Using preservation fund savings at retirement

Preservation funds are retirement savings vehicles that allow investors to transfer a lump sum amount from their pension or preservation savings when moving or in between jobs. This allows the capital to be “preserved”, continue to grow and eventually provide for retirement. At age 55, which is the current retirement age in South Africa, the preservation fund can be transferred to either a living annuity or life annuity which will then provide an income for retirement. This article will look in further detail at the key features and benefits of using preservation funds.  

Preservation funds allow for your retirement savings to continue to grow and compound over time. These funds have been hard-earned whilst in a pension or provident fund, and allowing them to remain untouched and grow within the preservation fund in order to provide for retirement is a wise choice. The growth within the fund is tax-free, meaning that the investment can grow without any tax deductions. Another benefit of preservation funds is that you can transfer between service providers once a year if you are not happy with your current setup. 

Accessing preservation funds  

The National Treasury implemented the “Two Pot Retirement Savings System” in September of 2024. This has changed the rules related to the accessing of funds from preservation funds as well as other retirement products. According to the new rules, all contributions will be split between a “savings pot” and a “retirement pot”. One-third of contributions will be allocated to the savings pot, and two-thirds of contributions will go to the retirement pot. There is also a third component, which is the “vested pot”. This refers to all contributions made prior to September 2024. The retirement pot is to remain untouched until age 55. The savings pot can be accessed in times of financial hardship or difficulty.   

However, it is best to leave the funds invested to grow and compound over time. Investors are able to withdraw from their savings pot once per year for a minimum amount of R2000. The withdrawals are subject to tax at your marginal tax rate. There will also be an administration fee charged, which is usually around R300, excluding tax. The rules prior to September 2024 apply to the vested pot, which essentially means one withdrawal before retirement. It’s important to note the tax tables governing withdrawals. Firstly, you can withdraw only R27 500 tax-free, above this, higher tax rates will be applied, depending on the amounts withdrawn. The following highlights how the tax rates are applied:   

• Withdrawal of R27,501 to R726,000, the tax rate of 18% of taxable income above R27,500 will be applied.  
• Withdrawal of R726,001 to R1,089,000, you will be taxed R125,730 + 27% of taxable income in excess of R726,000   
• Withdrawal in excess of R1,089,000, you will pay R223,740 in tax + 36% of your taxable income above R1,089,000 

Let’s look at an example of withdrawing your capital early versus keeping your funds invested in a preservation fund:  Both James and Jane change jobs and they each have R500 000 in the vested portion of their provident funds. The vested portion of the fund is governed by the old legislation in place before September 2024.  

Jane would like to withdraw her funds. She is allowed to do this as she is changing jobs, and the vested portion is governed by the old rules that allow for this. According to the tax tables, she can withdraw the first R27 500 tax-free. The remaining amount of R 472 500 will be taxed at 18% which equates to an amount of R85 050 in tax. After tax has been deducted, she will receive an amount of R414 950. By withdrawing her funds, Jane is missing out on the compounding of her funds and growth over time – unlike James. 

James decides to transfer his lump amount across to a preservation fund. This allows the funds to remain untouched and there is no tax obligation yet. The funds can compound and grow over time. If you look at a time span of 30 years with 12% annual growth, 6% inflation and fees of 1% p.a., the fund will grow to a value of R1,992,890 in today’s money.  

Offshore investments with a 10x preservation fund  

Investors often look at investing offshore as a way of diversifying their portfolios and hedging against any local currency depreciation and local market fluctuations. Regulation 28, which is part of the Pensions Fund Act, has put in place limits to the percentage of your investment that may be invested offshore. The aim is to help investors to diversify their investments without allowing them to concentrate too heavily in any one place.   

Currently, up to 45% of investors’ portfolios may be invested offshore. 10X offers a range of different funds that offer varying degrees of offshore exposure, depending on your needs, goals and time horizon. If you’d like to find out more about the various funds on offer, get in touch with one of the experienced investment consultants at 10X.  

Impact of fees on retirement savings  

It’s important to be aware of the fees that are being charged on your preservation fund. You might expect to see charges on preservation funds such as administration fees, management fees, advisor fees, performance costs and more. High fees have the impact of eroding the growth of your retirement funds, especially when compounded over time. When looking for a service provider, it’s important to make use of a provider that charges low fees. This enables more of your returns to be reinvested and continue to grow, and to provide sufficiently for retirement. 10X Investments prides itself on a simplified, transparent and low-fee structure with no hidden or advice costs, charging just a single management fee.   

The Effective Annual Cost (EAC) was devised by ASISA as a method by which you can compare different products and evaluate the costs that you are being charged by your service provider. The higher your EAC is, the lower your net investment returns, and less money is reinvested to compound over time. The lower your EAC, the higher your net investment funds are, which translates to more money to be reinvested and compound over time. By requesting an EAC from your service provider, you can see the total costs you are being charged and decide if you want to consider changing providers. An EAC calculator can help you get clarity on your investment costs.  Key takeaways in minimising your EAC:  

• Choose a service provider with low, transparent fees 
• Minimise the impact of advice fees, or get rid of them entirely 

Inflation's impact on retirement savings 

Inflation reduces the purchasing power of our money over time, and has stood at around 5% to 6% per year in South Africa. Effectively, inflation shrinks the basket of goods and services that one can buy with a certain amount of money each year. This is an especially important consideration for retirement savings like preservation funds, where you are not adding any additional contributions.   

In this case, one must rely solely on the market to grow your capital, and you therefore need to seek funds returns that are beating inflation by a healthy margin in roder to grow your savings and maintain or increase you standard of living.  There are some strategies that you can incorporate to try to mitigate the effects of inflation on your investments:  

• Understand your asset allocation: By diversifying your asset allocation and ensuring that your portfolio is invested in a variety of assets, including growth assets like equities, you have a better chance of outperforming inflation. Equities have been shown to be the most consistent inflation-beating asset class over the long term. 
• Regularly review your portfolio: It’s important to regularly review the underlying funds in which your preservation fund is invested. Inflation and fund performance fluctuates over time, and your needs are almost certain to change, so you may need to adjust your underlying portfolio. 
• Low fees: Ensure that the fees you are paying are low. Paying high fees on retirement savings will further deplete the funds you have invested after the effects of inflation. 

The importance of distinguishing between fund performance and net investment returns 

It’s important to distinguish between fund performance and net investment returns when comparing the performance of your retirement investment. Fund performance refers to the overall performance of your investment before any costs or expenses have been deducted. Net investment returns refer to the real returns that you receive after costs have been deducted from the investment. To make a proper comparison between the performance of different funds or retirement savings products, it is important to compare the net investment returns, as these are the real returns that you will receive at the end of the day.   

Post-retirement steps  

Once you reach age 55, you have the choice to retire from your preservation fund. You can take your savings component in cash, or invest some or all of those funds in a life or living annuity. 100% of the “retirement pot” is used to purchase a life or living annuity. For your “vested pot”, which is governed by the old rules, you can access one-third in cash, with two-thirds used for either a life or living annuity.  

A life annuity is a contract with an insurance company that provides a guaranteed, fixed-income amount for the duration of the rest of your life. You aren’t able to adjust the income amount, nor are you able to adjust the funds that the annuity is invested in. A living annuity will also provide you with a regular income, but it comes with more flexibility in terms of the income you draw and the funds that you are invested in: both of which can be adjusted. You can review and adjust your income draw annually and select between a drawdown rate of 2.5% and 17.5%. You are also able to adjust the funds which you are invested in, depending on your changing needs over time.   

Being financially literate is important when managing your living annuity. You need to ensure that you are aware of your financial needs, as well as your risk tolerance, in order to adjust your drawdown rates and investment portfolios accordingly. With a living annuity, you are responsible for your investment decisions – not anyone else.  

The 10x Preservation Fund 

A preservation fund is a smart way of keeping your funds invested and growing for retirement, whilst still benefitting from considerable tax benefits. Anyone considering a preservation fund should look at the 10X Preservation Fund. 10x fees are low and transparent, and there are a variety of underlying funds to choose from, with varying asset allocations and degrees of offshore exposure. A minimum of R50 000 from your pension or provident fund is required. 

You can expect excellent service from a team of experienced and knowledgeable investment consultants. A preservation fund is a sensible, tax-efficient way of preserving funds for retirement and taking advantage of compound interest. Speak to one of our consultants to find out more about your options.