Why you shouldn’t use your retirement savings to pay off your debt

Don't dip into your retirement savings to cover your debt.

Tapping into your retirement savings early can have a long-term devasting impact. If you find yourself changing jobs with the option to cash out your fund to pay off your debt. Don’t. You will accumulate more debt when you stop working to fund your retirement.

Another impact will be that you are not able to retire and need to continue working. The job market is not great now, what will it be like when you are 60?

Research shows that one in three South African retirees are in debt when they retire or can’t afford to retire because the funds have been spent prematurely. In addition, if you withdraw your retirement savings before you retire you lose the powerful impact of compound interest. Compound interest can have significant results if the funds are left for the long term and should not be underestimated.

It is also important to acknowledge that if you use your retirement savings to settle debt you are not teaching yourself to budget and live within your means. In the current economic times, it can be hard to cut back, but consider making lifestyle changes that can provide budget relief, to tackle your debt in the short-term and keep your pension nest egg growing. Remember that if you do cash out your retirement savings when you find a new job and resign or are retrenched you are going to have to pay tax on the cash lump sum.

Retirement planning

Retirement planning starts 5 years before your intended retirement date .i.e. when do you expect or want to retire.

Now think of all the things that can happen to you in these 5 years:

• You could be retrenched
• You could become disabled
• You could die.

You need to make provisions for these to protect your retirement savings.  There are many factors to consider when retirement planning. – Here are some thought starters:

• How much money do you and your “dependants” require to live off for the next “X” number of years?
• Do you want to leave a legacy?
• Do you have enough life cover for estate duty and other day-to-day living expenses before your life cover pays out or until your pension benefit is transferred to your dependents?
• What are your monthly expenses at retirement? Then add annual inflation to this for planning purposes and to decide how much income you require.
• Consider the increasing taxation payable on your retirement benefits.
• Make sure you have other non taxable income sources to supplement your pension.
• Medical aid and short-term insurance are a must.
• Make sure at retirement your mortgage is paid off.
• Carry on saving even when you are retired.
• Make provision for your wishes and dreams, what do you want to achieve during retirement?
• Have at least 6 months expenses readily available, fixed deposit, Unit Trust, etc.
• Stay away from dodgy advisers and risky fund choices.

There are many things to consider as you start planning your retirement and if you are battling with debt leading up to retirement, Get help now.

When you do come to retire, make sure you understand the tax implications. If your pension exceeds R1,5m it is imperative to take the first R500k tax free. This is the only opportunity for you to access tax free money from your pension. If your pension lump sum is larger than R3m however, it may be beneficial to take R1m in cash and pay the 18% tax on the additional R500k. Make sure you get proper advice and understand the full tax requirements.

If you need to use your retirement savings to pay debts, consider your options.

Before dipping into your retirement savings consider a debt management plan.  Investigate debt counselling or debt consolidation.  Debt management can help you create a debt repayment plan that enables you to get back on track with your finances.

Consider ways to reduce the costs of other financial vehicles. Do you have credit life cover on your loans? This is often added without you being aware and the costs can be high. Get a comparative quote to see where you can save money.  Look at your funeral policies, are you over-insured? If you have multiple policies for the different members of your family, you will likely be covered on each policy. See if you can replace the multiple policies with one more affordable premium.

Need help with managing your debt?

You don’t need to navigate your debt management options on your own. Get in touch and we will carry out a free assessment to determine the right solution for you based on your current situation.