension funds when changing or leaving jobs, industry experts caution against this tempting – but short-sighted – decision.

Recent industry research shows that as many as 70 percent of pension fund members cash in their retirement savings when they change jobs, something that Steven Nathan, CEO of 10X Investments, calls a very short-sighted decision.

“It’s always tempting to cash out pension savings with a job change, retrenchment or even dismissal,” he explains.

“But a far better option is to transfer retirement savings into a preservation fund.”

That way, he elaborates, investors protect not only their accumulated savings but also the compound return on those savings over time.

Take the example of a 35 year old employee who decides to cash out his R540,000 pension savings when he moves to a different employer, and to start saving afresh at the same 15% contribution rate.

What difference would that really make?

Assuming his real (after inflation) salary stays constant at R300,000 throughout, and his investments earned a 4% net real return per annum, had he re-invested the original savings in a preservation fund, calculates Nathan, he would have accumulated R4.3 million at retirement 30 years later, compared to just R2.5 million.

“So that decision cost him R1.8 million,” says Nathan.

In context, his monthly pension in retirement would be 70 percent higher had he not cashed in his original savings.

To make up the shortfall, he would have to save an extra R30,000 a year from age 35 onwards (equivalent to a 25% contribution rate). His total additional contributions (R900,000) would be double his entire contributions over the first ten years.

The purpose of retirement savings is, after all, to build an asset that will generate regular - and sufficient - income after retirement. But to do that, investors need to contribute consistently and diligently over their entire working life.

“The goal is to invest throughout your earning years, because your pension relies heavily on the long-term compound returns earned on those early savings,” says Nathan.

An added incentive is that preservation funds offer several tax advantages.

For one thing, the transfer of retirement savings from a pension or provident fund into a preservation fund is tax exempt.

Plus, any returns earned by a preservation fund are not taxed, while funds withdrawn on retirement are taxed at favourable rates.

“Proposed new regulations are likely to make pension preservation obligatory, and to restrict early access to retirement savings,” adds Nathan.

“And that’s a good thing.”

10X provides corporate retirement investment services to leading blue-chip companies including Deutsche Bank, African Bank, EOH and Macquarie. In 2011 it added retirement services for individual investors.

The 10X Preservation Funds are an innovative and direct alternative, allowing investors to extract the most out of their retirement savings through low fees, indexing, and excellent service. The Funds’ automatic life-stage portfolios ensure investors are always risk-appropriately invested and obviate the need for brokers and broker commissions. The 10X Preservation Funds are independently controlled and thus have a strong focus on the investors’ interest and hence low fees.