While researching one of the Retire blog posts, I stumbled across the 2020 Alexander Forbes Member Watch study. The study takes a closer look at the behaviour of their members in employ of 2,500 South African companies.
Amongst several grim realities, the study found that only 8.8% of members preserve their savings when leaving their employer. This means that 91.2% of more than a million members, will have to start saving from scratch for their retirement after they resign, are retrenched, or dismissed. Unfortunately, for many people, cashing in one’s pension fund is the only way to stay afloat while finding another source of income.
But then the study mentions that 61% of their members believe that amounts of R25k and less, are too small to make a difference and not worth the effort of joining a preservation fund. Turns out, I’m part of this statistic.
I left my previous employer in 2015 to travel the world. I had around R20k saved up in my pension fund, and it felt too little to make a long-term difference. Also, I couldn’t be bothered with the paperwork as I had bigger things on my mind. Now the negative effect this reasoning has on an individual’s income replacement ratio (IRR) is a prime example of vanilla compounding: Not allowing your money to truly leverage the power of time.
Starting again
Here’s an example:
You’re 30 years old and have R0 in your pension kitty because you cashed out your pension fund when you switched jobs. At your new employer, you’re allocating 13% of your income for the next 30 years to your retirement savings. This will give you an IRR of just below 50%. If you had started with a 13% contribution when you were 25 (and preserved it when changing jobs) your IRR at retirement would be just shy of 60%.
Many retirement funds and industry experts consider a replacement ratio of 75% as the golden number we should aspire to. So if you have the luxury of a pension benefit at your current employer and a new job waiting in the wings, don’t cash out. As seen in this example, 5 years can go a long way in getting you to a higher IRR.
The little Rand that could
Where would my R20k have been if I invested it? The answer to this question depends on many variables. Let’s assume I invested my pension fund payout in a tax-free savings account in 2015 with a 5% per annum real return over 42 years.
Using the Rule of 72 (and napkin math) to determine how long it will take for my R20k to double, the calculation will look as follows:
72/5 = 14 years.
So based on the above assumptions it would take 14 years for my R20k to double. And the magic of compounding will take off after the first 14 years as my future interest would be based on twice the amount I started with. After 42 years, my R20k would be a sweet R160k.
More importantly, preserving my payout would have established good behaviour at the outset of my working life. And when good financial behaviour starts to compound, you’re in for a treat.
Saving for retirement is the biggest investment most of us will ever make. Sadly, it can also be very complicated. In this monthly blog, we try to answer some of the retirement questions we hear most often, ranging from which products are best suited to different circumstances to efficient tax treatments. Words by Carina Jooste.
