By David Crossley
South Africans are some of the most indebted people on earth, with many having to use the bulk of their take-home pay to meet debt obligations. People who are in this spiral will resort to desperate measures to try and dig themselves out of the hole, and many will be tempted to cash in their pension funds.
A survey reported by Times Live revealed that 74% of people approached would approve of a law change to allow pension savings to be liquidated for this purpose. Former finance minister Tito Mboweni even mentioned in his 2021 Budget speech that consideration is being given to allow limited pre‐retirement withdrawals from retirement funds under certain conditions.
The government is still in discussion with the National Economic Development and Labour Council (Nedlac) and various other unions and labour bodies, so nothing has been passed into law yet, but it remains a troubling conundrum for a country struggling desperately to haul itself out of an economic freefall.
It’s important to have a rational look at the scenario and examine the merits and demerits of such an idea. No decision has been made about the amount that would be permitted as a withdrawal, but we can be almost certain that it would be limited to one third or less, thereby protecting the compulsory two thirds designed to set up pension benefits.
Why is it a bad idea to use pension money to clear debt?
One of the certainties of life is that you will get older. One day, you will no longer be able to work. When this happens you have to replace your income with some form of pension income, which you’ll hopefully have made provision for during your working life.
For the sake of argument, let’s assume that government will allow us to cash in one third of our pension benefits in order to clear some debt. Here is an example of how that might work for a 40-year-old person with a projected retirement age of 65. Say that person has a pension value now of R1 million, with an assumed annual growth of 6.5%. She withdraws one third (R333 333), leaving R666 666 in the fund:
• Growth on R666 666 from age 40 to age 65 at 6.5%: R3 218 462
• Growth on R1 million from age 40 to age 65 at 6.5%: R4 827 699
So, by withdrawing one third at age 40, she has effectively sacrificed R1 609 237 in potential growth on the original amount.
Here’s where the implication kicks in: To make up this loss, she would have to increase her retirement contribution by R2 277 each month, payable over 25 years until she turns 65. And that’s without assuming any annual contribution increases…
But what can I do as an alternative? I’m desperate!
When it comes to debt, you need to establish what the terms and conditions are in respect of each debt item. For example: What is the repayment term? What interest rates are being charged? What is the amount of the debt? How critical is it that I maintain the payments?
It’s important to ask these questions because every other solution should be investigated before any thought is given to using pension money to clear debt.
Let’s go into more detail:
Debt repayment term: If it’s a short-term loan, it’s better to negotiate with the creditor and continue to pay off the debt, even if this means financial hardship for a brief period of time. It’s definitely not worth sacrificing 25 years of compound growth on the cashed-out pension benefit to service this kind of loan.
Capital amount of debt: If you have many outstanding debts, it might be worth speaking to your bank and see if they will consolidate all your debt. This way you will only have one creditor to worry about.
In arrears? If you’ve missed home loan or vehicle repayments, approach the financial institutions that loaned you the money and ask for temporary relief. Most banks prefer honesty regarding financial troubles, rather than having to initiate legal action against you. The latter approach is costly for them and will damage your creditworthiness going forward. There are also many organisations that can assist you if you find yourself in a debt trap. Reach out and do everything in your power to fix the problem before you raid your pension.
Even if government does pass a law to allow individuals to access a portion of their pension savings to liquidate debt, this should be a last resort once all other avenues and solutions have been considered.
Excessive debt can be managed, but only if the person in debt is prepared to seek help. Speak to your bank, or set up a meeting with a Certified Financial Planner (CFP) – you’ll be amazed at what can be achieved when you take proactive steps towards managing your debt.
David Crossley (CFP) is business manager at BDO Wealth Advisers.
PERSONAL FINANCE