Retirement planning and the consequences of early withdrawals


Braam Bredenkamp | Financial Advisor | GraySwan | mail me |

Finding the right balance between short-term financial needs and your retirement prospects is possible with careful consideration of the various implications and good planning.

Some people don’t want to stop working, while others can hardly wait to switch to a lower gear. Either way, there’s no escaping the necessity of planning for retirement. Retirement planning is the process of financially preparing for life after employment. It comprises saving money and making strategic investment decisions to ensure that your lifestyle during your golden years is both comfortable and financially secure.

Life is unpredictable

Growing a hearty retirement nest egg is essential to achieving financial independence and peace of mind later in life.

While it’s never too late to start, it’s definitely a case of the sooner the better, as a longer savings period enables you to leverage the power of compound interest. However, life is unpredictable – especially in today’s increasingly volatile world – and circumstances may arise where you feel compelled to dip into your retirement savings. These might include job loss, medical emergencies, a family crisis or unexpected home repairs.

While retirement savings may offer a financial lifeline in such dire situations, using them without careful consideration can lead to a number of undesirable long-term consequences, including reduced compound growth, and fees and penalties being levied.

Understanding compound growth

Retirement accounts are designed to enable their holders to benefit from the magic of compound interest.

The compounding effect snowballs over time, meaning that the longer you leave your investment untouched, the more substantial the growth. This creates a cycle of growth, where each year’s gains contribute to the following year’s returns, resulting in an exponential accumulation of wealth.

For example, let’s say you put R10,000 into an investment product with an annual return rate of 8%. After one year, your original R10,000 + R800 interest = R10,800. If you leave that R10,800 invested and continue to earn 8% annual return, at the end of the second year your investment will be R11,664. After five years, your investment will be R14,693, and after 10 years it will have more than doubled to R21,589. This clearly demonstrates how as time goes on, the growth becomes more significant and the investment’s value continues to compound.

Withdrawing money from your retirement fund disrupts this cycle, reducing the pool of money from which interest can grow your returns, with the potential to significantly impact your retirement prospects.

Penalties and fees

Dipping into your retirement savings doesn’t just cost you compound growth; you can also get hit with penalties.

Current legislation allows for a retirement fund member to withdraw all or some of their accumulated benefits before retirement, under very specific circumstances, for example when you change jobs, become disabled or the fact that you may withdraw from your preservation fund, only once, before the age of 55. However, if you do so you will be heavily taxed, according to the lump sum withdrawal tax tables.

From March 2024, a new two-pot system will come into effect in our local retirement landscape.

Under this new set of rules, the following will apply:

  • On 1 March 2024 all retirement fund members will have two pots within their retirement benefits: a savings pot (from which they will be able to withdraw funds once a year), and a retirement pot (which they will not be able to access until they turn 55), thus compelling members to preserve the bulk of their pension benefit.
  • Once this new legislation takes effect, every member will immediately have 10% of their pension benefit, capped at R25,000, moved to their savings pot from which they will be able to request a withdrawal should they wish to.
  • Any new contributions towards their retirement fund from 1 March 2024, will be automatically split between these two pots: 1/3 to the savings pot and 2/3’s to the retirement pot.
  • Any withdrawal made from the savings pot will not be taxed according to the lump sum withdrawal tables as is currently the case, but at the member’s marginal income tax rate. Put simply, the amount you withdraw will be added to your gross income for that applicable tax year, thus increasing your tax liability.

The reform aims to discourage people from cashing out their retirement savings when they resign and prevent workers from resigning solely to access their retirement funds.

Getting the balance right

Balancing your short- and long-term needs involves walking a tightrope of financial decision making. You always have to maintain a balance between your retirement savings and your discretionary savings.

A few points to keep in mind are:

  • Consider putting money away into an emergency fund separate from your retirement savings, with three to six months’ worth of living expenses to cover any unforeseen eventualities. Over and above an emergency fund, further discretionary savings may also be advisable, keeping the inverse relationship between tax benefits and flexibility in mind. Retirement savings must be invested according to Regulation 28 of the Pension Funds Act (which puts certain constraints on the allocation to growth assets and offshore exposure). Discretionary capital may be invested without these constraints, via numerous investment vehicles, locally or directly offshore.
  • Developing a comprehensive budget and financial plan that takes into account both short-term goals and long-term objectives can help you allocate your resources efficiently to meet immediate needs while also contributing to retirement savings.

A qualified financial advisor, can prove invaluable in navigating these complexities, providing advice and guidance on how to strike the correct balance while granting peace of mind and the freedom of choice. They can recommend and help craft personalised retirement plans that consider your individual circumstances and goals.



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