Government recently announced that it may allow retirement fund members to take limited pre-retirement withdrawals from their retirement funds. While the intention is to offer members short-term financial relief under very specific circumstances, it is important not to lose sight of the long-term nature of these investments and the generous tax breaks given for investing in them.
An investment in a retirement fund is a long-term commitment. It allows you to amass a substantial chunk of money throughout your working life, resulting in a nest egg that should ideally only be accessed when you need it most — at retirement.
The taxman recognises the importance of retirement savings and offers savers tax breaks for doing this. Retirement funds are without a doubt one of the most tax efficient ways to build up and manage your long-term savings.
There are three basic ways in which the taxman encourages you to save:
Firstly, the contributions you make to your retirement fund are tax deductible, up to certain limits each year. This means that you pay less tax on your monthly earnings, while saving for your retirement.
Secondly, the money you accumulate in your retirement fund will grow tax-free over time. This means that the growth on your retirement savings, while in your retirement fund, will be exempt from income tax, capital gains tax and dividends tax.
And finally, when you retire, a portion of your retirement benefits may be tax free. Benefits taken as a cash lump sum at retirement will be subject to the lump sum tax tables, where the first R500 000 of the cash lump sum is tax free and the balance of the cash lump sum will be taxed at preferential rates. Any annuity you receive will be taxed at your marginal tax rate.
With all the savings that retirement fund members accumulate, it is no wonder that many people, including government legislators, are talking about the possibility of allowing members to dip into these savings to help them fight off financial problems that may exist in the present. Because these savings grow into substantial amounts of money over time, it is easy to imagine that they might help us in the present.
According to a recent National Treasury statement, government is considering allowing retirement fund members limited access to their retirement benefits prior to retirement, but only in the case of emergencies or extraordinary circumstances. It is proposed that members will build up two pots of money in their retirement fund — one pot for long-term savings and a second pot allowing members access for short-term financial relief. A member who accesses their short-term savings pot prior to retirement, may however be forced to preserve some of the balance of their benefits until retirement, even if that member leaves employment. The design and details of these proposals have not yet been bedded down and it is likely that we’ll only see these changes coming into effect next year, at the earliest.
While accessing your retirement benefits early may solve your immediate financial needs, you should avoid the temptation of dipping into your biggest savings pool. Early access undermines the ultimate aim of long-term savings, which is to take advantage of tax breaks and the time value of money to grow your investment until your old age.
The fact that these savings grow with time and that this growth is tax exempt should make anyone think twice about undermining their savings goals.
So, before these announcements come into effect, just take a moment to consider the significant tax breaks you get on your retirement savings, the importance of your long-term goals and the serious impact that early access may have on your retirement. — James Coutinho is Senior Tax Manager at the Liberty Group
This article does not constitute tax, legal, financial, regulatory, accounting, technical or other advice. The material has been created for information purposes only and does not contain any personal recommendations. While every care has been taken in preparing this material, no member of Liberty gives any representation, warranty or undertaking and accepts no responsibility or liability as to the accuracy, or completeness, of the information presented. Please consult your financial adviser should you require advice of a financial nature and/or intermediary services.
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