Moneyweb spoke to Dave Johnson, company secretary of Sygnia Asset Management, for insights on how these funds work and pitfalls to avoid.
Preservation funds are single payment, specialised pre-retirement vehicles governed by the South African Revenue Service (Sars) requirements – aimed at protecting retirement savings for exiting members on resignation, retrenchment or dismissal (not retirement) from employment.
No tax is levied on pension or provident fund transfers into a preservation fund, and investment returns in the fund are tax-free. Lump sum withdrawals are taxed on specific scales, with once-per-lifetime tax-free benefits. A person could establish multiple funds during their lifetime, depending on employment history.
Moneyweb spoke to Dave Johnson, company secretary of Sygnia Asset Management, for insights on how these funds work and pitfalls to avoid.
I’m a few months shy of 55. What happens at this particular milestone?
Fifty five is the age from which you can elect to financially retire from a preservation fund.
For a pension preservation fund, you can take a maximum of one-third of the accumulated lump sum as cash, taxed at retirement lump sum benefit rates, with the first R500 000 tax-free. The balance must be used to purchase an annuity product which pays a regular drawdown income, taxed at normal rates.
You cannot leave the remaining two-thirds untouched in the fund to let it grow with the intention of drawing down at a later date. The annuity has to kick in as soon as you elect to take the third lump sum – but if you select a living annuity and a low draw down, your capital will continue to grow.
For provident preservation funds, there is no on-third restriction and you can withdraw the entire accumulated capital as cash, with the first R500 000 tax-free. Otherwise all, or the remaining accumulated fund after the withdrawal, must be used to purchase an annuity.
Remember – the retirement lump sum tax-free benefit is once in a lifetime – so subsequent lump sum withdrawals from other preservation funds and retirement vehicles such as RAs will get taxed on a cumulative/aggregate basis.
How do I decide on the rate of annuity drawdown? **Fifty five seems far too early to access retirement money. Most people are still working for a salary.**
We need to distinguish between financial and physical retirement. Financial retirement is a fiscal concept and government allows you only one financial retirement date in your lifetime. It does not have to be 55, and can be later. Physical retirement is when you stop working and no longer earn income such as a salary. These dates do not have to coincide. You can retire financially at 55 but still carry on working for a company until its compulsory retirement age, say 63.
Historically, financial retirement age had an outer limit of 70, but this has now disappeared and you can elect to retire beyond that, as suits your circumstances.
People should extend their financial retirement date as far as they can. This enables their preservation funds to grow as much as possible, and reduces the time period for which these funds must support them. Just because legislation allows you to access savings at age 55, you don’t have to. Try to only access preservation money when most other income sources have ceased.
Take great care in deciding on your official financial retirement date, as this is when you get the beneficial tax break.
Before financial retirement age, how accessible is the money in a preservation fund?
Legislation allows only one early withdrawal from each preservation fund you have, and this is cumulatively taxed at withdrawal lump sum rates. The withdrawal can be of any size, including up to 100% of the accumulated fund. There are quite a few instances when savers try to access their money more than once and are distressed to learn they cannot. Rules are very clear and strict – only one early withdrawal per fund.
When you resign from employment, do you have to use an adviser to transfer into a preservation fund or can you DIY?
You can do it yourself – but the investment choice can be daunting, so an adviser may be of benefit. Using an adviser, there is generally an upfront percentage fee on the transfer value, followed by on-going commission over the life of the fund. However, these fees are always negotiable.
What are the fee structures in a preservation fund?
At the heart of the fund is the portfolio fee charged by the asset managers tasked with maximising your returns; then there is the Linked Investment Service Provider (LISP) fee for packaging and offering a range of funds on a particular platform; fees of trustees and administrators of the legal entity housing your fund; and then financial advisers. Investors should understand all fee components and how to minimise them, for example, by using only one platform for all their preservation funds, or by negotiating with advisers.
When changing jobs, should one invest the outgoing retirement money into a preservation fund or into the new employer’s pension fund?
The main consideration here is that with a preservation fund, you enjoy one early access withdrawal before age 55. Transferring it to a new employer, you cannot access the money until you leave that employment. So it depends on age, personal circumstances, and also the cost structure of the new employer’s scheme as it may be large and enjoy lower asset-based fees.
What happens if I’m unhappy with investment performance?
Individuals should not obsessively monitor fund performance as these are long term investments. However, if you are not happy with returns, you can change your investment portfolio, but be aware that this can be costly and performance losses get realised.
When choosing a fund, investigate its opportunities for switching in the underlying investment options. Flexible and complex products will be costlier. So don’t invest in an expensive fund with extensive options that you would never use – but also note that lower cost funds offer a limited range of products, asset managers and risk profiles. Financial advice may be beneficial.
In my twenties and thirties, I always cashed out and didn’t transfer across to the new employer or into a preservation fund. With financial education so available these days, is the younger generation more responsible?
While there is certainly greater awareness of preservation funds, regrettably the lack-of-savings culture persists. Employers, administrators and trustees see far too many departing employees cashing out their savings, instead of electing preservation. The youthful mind-set believes it can catch up over time, but many don’t. If the money is used to pay off debt, or is genuinely needed for living expenses, then that is fine – but unfortunately it is often used to buy a better car.
We now have draft legislation that addresses this lack of preservation. We could see employer pension fund trustees having to take on more responsibility, ensuring that departing employees are directed towards preservation funds. On exit, there would be a suitable low cost, default preservation fund, with no agents and commissions involved, making it easy for people to keep their precious savings intact.