It’s tempting to want to tap into your retirement savings when times get tough. But have you really thought about what this means for your financial future? While the short-term relief might seem appealing, the long-term effects on your savings could have far-reaching consequences.

The carrot and the stick

You may be familiar with the idiom: the carrot and the stick. But on the off chance that you aren’t, the expression refers to the approach of offering a combination of rewards (the carrot) and punishment (the stick) to encourage a certain type of behaviour.

In many ways the government has adopted this approach to encourage people to save for retirement. This is done by incentivising individuals to save for retirement through a series of tax rebates (the carrot), while at the same time discouraging them from tapping into their retirement savings through a series of tax ‘penalties’ (the stick).

While the tax implications of withdrawing from your retirement fund are immediate and therefore more obvious, the knock-on effects often take longer to be revealed. To illustrate this, the remainder of this article will focus on three specific elements, namely:

The tax implications of withdrawing from your retirement fund
The loss of future returns
The risk of not being able to achieve your retirement goals

The tax implications

Pre-retirement withdrawals are taxed according to the Retirement Fund Lump Sum Withdrawal Benefits tax table shown below (click to enlarge).

To demonstrate how the table works, the below calculation uses a pre-retirement withdrawal of R500 000 as an example. As the withdrawal amount is less than R660 000, the tax portion is determined by calculating 18% of taxable income above R25 000 (i.e. the second line item in the table):

R500 000 – R25 000 = R475 000
R475 000 X 18% = R85 500

Based on the above example, the amount of tax payable to SARS is R85 500. While this might seem like an insignificant amount relative to the after-tax portion, if you look at the tax payable as a share of your monthly retirement fund contributions, the story takes a slightly differently angle.

Assuming that you started saving towards retirement by contributing R3 000 a month, it would take you roughly 27 months to contribute R85 500 (based on your contributions increasing by 6% each year for inflation). This means that by withdrawing R500 000 prior to retirement, you are essentially forfeiting the first two years of your retirement contributions to SARS.

The loss of future returns

Assuming that you plan to retire in the next 25 years, the future value of the R85 500 which you paid to SARS would be worth R1,161,557 at retirement (based on your investment growing by 11% annually).

This means that by sacrificing R85 500 now, you are essentially reducing the future value of your retirement savings by R1,161,557. If you were to discount this amount by 6% (as a proxy for inflation), it would be worth R270,641 in today’s terms.

The risk of not being able to achieve your retirement goal

This is largely based on when you take your pre-retirement withdrawal. Generally speaking, the younger you are when you withdraw the funds, the more time you have to catch up, but that’s not to say that it will be easy.

For example, if you currently earn a salary of R35 000 and plan to retire in the next 25 years with an income replacement ratio of 75%, your retirement savings would need to be worth roughly R23,254,554 at the point of retirement. Assuming that you are comfortable contributing 15% of your salary each month towards your retirement fund (with an annual escalation of 6%), you would need to have already saved up roughly R799,239*.

By withdrawing R500 000 from your retirement fund, your monthly contributions would need to increase from 15% to 22% for the next 25 years to put yourself in a similar financial position had you not taken the withdrawal*.

Understandably, contributing such a large portion of your salary each month may be difficult – especially given that you would need to continue contributing at this rate for the next 25 years. Unfortunately, not following this course of action means that you run the risk of retiring with too little capital to sustain your current lifestyle in retirement.

There are many instances where tapping into your retirement savings might seem like a good idea, such as paying off your bond or other expenses. However, it’s important to remember that doing so not only has heavy tax consequences, it also significantly reduces the amount of money you have to retire with. Replacing what you’ve taken requires time and discipline, which is why in most cases it’s simply best to leave your retirement savings to grow until you retire.

For more information or if you have any questions, we recommend getting in touch with a good independent financial adviser. Alternatively, please feel free to contact our Client Services Team on 0860 105 775 or at query@prudential.co.za.

*Assumes you started contributing 15% of you salary towards your retirement fund from the age of 25 and plan to retire at the age of 60. Your starting salary is R20,000 with an annual escalation of 6%. Your annualised growth rate prior to retirement is 11% and 10% after retirement. Your retirement savings would need to last you at least 30 years after retirement with an income replacement ratio of 75%.