Retirement planning

The other day someone expressed concern about how many people, when leaving their employer, “cash in” their provident funds and how unwise this was.

There is much that can be said and everyone’s situation is different and often I am sure there are compelling reasons to take a “short term view” and “cash in’ the provident fund upon resignation. Having said that one should be very careful before making such a decision and if the person has no choice they should try and make a commitment to themselves that should move or  find new employment to start contributions again.

We live in a changing world as we all know and predicting the future is not available to us. There are however some realities that point to the wisdom of making provision for your retirement:

• We live in a world where increasingly there is “less to go around”. State support for those who can’t work or who are retired is reducing each year as both a South African and global trend
• Increasingly we see that young people are not able to find work even in the developed countries of Europe and instead of “being there for their parents” are having to move back in with them after university or when they get retrenched
• The world has seen “old folks” as unemployable for many years. It seems that the value placed on experience and wisdom is not as high as the value placed on energy, less caution towards change and of course familiarity with technology as the world changes at a faster pace.

I raise these points not to depress anyone but there is little doubt that even our precious families are unlikely to help us out when we are viewed as no longer “economically viable” to employ and so every one of us should ensure that we maintain an eye on our retirement as well as “keeping our heads above water” from day to day.

Provident and Pension funds are essentially long term savings plans that usually are established by employers to assist employees establish the beginnings of “retirement funding” plans. It is considered so important that the government has gone a long way to prepare South African legislation and structures so that every employee in the country belongs to a retirement fund of one form or another. A couple of years ago when the government first started the consultation process with unions, employer bodies and institutions the initial proposals were that every person would contribute as much as 15% of their monthly salaries to such retirement funding plans. The other key proposal is the requirement for employees to participate in a preservation fund so that the provident or pension fund contributions would be transferred to an “open” fund when they leave an employer and thereby be “preserved” for the employee.

As you may know that from the inception of provident and pension funds there has been tax relief given by the government to assist employees in the accumulation of their funds. Once again the amount of relief given is not as significant as it used to be but it is still a key aspect to the viability of maintaining your contributions through to retirement.

So there can be little doubt that if at all possible it is wise to maintain your provident and pension funds and should you leave your employer to move the funds to a preservation fund rather than cashing it in. It is also so important that even the unions are working with the government to try and ensure that people save for and to their retirement age even when they change jobs.

A quick insight:

A provident fund is indeed different in many respects to a pension fund and very few employers offer their staff pension funds anymore. Without going into all the specifics the key difference is that a provident fund is more of a structured savings/investment plan whereby the person on retirement gets the value of their contributions along with the employers’ contributions plus the investment returns. A classic pension fund is a plan whereby an employee receives a monthly pension on retirement based on a percentage of their salary when they retired. Generally in the “old days” a person who had worked for a company for 40 years would receive a monthly pension on retirement equal to the salary they received the month before they retired. There are a lot more differences as you can imagine including how the contributions were treated for tax as well as the benefits on retirement.

Whilst not within the context of the question I was given I think it is important to remember that keeping a provident fund intact and maintaining contributions all the way through to retirement is only one of the steps that one should take and consider when planning for and preparing for retirement. 

There are so many other opportunities to prepare for retirement and to mention but a few principles and steps:

• When you retire you want to not only ensure you have income but you also want to try to reduce wherever possible any costs you will have after you retire. 
  - Have your home paid off and probably settle in to a smaller less costly home before retirement as your children will likely have moved on and a smaller home will cost less to maintain.
  - The same could be said about a car: start retirement with a car that is economical and in good condition

•  Ensure that you have access to savings. Generally when you retire provident fund contributions are normally invested so as to give you a monthly return and it is not wise in terms of taxation or your future to use a major portion of the funds released from the provident fund to buy a home or car. The idea is to be able to leave as much as possible to ensure the best monthly income going forward.
  This suggests two things:
  - When you retire you want to have some savings for the unexpected when you are retired and should you have a “treat” planned to celebrate retirement like visiting family overseas you don’t want to reduce your future income by taking it out of the provident funds up front
  -And of course, it is as important to try and save even when you are retired as it is when you are still working!

• Something that is probably not really considered much when one is younger and people only “wake up to it too late” is that even as you need to prepare your finances and costs for when you retire but also your health. Probably the biggest shock to any retirement financially comes from health costs both the monthly contributions you have to maintain and even more worrisome should you require medical attention or services. A long history of good habits and reasonable exercise are probably one of the most significant things the average person can do to prepare for retirement. Without belabouring smoking unnecessarily it is an excellent example of how to make ones retirement more onerous. The cost of the habit over ones life and the cost of the consequences many experience when in retirement need no elaboration.

• One last thought: we have considered the “time value of money” but maybe some small numbers can indicate the power of what it means.

If you were to save R50.00 per month and earned only 3.5% interest on it the savings would grow to:

• R3 273.31 in 5 years
• R7 171.63 in 10 years
• R17 343.46 in 20 years

Previously we have mentioned the difference of savings versus investing. The example above is the time value of money when simply saved. If the same amount was invested say in a unit trust the numbers would likely be very much higher.

It is very possible that investing R50.00 per month in a unit trust could give a compound return of 9% per annum in which case the amount could grow to:

• R3 771.21 in 5 years
•  R9 675.71 in 10 years
• 33 394.34 in 20 years

And to motivate preserving provident fund positions rather than “cashing out” it is quite possible that a provident fund would grow more like this investment than the savings example above.

So most certainly it is wisest if at all possible to preserve your provident funds when you change employment and also important to start preparing for retirement when it seems too far off even!