Retirement cash – what not to do
Only R25 ooo of retirement funds can be taken tax-free when changing employment.
The decision to cash out retirement benefits when changing jobs is arguably the biggest contributor to pensioners’ dire financial position.
International research suggests that millennials are most at risk as they change jobs more often than previous generations and will need to overcome the urge to cash out retirement benefits more frequently.
While there may be instances where it could make sense to cash out retirement benefits, it should be the last resort and it should only be done after carefully considering the long-term implications. Here are things to ponder: Although one may argue that at age 30 or 40 there is still a long way to go to retirement, and that you will catch up along the way, it becomes increasingly difficult to do so, due to the impact of compound interest.
PSG’s head of public policy and regulatory affairs, Ronald King, says if someone starts saving for retirement at age 20, they would need to save 12.5% of their salary. If they only starts at age 30 (because they cashed out), they would need to save 22.5%.
If the same person decides to cash out his benefits at age 40, he would need to save 42% of his salary to be in the same position at retirement, he adds. Most people would be unable to afford such a high contribution rate.
If someone takes his retirement benefits at age 50, and starts saving anew, he would need almost his whole salary to maintain his living standard in retirement.
Significant tax breaks are allowed for contributions to retirement vehicles. Not only can individuals claim a tax deduction of up to 27.5% of their total taxable income each year, all retirement assets are allowed to grow taxfree while inside this vehicle.
But if you cash out prior to retirement when changing jobs, the taxes are punitive.
Only R25 000 of retirement funds can be taken tax-free when changing jobs. Yet, the most significant tax impact will only become visible at retirement.
Retirement annuity and pension fund investors can take up to a third of their benefits as a cash lump sum at retirement. Provident fund members can take all their funds in cash at retirement. The first R500 000 will be tax-free.
King says the biggest problem is that those pension benefits taken as a cash-lump sum when resigning will be deducted from the amount that can be taken tax-free at retirement. “If you take R500 000 during your lifetime when resigning, you won’t be entitled to the tax-free amount of R500 000 at retirement.”
This means a person would pay roughly R85 000 more in tax when they retire, because they cashed out when changing jobs.
Millennials are most at risk as they change jobs often.