The rational, logical, mature choice is to preserve. You know that you – or your family – will need this money one day, when you no longer earn a salary, so we have no doubt you will make this choice.
But we are not sure about your colleagues. Why? Because according to various industry surveys, between 70% and 80% of employees don’t preserve their retirement savings when they change jobs. In fact, some of are so desperate for cash, they resign just to get their hands on this money. They end up with no job and no savings. Way to go…
Younger employees are especially at risk, because they believe they have time to make up this dip into their pension.
But they don’t. The following three charts bring home this reality far better than any lecture on preservation will do. Please note that these charts are not suitable for sensitive readers, who may have cashed in their retirement savings in the past.
The optimal scenario: you invest 15% of your income for 40 years in a low cost, high equity retirement fund, earning a net real return (after fees and inflation) of 5% pa. This will give a very high chance of securing your accustomed lifestyle in retirement. We assume your annual income grows at 1% above inflation over 40 years.
After ten years of saving, you’re almost half way there!
Consider this: in a diligent forty-year savings plan, the first two years’ contributions already pay for 10% of your retirement. By the time you hit 36 (after 13 years of working), you have already funded half your pension – provided you leave this money alone. By contrast, the last ten years’ contributions make up only 13% of your pension.
Based on investing 15% of income (growing at 1% pa) for 40 years, earning a net real (after inflation and 1% pa investment fee) return of 5% pa.
Bottom line: Save like crazy in your twenties, if you can. Then keep your hands off this money. And if you want to skip ten years of saving, skip the last ten years, not the first. If you cash out in your mid Thirties, it will cost you half your pension. Do you really want to blow that on a new car?
You can’t save enough to make up the shortfall
You may believe that you can make up the shortfall by saving more in future. Only in your dreams.
Most employees already struggle to save at the recommended rate of 15% per annum. But if you cash in your retirement savings after ten years, you would have to save 25% of your income for the subsequent 30 years to make up the shortfall. Not only is that a big bite out of your lifestyle, but only just below the 27,5% new tax-deduction limit. Delay for another two years, and you won’t even be able to claim all your required contributions for tax.
And if you delay until our Forties, you will have to save half your income, to make up the shortfall. Possible, but not likely.
The later you start, the more you have to save in total (much more)
Your retirement income is funded by both your contributions and the return you earn on those contributions. The shorter your savings period, the less you earn by way of investment returns, and the more of your pension must be funded by your own contributions.
Let’s reduce the total amount you have to save over your working life (40 years) to a base number of R100. If you cash out after ten years (age 32), you have to save 33% more in total (R133 v 100); after 20 years, 70% more in total (blue columns in Figure 3). Expressed as a percentage of your life time income, that means instead of saving 15% of your total (lifetime) income, after 20 years you have to save 25% of your total (lifetime) income (line graph in Figure 3).
Bottom line: don’t waste your precious savings time
Why do your youthful saving follies have such a big impact on the savings outcome? It’s due to the phenomenon of compounding. When you cash in your pension after ten years, you don’t just lose what you have saved, but also the return you would have earned on those savings, compounding for thirty years (or even fifty years, if you buy a living annuity at retirement). That is a lot of money coming your way that you don’t have to work for.
If you save over your entire working life, then compounding returns make up the greater portion of your retirement nest egg. But not if you cash in your retirement fund at age 35. If you do, you will one day appreciate that the term “preservation” did not just refer to your savings, but also to your post-retirement life style.
