Debt is temporary, a low pension is for life

South Africans across all income groups are fighting a losing battle to maintain their standard of living. The country has stagnated in terms of economic growth, the job market and the stock market, and real income growth has slowed.

According to Steven Nathan, CEO of 10X Investments, an annual salary growth of 6.7% is not nearly enough to offset the impact of rising interest rates and income tax drag. “In addition, many households are experiencing above-average inflation increases in education and healthcare-related costs, two major expense items. This squeeze is forcing many people to dip into their long-term savings policies.” 

Reports by the Association for Savings and Investment South Africa (ASISA) show that R74.6bn of savings policies were cashed in during the year to June 2016. 

Nathan says that it is perfectly reasonable for people to tap into their discretionary savings when they come under financial pressure. “That is, after all, the point of saving for a rainy day. The bigger issue is that people will also look to access their retirement savings at such times.” 

It is well-established that the great majority of employees don’t preserve their retirement savings when they change jobs. Even worse, some resign simply to access their pension benefit. “They run the risk of a double whammy: being without retirement savings, and being without a job,” Nathan points out. 

But, the reality is that many people are over-burdened by debt and cashing in their retirement savings is the easiest way to solve this problem. 

Nathan says that, unfortunately, this is no more than a patch-up job that kicks the proverbial can down the road. “It may ease the immediate pressure from creditors, but it does not improve that person’s overall financial position.” 

He explains that consumers have two types of debt. “One is ‘on-balance’ sheet, which is money they owe to lenders such as banks and credit card companies. But, they also have ‘off- balance sheet’ debt, which represents future obligations, such as their children’s education, or their living expenses in retirement. Many people do not acknowledge this debt until it knocks on the door.” 

In a prudently-managed household, on-balance sheet debt is serviced out of current income only, which implies that the debt is affordable. The off-balance sheet retirement liability must be met by retirement savings, which should make it a compulsory “expense” in any household budget. Not using these savings for other purposes is made easier by the fact that they can only be accessed at certain times. 

One of those times is when employees change jobs, explains Nathan. “The money then becomes available to pay down on-balance sheet debt. But, this does not improve the employee’s overall financial position; the savings are merely offset against a different debt. The overall net debt is unchanged.” 

He says that rarely is the money freed from paying down debt used to increase retirement fund savings. “Invariably, the lifestyle adjusts to the available cash flow and the pension gap. The savings required to fund retirement is thus never filled.” 

Younger employees are especially at risk, because they believe they have time on their side to make up this shortfall. “In this context, however, time really is money and it is practically impossible to make up the lost time,” stresses Nathan. 

Younger employees don’t appreciate that when they cash in their retirement fund, they don’t just lose that money, but also the investment return they would have earned on this money for the remainder of their savings life. Nathan says that over thirty years, this is by far the bigger loss. 

Many people change jobs in their mid-Thirties, for a more senior position elsewhere. Their retirement savings may not seem impressive at that point, perhaps only two times their annual salary. But, left alone, this money will probably fund half their pension one day. The converse of that is that by cashing out, they will have 50% less money in retirement. 

“That is the power of long-term compounding,” points out Nathan. “It is practically impossible to match that with a higher savings rate. For example: someone who had saved 15% of their income for ten years, cashed out and restarted would now have to save at least 25% for the next thirty years to make up for lost time. The total lifetime savings required, to fund a retirement over thirty rather than forty working years, will be 30% higher.”

In other words, cashing in after 10 years disproportionally erodes either their subsequent lifestyle, or their post-retirement income. Either way, it is a terrible trade-off. 

“The bottom line is that people will only be able to secure their lifestyle in retirement if they let their savings do most of the work. If they don’t preserve their retirement funds, that work will simply not get done. They run the real risk of experiencing a different level of financial hardship altogether, once they retire. Except it will then be too late to do anything about it,” concludes Nathan.