Pay attention to the collection of your pension to settle your debts
By David Crossley
South Africans are among the most indebted in the world, with many having to use most of their take home pay to pay their debts. People who are in this downward spiral will resort to desperate measures to try to get out of the hole, and many will be tempted to cash out their pension funds.
A survey published by Times Live found that 74% of those approached would approve of a change in the law to allow the liquidation of pension savings for this purpose. Former finance minister Tito Mboweni even mentioned in his 2021 budget speech that he was considering allowing limited pre-retirement withdrawals from pension funds under certain conditions.
The government is still in discussions with the National Council for Economic Development and Labor (Nedlac) and various other unions and labor organizations, so nothing has been passed yet, but it remains a troubling conundrum for a country that is desperately struggling to get by. come out of an economic free fall.
It is important to have a rational look at the scenario and to consider the merits and disadvantages of such an idea. No decision has been made on how much would be allowed as a withdrawal, but we can be pretty sure that it would be limited to one-third or less, thus protecting the mandatory two-thirds intended to constitute the pension benefits.
Why is it a bad idea to use pension money to pay off 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 need to replace your income with some form of pension income, which you will hopefully have expected during your working life.
For the sake of argument, suppose the government allows us to cash out one-third of our retirement benefits in order to write off some debt. Here’s an example of how it might work for a 40-year-old with a projected retirement age of 65. Suppose this person has a pension value of R1 million, with an assumed annual growth of 6.5%. She withdraws a third (333 333 R), leaving 666 666 R in the fund:
• Growth on R666,666 from 40 to 65 at 6.5%: R3 218,462
• Growth over R1 million from 40 to 65 at 6.5%: R4 827 699
So by removing a third at age 40, she effectively sacrificed R1 609 237 of potential growth over the initial amount.
Here’s where the implication comes in: To make up for this loss, she would have to increase her pension contribution by R2,277 each month, payable over 25 years until she turns 65. And that’s without assuming that no annual fee increases …
But what can I do as an alternative? I am desperate!
When it comes to debt, you need to establish the terms of each item of debt. For example: What is the repayment term? What are the applied interest rates? How much is the debt? How essential is it that I maintain payments?
These questions are important to ask, as any other solution should be explored before considering using the pension money to pay off the debt.
Let’s go into more detail:
Debt repayment period: If it is a short term loan, it is best to negotiate with the creditor and continue to pay off the debt, even if it causes financial hardship for a short time. It is certainly not worth sacrificing 25 years of compound growth on the retirement benefits collected to pay off this type of loan.
Principal amount of debt: If you have a lot of unpaid debts, it may be worthwhile to talk to your bank and see if they will consolidate all of your debts. This way, you only have to worry about one creditor.
Late? If you have missed a mortgage or vehicle loan repayment, go to the financial institutions that loaned you the money and ask for temporary help. Most banks prefer being honest about financial matters, rather than having to take legal action against you. The latter approach is costly for them and will hurt your creditworthiness in the future. There are also many organizations that can help you if you find yourself in the debt trap. Reach out and do whatever you can to resolve the issue before you plunder your pension.
Even if the government passes a law to allow individuals to access part of their pension savings to liquidate their debts, 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 willing to ask for help. Talk 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 to manage your debt.
David Crossley (CFP) is Commercial Director at BDO Wealth Advisers.