At risk in a debt-ridden environment

FATAL MISTAKE: MOST PEOPLE DRAW THEIR RETIREMENT SAVINGS WHEN CHANGING JOBS

When you cash in, you lose that money and also the investment return you would have earned.

South Africans are fighting a losing battle to maintain their standard of living. Real income growth has slowed in the face of a variety of strong economic headwinds and continued political uncertainty.

The Association for Savings and Investment South Africa statistics show a 16% increase between 2015 and 2016 in the value of individual savings policies surrendered.

The bigger issue, however, is that people also look to access retirement savings at such times.

The majority of employees don’t preserve their retirement savings when they change jobs. Worse, accessing pension savings can be a contributory factor in the decision to leave a job. Many people are over-burdened with debt, and cashing in their retirement savings is the easiest way to solve the immediate problem.

Consumers have two types of debt. One is on-balance sheet – money owed to lenders such as banks and credit card companies. The other is off-balance sheet debt: future obligations, like their children’s education or their retirement living expenses.

In a prudently-managed household, on-balance sheet debt is serviced out of current income only, which implies that the debt is affordable. The off-balance sheet retirement liability must be met by retirement savings, which should make it a compulsory “expense” in any household budget. Not dipping into these savings is made easier as they can only be accessed at certain times.

One of those times is when employees change jobs. The money then becomes available to pay down on-balance sheet debt, but this doesn’t improve the employee’s overall financial position. The savings are merely offset against a different debt. The overall net debt is unchanged.

Younger people tend to believe they have time to make up this shortfall. They don’t appreciate that when they cash in, they don’t just lose that money, but also the investment return they’d have earned on it for the remainder of their savings life.

Many people change jobs in their mid-30s and most cash out their policies at this time. Had they left this money in their policies to grow it would probably fund half their pension one day. By cashing out these savings early, many end up with around 50% less money in retirement.

That’s the power of long-term compounding. It’s practically impossible to match that with a higher savings rate. For example, someone who’d saved 15% of their income for 10 years, then cashed out and started again would have to save at least 25% for the next 30 years to make up for lost time.

Most people will be able to secure their lifestyle in retirement only if they let their savings do most of the work. If they don’t preserve their retirement funds, that work won’t get done and they run the real risk of experiencing a different level of financial hardship once they retire.

Steven Nathan is CEO of 10X Investments