Leaving an employer creates one of the most important financial decisions many people will make, namely, what to do with the retirement savings accumulated in their employer’s pension or provident fund. While many members assume that the logical destination for these funds is a preservation fund, it’s important to note that this is only one of several available options.
Depending on the rules of both the transferring and receiving funds, a member may leave the benefit invested in the former employer’s retirement fund, transfer it to a preservation fund, move it into a retirement annuity, or consolidate it with the retirement fund offered by a new employer. Choosing between these options involves far more than simply comparing investment returns. It’s important, also, to consider costs, investment flexibility, governance, administration, future contribution opportunities, and accessibility before retirement.
Although taking the benefit in cash when resigning is often an available – and attractive – option, it is almost always the least desirable. Besides triggering immediate tax, a cash withdrawal permanently removes retirement capital from the power of long-term compounding, while also reducing the tax benefits available when retirement eventually arrives because retirement fund lump sums are taxed on a cumulative basis. Here we explore the four available options.
Option 1: Transfer your benefit to a preservation fund
The nature of a preservation fund: A preservation fund is specifically designed to receive retirement benefits when membership of an employer-sponsored retirement fund comes to an end. Provided the transfer takes place directly between approved retirement funds, it can generally be completed without triggering tax, allowing the full retirement benefit to remain invested.
The advantages: One of the greatest attractions of a preservation fund is the flexibility it offers. Investors are no longer limited to the investment menu selected by their former employer and can instead choose a provider and investment strategy that align with their broader financial plan, risk profile and long-term objectives. In many cases, a preservation fund also provides access to a wider range of investment portfolios and makes it easier for a financial adviser to integrate the retirement capital with the client’s overall investment portfolio.
Another distinguishing feature is that a preservation fund generally retains the once-off pre-retirement withdrawal from the vested component, provided this right has not already been exercised, while the savings component remains subject to the separate withdrawal provisions introduced under the two-pot system.
The disadvantages: The primary limitation is that additional monthly contributions cannot ordinarily be made to a preservation fund, and investors must therefore build future retirement savings elsewhere.
Key takeaway: A preservation fund is often most suitable where an individual wants greater investment choice, does not have access to a suitable employer fund, or wishes to preserve the valuable once-off withdrawal right attached to the vested component.
Option 2: Leave your benefit in your former employer’s retirement fund
The nature of the investment: Many people are unaware that, where the rules of the fund permit, they are not obliged to transfer their retirement benefit when leaving employment. Instead, they may become a paid-up member, allowing the accumulated retirement capital to remain invested within the former employer’s fund until retirement or until they decide to transfer it elsewhere.
The advantages: This can be an excellent option where the existing fund is well-governed, competitively priced and offers high-quality investment portfolios. Large occupational retirement funds often enjoy institutional pricing that individual investors cannot easily access, while leaving the investment where it is avoids unnecessary administration and allows the retirement strategy to continue uninterrupted. For someone nearing retirement, this stability may be particularly valuable.
The disadvantages: The downside is that no further contributions can generally be made to the fund, investment choice may be relatively limited, and members remain subject to the governance, administration and investment decisions of the trustees. Another consideration is that, over time, retirement savings spread across several former employer funds can become fragmented, making it more difficult to monitor overall retirement progress and maintain a coherent long-term investment strategy.
Key takeaway: Leaving retirement capital in a former employer’s fund is therefore most appropriate where the fund remains highly competitive, and there is little practical benefit in transferring elsewhere.
Option 3: Transfer your benefit to a retirement annuity
The nature of the investment: A retirement annuity is a personal retirement savings vehicle that can receive a tax-neutral transfer from an employer’s retirement fund. Unlike an occupational retirement fund, ownership remains entirely independent of future employment, making it particularly attractive for individuals who become self-employed, work as independent contractors, or join employers that do not offer retirement fund membership.
The advantages: Perhaps the greatest advantage of a retirement annuity is that future contributions can continue indefinitely, allowing both the transferred capital and ongoing retirement savings to accumulate within a single retirement structure. Investors also enjoy considerable freedom when selecting investment portfolios and providers, while the retirement savings remain independent of future career changes.
The disadvantages: The principal disadvantage is that retirement annuities offer less flexibility if you need access to your retirement capital before retirement. Unlike preservation funds, they do not provide the once-off pre-retirement withdrawal that preservation funds generally allow, meaning your retirement savings remain more firmly preserved until you reach retirement age. While the savings component remains subject to the separate withdrawal rules introduced under the two-pot system, investors who value retaining some degree of access to their retirement capital may find a preservation fund more attractive.
Key takeaway: A retirement annuity is often the preferred solution for individuals who wish to continue making retirement contributions independently while consolidating their retirement savings into a single long-term investment.
Option 4: Transfer your benefit to your new employer’s retirement fund
The nature of the investment: Where the new employer’s retirement fund permits incoming transfers, members may consolidate their previous retirement savings into the new pension or provident fund. Assuming the transfer takes place directly between approved funds, the transaction can generally occur without triggering tax.
The advantages: Consolidation can simplify retirement planning considerably in that all retirement savings are then housed within a single fund. Further, future employer and employee contributions accumulate alongside the transferred capital, beneficiary nominations become easier to manage, and administration is often simpler. Large employer-sponsored funds may also benefit from institutional investment fees that compare favourably with individual retirement products.
The disadvantages: This option is only as good as the new employer’s retirement fund, bearing in mind that some employer funds offer relatively limited investment choice, while others may be more expensive or less efficiently administered than the fund from which the member has resigned. Our advice is that convenience alone should never determine the decision.
Key takeaway: Where the new employer’s retirement fund is well governed, competitively priced and aligned with the member’s long-term retirement objectives, consolidation can make excellent sense. Where it is not, one of the alternative retirement vehicles may prove more appropriate.
Each of these options can be appropriate under the right circumstances, which is why the decision should never be made in isolation. Ultimately, there is no universally superior destination for retirement savings following resignation. The most appropriate solution is the one that preserves retirement capital, protects valuable retirement rights and fits comfortably within the investor’s broader financial plan, recognising that this decision may influence their financial security for decades to come.
Have a great day.
Sue
