Cashing out savings early denies investors the benefit of compound interest, the magnifying force that increases the value of an investment significantly in later years, as the graph below illustrates.
10X Investments’ third annual South African Retirement Reality Report (RRR20), which was released in late October, describes the premature cashing out of retirement savings as a major contributing factor in South Africa’s retirement savings crisis.
RRR20 – which is based on findings of the 2020 Brand Atlas Survey, which tracks and measures the lifestyles of the universe of 15.1 million economically active South Africans – acknowledges that cashing out savings is often the result of economic hardship. More than half of the survey’s respondents indicated severe financial stress.
While pointing out that cashing out savings is not always a choice, “when jobs are lost pension savings can be the only source of cash for many”, the report notes that the lack of understanding about the effects of cashing out pension savings is a contributing factor for many.
“When you leave a job and cash in your pension you don’t only lose your accumulated savings, but also the return you would have earned on those savings for the rest of your working life,” says Asavela Gwele, Client Relationship Associate at 10X Investments. “Over 20 or 30 years that amounts to a significant loss.”
She adds that it is very difficult to make up this shortfall in later life. “Those years’ worth of saving are essentially gone forever.”
Your pension savings pot might seem like an obvious emergency cash fund, but it is not, adds Gwele. “Cashing out your savings is tantamount to borrowing from your older self, who will quite probably be less able than you are to weather the storm of not being able to pay the bills.”
There is no doubt that these are difficult times for many people, but if people knew what they stood to lose by cashing out early it seems that many would fight to preserve at least some of their savings.
The RRR20, 10X Investments’ third annual report on the state of retirement saving in South Africa, notes that while Covid-19 and the lockdown have magnified South Africa’s retirement saving crisis by pushing people “who were teetering on the brink of disaster over that edge”, it has also been a wake-up call to many about how unprepared they are for a crisis.
The RRR20 found that more than half of those respondents who had a retirement savings plan had at some time belonged to a corporate retirement savings fund. The report also makes it clear that corporate membership should be an opportunity for education.
“Being part of the formal retirement saving ‘system’ should mean that these respondents had been exposed to some structured information and training about their fund, retirement saving in general, and options available when leaving employment,” according to the RRR20. “Yet, the proportion of people who said they had cashed out their savings when they had a chance to suggests otherwise.”
The report said 62% of those survey respondents who had left their corporate fund had cashed out their savings, rather than preserving some or all of it. The RRR20 makes it clear that a much better choice would have been to take their savings to their new employer’s fund or ringfenced them (and the associated tax benefits) in a preservation fund.
While highlighting how the global pandemic has magnified an already difficult situation in South Africa, RRR20 also makes it clear that various game-changing factors remain within the control of individual savers. Not cashing out savings when changing jobs is one of the key factors.
This is not just a South African issue. In a note released in August, the World Economic Forum said: “Extra freedoms have been allowed in some countries to draw from pension pots early, but this is like robbing Peter to pay Paul.”
10X’s Gwele said that even if you find yourself in financial difficulty and feel you have no choice but to dip into your retirement savings, “it’s better to cash out only a small portion and save the rest for the long-term”.
Cashing out will also expose you to tax. Only R25,000 withdrawn before your retirement date is tax-free; anything more is taxed at 18% or more.
For more information about what you could save by preserving run your numbers through 10X’s online preservation fund calculator.
More information and the full Retirement Reality Report https://resources.10x.co.za/en/retirement-reality-report-2020
