With the festive season underway, consumers may be considering using their two-pot retirement savings component to splurge. However, Richard Carter cautions against dipping into your retirement investments for holiday spending, as this could undermine your long-term retirement goals.
The recent introduction of the two-pot retirement system in South Africa may provide consumers with high levels of temptation to withdraw retirement savings to pay for discretionary festive season spending.
We continue to worry about investors taking out money for short-term needs that aren’t emergencies, undermining their long-term retirement savings goals.
South Africa’s two-pot retirement system, introduced on 1 September, divides all future contributions from retirement fund members into two components: a savings component and a retirement component.
The aim of the two-pot system is to preserve your retirement investment, while allowing access to the savings component once per tax year in case of emergencies – where not withdrawing would lead to worse financial outcomes.
Don’t touch your vested component
As well as the retirement and savings components, there is also a vested component, which consists of retirement contributions accumulated before 1 September and growth thereon – less the amount used to “seed” your savings component. Although investors won’t be able to make further contributions to this portion, they may be able to access it in certain circumstances, including if they resign, if their retirement fund’s pre-two pot rules allow.
For many investors, especially those who have been investing diligently for several years, keeping a lid on the vested component is even more important than not dipping into the savings component. For example, for a 55-year-old investor who has been contributing to a retirement fund since they were 25 and intends to retire at 65, the vested component (plus growth) could be as much as 90% of the amount available at retirement.
For these investors, the most important thing to do is to make sure that the vested component remains invested appropriately and resist the urge to take this money out.
Could you use your savings component as an emergency fund?
Using your savings component as an emergency fund could make sense – if you are willing to direct emergency fund contributions into your retirement fund, over and above what you are currently contributing to your retirement fund.
If you were previously contributing 12% of your salary for retirement, and that was enough, dipping into the one-third of your contributions that now go into a savings component for emergencies will leave you with a shortfall. To the extent that you use this one-third for emergencies, you will be eating into your retirement investment, and all else being equal, you will not have enough at retirement.
However, using the example above, if you want your retirement vehicle to double as an emergency fund, you could increase your pre-tax contribution to 18%. If you don’t need it for emergencies, or even if you use some of it, but not the full amount, it could enhance your retirement investment.
Even if you end up needing all of it for a rainy day, you would not worsen your retirement outcome.
Plan for festive spending
Rather than dipping into your retirement investment to fund your festive season splurge, discipline should be your first priority. Marketing tricks entice us to spend, but it’s important to protect your future financial wellbeing.
Although too late for this festive season, a strategy for the future is to set aside money monthly to account for this expensive time of year. Regular contributions over time into a low-risk unit trust, such as a money market or interest fund, will preserve and grow your capital, and you can access it when you need to.