Retirement fund choices can confuse. In this fourth and bonus article on retirement funds, BRUCE CAMERON looks at preservation funds.
WHAT IS IT?
Many people, when they leave or change jobs, unfortunately take their cash and either spend it on a new car, pay off debt, or use it for some other thing they consider a necessity.
This is a dangerous practice as it means that most probably you will not have enough money for a financially comfortable retirement.
Preservation funds, or more correctly preservation retirement funds, are there to preserve your retirement savings, particularly when you change jobs.
The government paved the way for preservation funds by allowing you to preserve any tax benefits you have accumulated in the build up of your retirement savings.
As a member of a defined benefit, or a defined contribution pension fund, your contributions to your fund will have been tax deductible and your employer's contributions will have been tax free.
If you are a member of defined contribution benefit fund, you will not have been taxed on your employer's contributions.
If you changed jobs and merely withdrew your money from your fund, you would be taxed on the proceeds.
However, to encourage you to keep the money until retirement, the government allows you to take R1 800 tax free and to put the rest of your money into another retirement fund vehicle without paying any tax.
One of your choices is a preservation fund. Other choices include a retirement annuity; transferring to your new employer's fund; or leaving your retirement savings in the existing fund and deferring taking pension benefits until you reach retirement age.
HOW DOES A PRESERVATION FUND WORK?
Preservation funds come in two forms. These are:
* A traditional life assurance product, where you have low risk, lower costs and little investment choice or flexibility. Your money is normally invested in one or other type of guaranteed product, where your capital and some growth are guaranteed. The rest of the growth will come in the form of bonuses that are declared annually.
You will pay an initial fee, which will include a commission to an intermediary. There will be on-going management fees, but these are mainly contained within the investment portfolio; and
* A linked investment product, offered by both life assurers and what are called linked investment product companies, where you have higher charges, including commissions, potentially higher risk, but greater investment choice and flexibility.
You are offered a wide range of underlying investments and the ability to switch between the investments at any stage. The underlying investments will include unit trust funds and life assurance investment portfolios.
You should only consider this option if you have some knowledge of investment markets, or have a financial adviser with exceptional investment skills.
There are very few financial advisers in South Africa who do have the skills, but many will encourage you to go this route because of the higher commissions they receive.
OTHER ISSUES TO ACCOUNT FOR INCLUDE:
* Preservation funds have one major advantage over the other options of protecting your retirement savings. You are allowed one withdrawal from a preservation fund.
The reason for this is to allow you some reserve in case you have a financial crisis. But be warned, this one withdrawal includes the R1 800 tax free amount. You will be taxed at your average rate of taxation on any amount you withdraw above the R1 800;
* If you transfer from a pension fund, your money must go into a preservation pension fund. If your money is in a provident fund, it must go into a preservation provident fund.
* After you have transferred your retirement savings to the preservation, the rules of your original fund apply.
For example, if the retirement age of your original fund was 60, then you will only be permitted to retire from the preservation fund at age 60.
If you had opted for a retirement annuity to preserve your retirement savings, you would have been able to retire at 55.
The rules of your retirement fund may prevent you from putting your money in a preservation fund, in which case you will have to use another option to preserve your retirement savings;
* When you retire, your retirement savings will be treated for taxation purposes in the same way as for any other retirement fund.
For example, if you are in a preservation pension fund you must use two thirds to buy a pension.
You are not obliged to buy the pension from any particular company, and you should shop around for the best rates.
You will be allowed to take up to one third as a lump sum payment, with the first R120 000 being tax free and the remaining amount taxed at your average rate of taxation.
You only get the R120 000 once, so if you belong to another fund or funds, you will not be given the R120 000 again;
* As with most retirement funds, you are not allowed to take loans or use a preservation fund as security for a loan; and
* You can not add other non-retirement fund money to a preservation fund. With a retirement annuity you can continue to contribute additional money.
WHO SHOULD INVEST IN A PRESERVATION FUND?
Anyone who wants to protect their retirement savings.
INVESTMENT PERIOD?
You have to leave the money in a preservation fund until the retirement date of your original fund.
MINIMUM INVESTMENT?
Minimum investments vary. The minimum investment tends to be higher with a linked investment product preservation fund.
INVESTMENT COSTS?
Investment costs can vary quite dramatically.
It is important that you establish the costs, as high costs will, in many cases, undermine your investment performance. These costs will include:
* Initial and annual costs;
* Initial and on-going commissions. If the commissions are higher you must make your adviser justify the higher costs; and
* Underlying costs. This is very important with the linked investment product options. Not only do you pay costs at the level of the provider of the linked investment company, but also on the underlying investments. You must establish these costs.
IS YOUR MONEY SECURE?
The security of your money depends on your investment choice. Be aware that if you go into a market linked product, you could lose all or part of your capital.
Last year's share market crash saw large amounts of savings being wiped out.
But markets recover and you could well do better by being in a market linked investment, rather than a guaranteed product.