Upon leaving your employment as a result of resignation, retrenchment or dismissal, one of the options you have for your retirement funds is to transfer them to a preservation fund for capital growth in a tax-efficient manner. As a repository for the proceeds of company-sponsored retirement funds, preservation funds have some distinctive features which investors should be aware of. In this article, we unpack the advantages and disadvantages of preservation funds to ensure that you can make informed decisions when leaving your employment.
Some of the most notable advantages of a preservation fund include the following:
- Tax-neutral transfer: If you elect to transfer your funds to a preservation fund, note that the transaction will be tax neutral as you are effectively moving your capital from one retirement fund to another.
- One full or partial withdrawal before retirement: One of the most significant advantages of a preservation fund is that you are permitted to make one full or partial withdrawal from the fund before age 55. If there is a likelihood that you may need access to your capital before age 55, then a preservation fund may provide a workable solution. That said, keep in mind that you will be taxed on your withdrawal with only the first R25 000 being tax-free on an individual’s withdrawal tax tables.
- Tax-efficiency: Being an approved retirement fund, preservation funds are highly tax-efficient in that no local dividend tax or tax on interest is payable, and switches between unit trusts within your fund will not trigger a capital gains event.
- Transferring to another service provider: Being a flexible investment, you can transfer your preservation fund from one provider to another for whatever reason, with this process being governed by Section 14 of the Pension Funds Act.
- Tailormade portfolio: If your preservation is invested on a LISP platform, you can tailor-make an investment strategy that is suited to your needs, with the only limitations to your portfolio construction being those imposed by Regulation 28 of the Pension Funds Act.
- Protected from creditors: The funds held in a preservation fund are protected from creditors in terms of Section 37B of the Pension Funds Act, although this section does not provide outright protection. Certain monies can be deducted from your retirement funds, such as money owed to SARS and amounts due and payable under the Divorce Act and Maintenance Act.
- Falls outside of estate: Funds held in a preservation fund, as in the case of money held in all approved retirement funds, fall outside of your deceased estate and, as such, are not estate dutiable – nor do these funds attract executor’s fees.
- Guaranteeing an annuity income: When retiring from your preservation fund, you are obliged to use at least two-thirds of the investment to purchase an annuity income to provide for you during your retirement years.
- One-third withdrawal option at retirement: The option to make up to a one-third withdrawal from the fund at retirement is useful in creating additional liquidity in retirement, especially if you have debt that you want to settle or large capital expenses such as a vehicle purchase or overseas vacation. Unlike making a withdrawal pre-retirement, this one-third cash commutation at retirement is subject the retirement tax tables with the first R500 000 being tax free.
- Competitive fees: When selecting a preservation fund, it is important to ensure that the investment fees are market-related. Preservation funds housed on LISP platforms provide transparent fee structures and, if you’re not happy with the fees or service, there are no costs for transferring your investment.
- Invested for growth: As you do not pay tax on the growth in your preservation fund and (other than the once-off allowable withdrawal) you can’t access your funds before age 55, your money will remain invested for growth and can help fund a comfortable retirement.
- No forced retirement: You do not need to retire from your preservation upon formal retirement from work. You can keep your money invested in your preservation fund for as long as is suitable for your circumstances.
There are a few disadvantages when it comes to preserving your retirement fund benefits, which include the following:
- The limitations of Regulation 28: As preservation funds fall within the ambit of the Pension Funds Act, your investment diversification will be somewhat limited by Regulation 28 which is designed to protect retirement fund investors against poorly diversified investment portfolios. In terms of these regulations, your offshore exposure is limited to 45% of the portfolio value and an equity asset class limit of 75%, which some investors may find restrictive. That said, if you choose to transfer your retirement benefits into a retirement annuity structure, leave it in your current employer’s default investment strategy, or transfer it to your new employer’s retirement fund, you would still be restricted by Regulation 28.
- No additional contributions: Generally speaking, you may not make additional contributions to your preservation fund except if the money originates from another retirement fund. This means that, if you want to keep contributing towards a retirement fund, you may need to set up a retirement annuity which would allow you to make ongoing contributions.
- Tax on withdrawal: While the ability to make one full or partial withdrawal before age 55 may appear advantageous, keep in mind that you will be taxed on the withdrawal with the first R25 000 being tax-free. Before making a withdrawal, ask your service provider to prepare a tax simulation for you so that you fully understand the tax implications of making a withdrawal.
- Distribution of benefits via Section 37C of the Pension Funds Act (PFA): Although you can keep your funds invested in a preservation fund for as long as you like, there are estate planning implications for doing so which should be kept in mind. If you die while your funds are housed in a preservation fund, the distribution of your death benefits will take place in terms of Section 37 of the PFA. In terms of this legislation, the fund trustees are responsible for identifying your financial dependants and for allocating the funds proportionately. This means that the beneficiary nomination on your preservation fund will be used by the trustees as a guideline when making their determination.
Remember, when leaving your employer as a result of resignation, retrenchment or dismissal, there are several critical financial decisions that you need to be made and it is always best to discuss these with an experienced, independent advisor.
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