This one mistake can cost you big at retirement

People are still cashing out their retirement savings, facing massive losses in the long term, says financial services firm 10X Investments.

The group has published the latest edition of its South African Retirement Reality Report 2022, showing that even when people have been exposed to the structured nature of retirement savings through a formal employment-based retirement scheme – 60% of people who have left a corporate scheme cashed out their savings.

“There is no doubt that in today’s economic climate, many of those who cash out their savings, especially those who have lost their job, have no other realistic choice,” said 10X.

“Even if they are aware of how much they’ll lose over the longer term, pressing concerns such as hungry children or being handed over to debt collectors will override worries about their long-term financial well-being,” added the group.

10X Investments said that based on the previous findings from earlier reports and broader industry insight, there is still a high level of people who cash out their savings despite not having an urgent need for the money.

A much better choice for those people 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, said 10X Investments. The loss of the growth of those savings, which compounds over time, is almost always significantly more than the loss of the amount saved.

For example, if two 25-year-olds were to start by contributing R1,000 every month to their retirement fund and then, 10 years later, one of them cashes out, not only would they suffer a tax penalty imposed by SARS but the long-term gains from compounding contributions.

The group provided the graphic below that shows the dramatic effect early withdrawal has on a person’s retirement savings:

The following graph, based on a 5% per annum net real growth rate (after fees and inflation), quantifies the actual cost of an early withdrawal in a 50-year investment life (40 years of work and half the retirement period).

To put it another way, R10,000 withdrawn at age 25 means R115,000 less money in retirement, said 10X Investments.

“Or, more practically, someone who withdraws R300,000 at age 35 will have R2,1 million less money in retirement (in today’s money terms) than they could have had.”

According to Nedbank, it is best not to mess with your retirement. Under South African law, you can not draw from retirement savings before the age of 55.

There may be a few exceptions, such as becoming disabled or if the fund value is less than R15,000, said the bank.

Under the newly upcoming two-pot retirement system, there is one pot that a person can access at retirement and a second one you can dip into earlier – two-thirds of your monthly contribution would go into the first pot and the remaining third into the second.

“Ringfencing the bulk of your savings means they continue growing up to and beyond your retirement. In theory, you’ll do less damage to your long-term savings if you dip only into this smaller pot,” said that bank.

The Treasury said that the implementation of the new system is postponed from 1 March 2023 to 1 March 2024.

Read: Reserve Bank says more interest rate hikes are coming.