We answer readers’ questions about pensions.
1. Should I use my pension to pay my bond?
Q: I am changing jobs and my retirement fund is worth R1.2 million. I have a bond with a balance of R360 000 and I want to use my pension fund to settle my bond. Is this a wise move? I am currently paying extra into my mortgage each month, bringing my total repayment to R7 000.
A: We would all love to wake up one morning and not have a mortgage to pay, but you need to find a balance between saving for your retirement and paying off your home. Although, in theory, the interest on your home loan may be higher in some years than the return on the pension investment, if you cash in your retirement fund, you lose out on the power of compounding over time. The rule of thumb is that if your pension fund has a 10% return each year, it doubles in value every seven years. In your case, if you cash in R360 000, that will reduce your final pension at age 65 by around R2.8 million. (Age 43: V R360 000; Age 50: V R720 000; Age 57: V R1 440 000; Age 64: V R2.8 million.) Rather use additional cash, future salary increases or bonuses to increase the amount you pay on your mortgage so that you settle it ahead of time. For example, if you increased your mortgage repayment to R7 700 per month, you would have paid it off within five years. That is just an extra R700 per month.
2. Should I cash in my pension and buy a business?
Q: I am 56 years old and a member of the Government Employees’ Pension Fund. I am due to retire at the age of 60, but I am tired and thinking of taking my R3.7 million pension and buying a franchise business. Is this a good idea?
A: This is not something to rush into. You will lose a significant amount of your pension to tax if you resign – based on your current pension value, you will most likely pay more than R1 million in tax, which is a waste of money and equivalent to an income of about R5 500 a month in retirement. The other concern is that, if you invest all the money in a business and the business fails, you could lose your entire pension. A better strategy would be to wait until retirement, take the one-third lump sum you are entitled to and invest in a business. You will still have the remaining two-thirds of your pension invested for a regular income. On retirement, the tax tables are more favourable and you should not pay tax on the first R500 000 of your lump sum. If you really feel you cannot wait until the age of 60, speak to your employer about the possibility of retiring early.
3. How can I protect my pension payout?
Q: I am changing jobs and I want to save my pension payout to earn a good return. What are my options?
A: There are a few options to consider:
- Your company pension fund will have a default preservation fund. This means you can leave your pension fund with your existing employer’s fund to grow. This is the least hassle and it can be cost effective;
- You can transfer the pension to your new employer’s pension fund. This is a good option, as it keeps all your pension money in one place.
- Take out your own preservation fund. You can do this directly with an investment house, or through an adviser. Here the money is kept until retirement. Depending on the rules of the fund, you could make one withdrawal before retirement; and
- You can invest in a retirement annuity. This is a good option if your new employer does not have a retirement fund. You can add money to a retirement annuity and build up your retirement funds. However, on retirement, two-thirds of the total must be used to buy a pension income.
4. How can I preserve my pension benefits?
Q: I’m working in the mining industry and we will be retrenched in two months’ time. Fortunately, there is a contractor who will take over and we will be paid severance packages. I am 48 years old and I would like to move my pension fund to a product where it will be safe, and where it will grow.
A: It is great that you are focused on preserving your pension. Not only are you taking care of your future, but you are also avoiding paying tax on your pension withdrawal. There is new legislation which requires employer retirement funds to offer the preservation of an employee’s retirement funds should they resign or be retrenched. Most employer funds already comply. Speak to your current employer to determine whether you can leave the funds with them. This would be invested in line with your current pension and would be the easiest route to preserve the funds. As a rule, the costs of an employer fund tend to be less expensive than taking out a preservation fund yourself.