Your savings pot can boost your financial position or cost you dearly

If you have taken a withdrawal from your retirement fund savings pot and put it to good use – for example, to pay off costly debt or to put a deposit on a home - you may have reduced your pension in retirement but still improved your financial position overall.

But equally using your savings pot to buy a car or gamble, for example, provides an opportunity to destroy your long-term financial position, Subedra Reddy, executive head of actuarial services at NBC told this week’s Institute or Retirement Funds conference.

As a retirement fund member you should get help from a retirement benefits counsellor or a financial adviser when making these complex decisions, Reddy said.

How to use your savings wisely

Reddy said if a member earning R20 000 a month at age 20 contributes 12 percent a year to a fund and saves for 40 years until age 60, they could retire on a pension of around R15 200 a month in today’s rands.

However, after 30 years of saving, the member could use R1 million in their savings pot as a deposit on an entry-level house, costing R800 000 today but R3 million in 30 years.

After taking their withdrawal, their pension at age 60 would reduce from R15 200 a month to R14 700 – about a 3.6 percent drop, but they would have the benefit of the house and enjoy the growth in the value of that asset.

The tax payable on the withdrawal – the R1 million would be R638 000 after tax - would be the main detractor from his financial position, Reddy said.

Saving interest on debt

USING THE SAVINGS POT WISELY
Assuming a member earning R20 000 a month, contributing 12% of their income for 40 years and retiring at age 60
Scenario	Savings pot at retirement	Difference	Pension (based on retirement and savings pot balances)	Difference
No savings pot withdrawals	10,5 million		R15 288 a month
Withdrawing R1m for a house in year 30	R9,3 million		R14 736 a month	-3,6%
Withdrawing R30 000 a year for 7 years from year 20 to repay debt	R10,1 million	-2,7%	R15 103 a month	-0,9%
Withdrawing R600 000 in year 20 for a car	R5,7 million	-45,7%	R12 961 a month	-15,2%
www.smartaboutmoney.co.za                                         Source: NBC

Similarly, if as a member of a retirement fund you use your savings pot to repay your debt earlier you can save large amounts of interest especially over long terms.

For example, if the same member took a R300 000 personal loan attracting interest of 18 percent a year over seven years, they could reduce the interest payable by withdrawing R30 000 a year from their savings pot – or R21 000 after tax - until the debt was repaid. This would reduce their pension by 1.2 percent from R15 200 to R15 100 a year, Reddy said.

Ideally, a member using savings to repay debt should avoid incurring further debt and consider contributing the interest saved on the debt to their retirement fund.

Beware of spending on a car

As a retirement fund member, you should be careful of spending your retirement pot savings on a depreciating asset like a car.

Reddy said if the same member after 20 years of saving withdrew money from their savings pot to buy a second hand car like a Toyota Yaris, it could end up costing them a lot of money.

In order to buy a car worth R125 000 now, the member would in 20 years time need to withdraw R600 000 which would be reduced to R400 000 after tax, Reddy said.

This withdrawal would reduce the member’s savings pot at retirement by 45 percent from R10.5 million to R5.7 million. And the member’s R15 200 a month pension would drop to under R13 000 a month - a 15 percent drop just because they decided to buy a car, Reddy said.

When the member retires at age 60, the car would be worth little, but the value in retirement savings lost to buy the car would be worth that of 12 cars, Reddy said.

This shows how the decisions you make, when you make them and what you spend the money on, makes a huge difference to your long-term financial situation, Reddy said.

Savings pot uses

Many members are using their retirement savings pot withdrawals to pay for their children’s education, Discovery Corporate’s membership data shows.

Guy Chennells, chief commercial officer for Corporate and Employee Benefits at Discovery told the IRFA conference that the company’s data shows that 25 percent of retirement fund members who made withdrawals used them for their children’s education costs, 20 percent for home and car expenses and 18 percent for short-term debt.

While parents may value their child’s education, it does not come with any guarantees of improving your own financial situation at retirement.

Chennells said only two percent of members who withdrew from funds administered by Discovery, used the money for emergencies – the reason for which the access to retirement savings through the two-pot system was introduced.

Serial withdrawers

Discovery’s data also shows that most people – six in every 10 eligible members - did not access their savings pots. Among those who did, many accessed their savings again when the new tax year began in March - albeit at lower amounts.

The retirement fund industry is expecting that these members will be “serial withdrawers”.

People who are in deep financial stress will access money from their funds whenever they can, Chennells said.

Their problem is not how they think about their retirement savings – but rather that they are under a snowball of debt and survive by paying most of what they earn to loan providers instead of building up retirement savings, he said. 

Better retirement outcomes

The two-pot system will not get everyone to an ideal income in retirement, but it will move all members forward, Chennells said. 

Retirement savings in the pre- and post two pots world
Behaviour	Pre-two pots	Post-two pots	Difference
Never withdraws, preserves after every resignation	80%	80%
100% cash withdrawal after every resignation	4%	41%	10 X
100% cash withdrawal after resignation and 100% preservation from age 45	21%	48%	2.3 X
Never withdraws, preserves after every resignation	50%	50%
100% cash withdrawal after every resignation	4%	19%	4.8 X
100% cash withdrawal after resignation and 100% preservation from age 45	21%	26%	1.24 X
Source: Discovery Corporate www.smartaboutmoney.co.za

Even the serial withdrawers will end up with more money as a result of being compelled to preserve two-thirds of their contributions from the implementation of the two-pot system in September last year, he said.

Retirement funds typically target an amount that will provide a pension equal to between 60 and 80 percent of members’ final salaries. This is known as their replacement ratio.

If a 25 year old saving enough to replace 80 percent of their income, was allowed to continue to withdraw all their savings on resignation from their job, they would reach retirement with a pension that replaces just four percent of their final salary.

Under the two-pot system the person withdrawing the full saving pot balance each year is likely to achieve a replacement ratio of 41 percent which is ten times more than the four percent ratio.

Before the two-pot system members who withdrew until age 45 and then preserved their savings would typically only achieve a replacement ratio of 21 percent, Chennells said.

Under the two-pot system, the member who withdraws their savings pot each year until age 45 is likely to achieve a replacement ratio of 48 percent - which is 2.3 times higher than before the two-pot system was introduced, he said.

Still not enough

Chennells said these replacement ratios are still low and not the pension you would want to live on in retirement, but they are significantly better that before the two-pot system.  

Members need to be aware how much they need to save for retirement but often do not understand replacement ratios or what they will mean many years in the future when they reach retirement, Danie van Zyl, head of Smoothed Bonus Centre for Excellence at Sanlam, told the conference.

Sanlam now shows members the age at which they will be able to retire with a pension that provides a suitable replacement ratio. And Sanlam’s latest Benchmark survey of retirement funds and members found most members will only reach this ideal pension when they are 80 years old.

Chennells said Discovery provides members whose retirement savings are not on track with the size of the gap in their savings (expressed as a percentage).

But this powerful “ah ha” moment isn’t enough – members also need a plan that shows how they can close the gap by, for example, increasing their retirement fund contributions at each salary increase. This plan can completely change your life, he said.