We get it: you struggle to save. And it may not be your fault. According to a scientific study on 15,000 Swedish twins (1) , some people have a lower propensity to save than others due to the genetic component underlying their time preferences and self-control. Apparently, this determines between a third and half of our savings behaviour.
In layman’s terms: your improvidence could be down to your grasshopper (2) DNA. You know you have it if you save only under duress, and then as little as possible. And if your pension fund appears as a ‘current asset’ on your mental balance sheet.
If that’s you, we probably can’t help you, or change your world view. To quote the study authors: “It would be counterintuitive to try to change a spending or saving behaviour since it’s determined to such a great extent by genetics.”
But your struggles may not stem from your genes. Perhaps you suffer from ‘Protea-sitis’. It may be that, like the South African cricket team, you have the means and the desire to succeed but collapse under the slightest pressure. Or you are the impulsive sort, with the marshmallow in your mouth before the rules of the game are even explained.
Much more likely, though, you simply cannot resist the temptations afforded by our permissive tax laws, which give you easy access to your retirement money before time. In that case, good news: there’s a product for that!
Soft on preservation
Strangely enough, it’s not compulsory to save for retirement in South Africa, and your employer is not obliged to offer a pension scheme. Should they start one, you can opt out. Even if you are forced to join an existing workplace fund you don’t have to preserve those savings on leaving, which is why 70-80% of us don’t. Instead, we cash out, usually to reduce our debt or fund a capital purchase.
If you do preserve on leaving your employer you get another chance to claim before retirement. And if you’ve used up your one claim you can access any remaining balance by transferring it to your new employer’s fund. This effectively restores the original “factory settings” on those savings.
Don’t worry if you are forced to hold on until retirement because that can’t come soon enough as far as our law is concerned. The earliest you can retire from your preservation fund is at 55. In the context of our ever-growing life expectancies, that’s barely out of high school.
Soft on annuitisation
Age 55 is also the minimum you can retire from your workplace retirement fund, once you resign. And while you may be around for another 40 years you are not compelled to make your savings last.
Provident fund members are not obliged to buy a monthly pension at retirement. They can take their savings as cash, net of tax, and spend away. Pension fund members do have to buy an annuity with at least two-thirds of their balance, but only if they choose to “retire” (rather than “withdraw”) from the fund. This becomes compulsory only once they reach the fund’s set retirement age. Few people stay in the job that long.
The incentive to get you to “retire” rather than “withdraw” is woefully weak: you pay a lower tax rate on the lump sum portion of your pay-out. But that benefit is reduced by prior withdrawals, which we know are the rule not the exception. Those who do preserve throughout will accumulate such a large balance as to render the tax benefit immaterial in their decision. In short, pension fund members who don’t want to annuitise avoid it easily.
With such “suggestive” legislation who can blame you for yielding to temptation at some point? But there is a product to deliver you from this evil: the humble retirement annuity or RA.
Saving through an RA is more effective
The RA is sometimes maligned for the restrictions it imposes. But that ‘flaw’ is also its strength, because it stops you getting at your savings before time, no matter how much you plead and beg (subject to two important exceptions).
Unlike a pension or provident fund, you cannot “withdraw” from your RA, you can only “retire”, from age 55 onward. That applies even if you lose your job and even if the RA was facilitated by your employer. It is also true if you can no longer afford the contributions. In that case your RA will simply be made ‘paid-up’, but your money stays invested until you do get to claim.
(Just be sure to avoid the policy-based life insurance RA or you may end up with an early-surrender charge. These RAs also have a reputation for being expensive and inflexible on contributions so rather go for a low-cost unit trust-based RA, as offered by 10X, for example.)
Your RA affords you the exact same tax advantages as your employer’s pension or provident fund: tax-free contributions up to 27,5% of your income, tax-free investment returns and a tax-free lump sum at retirement.
Because you can’t access your RA early, there’s no danger you will lose your R500,000 tax-free portion (unless you withdraw early from an employer fund). Your money is also protected from creditor claims and does not attract estate duty if you die before claiming.
You can delay claiming your RA for as long as you like. Once you do, you are required to annuitise at least two-thirds of your balance (if above R247,500). That’s a further incentive to leave this money alone until you really need it, which is when you stop working.
You may not like the idea of compulsory annuitisation. We agree, for small balances it is a nuisance but otherwise it really is the most sensible way to deal with your retirement fund proceeds, both from a tax and a preservation perspective.
For example, you can take your tax-free portion as cash and transfer the balance tax-free to a living annuity. There your savings will be professionally managed (at low cost, if you choose right) without attracting tax while you retain some control over your investments and income level. Adopting a prudent draw-down rate you are unlikely to outlive your savings. You do pay tax on the income you receive, but at a lower rate than if you had taken a lump sum and invested the net proceeds yourself.
As mentioned, there are two important exceptions that allow you to access your RA before age 55: if you are forced to retire early due to ill-health or if you are emigrating. So you are not kept from your money when the circumstances dictate that you shouldn’t be.
Bottom line
As counterintuitive as it may seem, putting a time lock on your savings is the most empowering thing you can do with your money because it opens the door to your future financial independence. The RA is the only retirement fund that fully lives up to its promise to secure you a retirement income. It does so by eliminating the weakest link in the process, most often members’ (lack of) self-discipline. This ensures you don’t just save in the most tax-efficient manner, you also preserve your asset to retirement and beyond.
(1) http://www.jstor.org/stable/10.1086/679284?seq=1#page_scan_tab_contents
(2) https://en.wikipedia.org/wiki/The_Ant_and_the_Grasshopper
