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Saving for retirement: popular misconceptions

March 6, 2017

As we head into another tax year, retirement fund members will feel the pressure of the rising cost of living and some will have to relinquish more of their earnings to the receiver.

Carol Kritzinger, a senior retirement fund consultant at Chartered, shares insights derived from her experiences with members regarding misconceptions about saving for retirement.

Having interacted with many members of retirement funds over the years, I often come across misunderstandings about saving towards retirement. In this article, I will detail and explain the ones I encounter most often.

Let’s consider an average South African employee.

Tracy has worked for several different employers over her forty years of employment. She plans to retire at 65. During her working years, she earns an income that increases annually at inflation rates. In retirement, Tracy will need an income that keeps pace with inflation and allows her to live in much the same comfort as she did while she was working.

These are her misconceptions:

Misconception #1:  Belonging to my employer’s retirement fund is all the security I need
Although Tracy belonged to many of her various employers’ retirement funds, the total net contribution was not always 15% of her gross income. One employer had no retirement fund for its employees and Tracy did not contribute towards her retirement savings during her years of employment there.

In fact:
Employers set up different contribution rates which could include or exclude the costs of administration, consulting and insured benefits. Contributions to a retirement fund are most often based on pensionable income and not gross income, which could include payments like commission. Owing to this disparity, there is a high probability that the desired income from her retirement investments will not be met. All people should consider their individual needs and supplement their retirement savings to meet their long-term goals.

Misconception #2:  When I leave my employer, it is best to use my withdrawal benefit to pay off my debts

When Tracy was retrenched from one of her employers, she cashed in her retirement savings to cover her daily expenses and debt repayments while she was unemployed. She also accepted a pay-out from a company pension fund when she moved to a new employer. In both cases, she believed that paying off her debts was the wisest course of action at the time.

In fact:

Using your retirement savings to pay off debt may provide a short-term solution, but is not necessarily the wisest choice for the longer term.  Consider the amount of tax that you will pay on your retirement savings and the strain that will be placed on your current finances to once again meet that same desired level of retirement savings. Generally, people tend to utilise the disposable income available to increase their standard of living rather than to allocate this to retirement savings, regaining the lost capital is extremely difficult.

Living only for the present and fulfilling immediate desires often comes at the cost of future security and peace of mind. Rather than resenting a sense of deprivation, aim to create a balance – enjoy the life you are living, but not at the cost of your retirement.

Misconception #3:  Retirement is years away … I have plenty of time to save for it

When Tracy was starting out in her career, retirement was a distant reality that was hardly worth worrying about. As she became older and wiser, more pressing expenses seemed to demand her attention – bond repayments, school fees, new cars… Tracey became one of the many people I meet who revealed, with a look of horror on their faces, that they have insufficient savings for retirement.

In fact:

Time is fleeting and can either be an enemy or, when harnessed for advantage, be an ally. Starting early with retirement savings doesn’t just give you a head start, it gives you a massive boost in the form of compound growth. It’s almost impossible to make up for lost time later because life only gets more and more expensive. The earlier you start saving for your retirement, the more comfortable your retirement will be.

Some points to consider about retirement

How will Tracy accumulate an income that will enable her live comfortably at retirement?
Tracy will derive this income from her retirement savings. These savings will be the accumulation of all contributions made to the retirement funds and investment growth during her working career spanning forty years.

Tracy’s retirement funding should be substantial enough to provide an income for the rest of her life.

So, how much income does she need at retirement?  It is generally accepted that in order to maintain a similar standard of living after retirement, Tracy will need an income of at least 70% of her last income earned before she retires. In Tracy’s case, she earns a gross monthly income of R10,000 just before retirement so to live comfortably after retirement, she would need an income of R7,000 per month.

To ensure retirement savings substantial enough to meet her needs, Tracy will need to have contributed at least a net of 15% of gross monthly income to a retirement fund for 40 years with a nett growth rate of inflation plus 6% per annum.

Retirement funds are tax efficient
There is no capital gains tax on growth in a retirement fund and there are generous tax deductions available on contributions to retirement funds. To reach your desired level of savings, it therefore makes sense to make additional voluntary contributions to your employer’s retirement fund or set up a separate retirement annuity.

When you retire from your retirement fund, the first R500,000 that you may take in cash, is tax free, making your retirement funds tax efficient at retirement as well. However, should you take your retirement savings before retirement (if you change employers) you will use up the tax-free portion of your lump sum. On retirement, the amounts that you have withdrawn over the years will be subtracted from the R500,000 you could have enjoyed, tax free.

Cashing in before your retirement deviates you from your desired retirement income
The current law still allows an employee to take their full retirement benefit when leaving an employer. If you do this, you will need to save all over again towards your desired goal, and with less time to do so, you will place strain on your finances and your ability to retire comfortably.

As Carol has pointed out, these misconceptions can shipwreck a successful retirement if not addressed in time.  The onus remains on the member to ensure you understand the implications of your decisions regarding retirement savings.

Remember, saving towards your retirement is your responsibility.

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