Financial crisis brings ugly surprises but is smart
Retrenchment provides you with an incentive to plan. Really.
The world is undergoing a financial restructuring the likes of which have not been seen for generations. We will however emerge from this scenario, and the financial world, as we know it, will return to normality. Uncertainty impacts not only individuals and households but organisations as well. This can translate into organisations reviewing their cost structures, which in turn can lead to retrenchments. Many local and international blue-chip companies have recently announced that they will be shedding jobs.
Our attitude does determine our attitude and a positive frame of mind can create opportunity. However, if you are unfortunate to be included in the cost-cutting exercises, you should have the presence of mind to carefully consider your exit from your company retirement fund. The investment value of your retirement fund might well make up the bulk of your financial wealth. It is vital that it is preserved, especially in uncertain economic times. You also don’t want to be selling out of your investments when they may be almost 30% discounted by the stock market turbulence.
The current investment environment presents an opportunity for all of us to review our financial plan. Upon retrenchment the need to revisit our financial plans becomes unavoidable. Issues to be addressed are whether to transfer your retirement fund investment value to a preservation fund vehicle, a retirement annuity fund, or one may take the cash. The retirement annuity option is inflexible, as you cannot access the funds until age 55. Taking the cash is not a good idea either, as you may be tempted to spend your retirement savings. Added to this, the cash withdrawal will be taxed at your average rate, which may be close to 38% depending on your taxable income. Note that there is draft legislation on the table which may change this position from 1 March 2009.
Preservation funds are an excellent way to preserve your savings until retirement. The transfer into a preservation fund is tax-free, as well as offering the flexibility of making a withdrawal from the preservation fund prior to your retirement. If you have been retrenched, and are struggling to secure new employment, this may be a necessity.
Let’s assume a 50-year-old individual with a retirement age of 65 has accumulated R2,000,000 in retirement capital and is retrenched. After being retrenched he will have the option to transfer the benefit to a preservation fund or to take the cash. The accompanying graph shows the significant benefit of preserving the retirement fund benefit. In fact, transferring the benefit to the preservation fund results in the individual being nearly 54% better off than if the cash were taken! In our example we assumed that the individual would be taxed at 30% if the cash were taken and a real (above inflation) return of 4% per annum. The reason for the sharp difference between the 30% tax and the enhanced value of 54% is the power of compounding.
Legislation has changed recently, removing the requirement to only use the preservation funds of which your ex-employer was registered as a participating employer. This provides flexibility to transfer the retirement fund investment value into a preservation fund of your choice. But take note – this still needs to be communicated to your ex-employer. Making no decision as to your retirement savings may cost you dearly. If you have not transferred your retirement fund money into a preservation fund, or a retirement annuity, within six months of your date of exit, the Receiver of Revenue will knock off its dues in income tax, and you will be paid the balance in cash. Getting this reversed can be a painful and lengthy exercise.
It’s also important to remember that you may be able to convert your life and disability cover on your fund into an individual policy without medical underwriting. This could be a valuable benefit if you have health problems and are unlikely to obtain the cover in your personal capacity. If you are fortunate enough to head straight across into a new job, investigate whether your new employer has a retirement fund with life and disability cover and if not, then you should seriously consider converting your cover- your family probably needs it. Most funds give you 30 days after exit to take up the conversion option- again, it’s a case of ‘you snooze, you lose.’
Changing careers provides us all with an opportunity to review our financial planning. As mentioned our retirement savings may be the bulk of our wealth. Managing this money could have a material effect on one’s ability to retire when one wants to. If retrenched, it is important not to take it personally as a reflection of our ability – it is often the economy or our employer’s shortcoming which is beyond our control. If the news causes a lack of sleep, tiredness or irritability I recommend counselling during this transition.
Netto-Jonker, CFP® is the founder of Netto Financial Services and was the financial planner of the year in 2001. Her business partner Ian Beere, CA(SA) CFP® was the financial planner of the year in 2007
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