9 things to consider when you are retrenched

  1. Retrenchment has become very common in South Africa in our current economic environment. This does not detract from the fact that if you become retrenched it can be a very emotional time. To assist in removing some of the fear associated to retrenchment, I have put together 9 points to consider.
  2. First start looking for a job (Plan A) or another source of income (Plan B)
    Your first priority is to replace the income that you have lost.  This must take precedence over all other considerations! Plan A – If you are young, skilled and readily marketable you can look for a new job.

    Go to employment agencies and lodge well prepared CVs.  Search advertisements on-line and in the newspapers for suitable jobs and apply with well-prepared CVs and other personal information.  Update your LinkedIn profile and ensure that it reveals that you are in the market for a new job.  Here is a link for The 31 Best LinkedIn Profile Tips for Job Seekers.

    Plan B – Your other option is to find another source of income.

    If you are not so young and not so marketable there is really only one option and that is find a regular source of income.  This is not a death sentence and there is no need to panic. There are many options out there to be considered.  You just need to be open to them. If you are over 55, you can consider early retirement and I will expand on this further on.

  1. Claim from UIF
    This can be a lengthy process.  There have been reports of a backlog of UIF payments due to the implementation of a new claim system.  Ensure that you have all the relevant documentation required to make the application.  Also consider going through an agency to make the application on your behalf.  This will be an added expense but it may be worth it in the end.
  1. Know exactly how much money you stand to receive
    Your severance package, which must be taken in cash is made up of your severance amount, pro rata bonus, if applicable, notice pay and leave pay, if owed to you.

    Your Retirement Fund value. You can either preserve this for retirement or take it as cash.  Wherever possible try and preserve as much of your retirement benefit as you can in a retirement fund preservation product or in the retirement fund of the company you are leaving.  You should only take this amount is cash as a last resort.

    Tax
    For the purposes of retrenchment, as referred to above, severance packages and cash withdrawn from a retirement fund at retrenchment are added together and taxed in terms of the Second Schedule to the Income Tax Act as though the person retired.

    Rates charged:

  • Up to R500 000 is tax free;
  • R501 000 to R700 000 is taxed at 18 percent;
  • R701 000 to R1 050 000 is taxed at 27 percent; and,
  • Any amount in excess of R1 050 000 is taxed at 36 percent.

    What is important to remember is that concessions used at retrenchment will reduce tax concessions at a later retirement.

    Example of tax payable

    Let’s say, you receive a severance package of R450 000 and your full retirement fund value is R1 200 000.

    If you take only take the severance in cash;

    R450 000 is less than R500 000 so there would be no tax payable at all.  To do this the retirement fund money would need to be invested in a retirement fund preservation fund product or left in your old retirement fund.

    You would thus have retained the full value of your severance package and the retirement fund.  A total of R1 650 000.

    If you take the full cash withdrawal benefit from the retirement fund and the severance cash.

    The total of R1 650 000 (R450 000 severance and R1 200 000 pension) is obviously great than the R500 000 tax free withdrawal amount and so tax will be levied on the R1 150 000. The tax amounts to R346 500.

    You would thus receive your severance package and the retirement fund less the R346 500 tax.  A total of R1 303 500.

  1. Deal with debt, if you have any

    Find out exactly how much you owe, to whom you owe the money and what interest rates are charged on each amount.  It’s also important to know which debts have retrenchment insurance and how that actually works.  Setting out a summary of these makes the picture very clear.

    Once the full picture is established you will be able to think about the next step.  It is important to know what rates of interest you are paying on each debt so that you can start by paying off the debts with the highest interest rate first.

    There are two possible ways of dealing with debt at the time of being retrenched.  The first is to settle it all with the money that you have and the second is to continue paying your instalments to make your capital last.

    People like to settle their debts as quickly as they can but what use is it to do that if it leaves you with no money to live on.  If you are able to settle all debt in one fell swoop and still have enough cash to carry you until you can either re-establish yourself with a new job or a way of earning money then clearly it’s something to consider.

    What I have found is when people pay off their debt when they receive large sums of money, within a very short period of time they are right back where they started with just as much debt if not more.  Paying off debt opens the door to access more debt.

    Withdrawing any part of your retirement benefits to deal with debt is a tricky decision as the reward of getting your debt paid off earlier will mean that you will have less money to retire on later.  If you do need to withdraw money from your retirement fund please think it through very carefully.

  1. For how long can your money last?

    This is best illustrated with an example. Let’s say you received an after-tax severance package of R250 000 and you contribute R20 000 per month to the family budget.  If you divide R20 000 into R250 000 it gives you 12. That is 12 months breathing space in which to find another way of earning a living.

    However the sooner you can find a way of earning a living the more saving you will retain and be able to invest.

  1. Preserving retirement fund benefits and other investments

    One of the aims of a working life is to accumulate money for a comfortable retirement.  This requires that all savings be protected and encouraged to grow as well as possible for as long as possible.  So whenever one is retrenched, or resigns, it is important to keep your retirement fund proceeds growing.

    A)Products and investment considerations for preserving retirement fund benefits;
    The money may, in most cases, be transferred to the pension or provident fund of a new employer.  New legislation will permit you to leave your retirement benefits in the retirement fund of the employer you are leaving and retire with those benefits at a later date.
    The money can also be invested in a retail financial product called a preservation fund.  Or the money can be invested in a retirement annuity.

    B)Costs
    Costs play a huge part in the amount of capital you will have when you retire.
    If you leave your retirement money in your old employers’ retirement fund you will pay negligible costs as you are enjoying the lower costs that retirement funds enjoy.  This means more for you at retirement.

    On retail products such as preservation funds and retirement annuities investment, administration and advice costs are charged as a percentage of the capital sum invested in these transactions and must be watched very carefully.

    With a gross investment return of say 12 % pa this represents a reduction in yield of 25 %.  (3% as a percentage of 12%)  With a gross return of 10 % per annum this is a reduction in yield of 30 %.

    C)Taking the next step in preserving benefits
    If you have a new job to go to you can ask your new HR department to explore moving your money across to that new employer’s fund, or you can leave it where it is.

    There are several ways to invest either in a preservation fund or a retirement annuity fund in the retail market. You could approach a financial advisor or you could approach any of the institutions that provide preservation and retirement annuity funds directly to the public.

    Choosing the investment portfolios for your preservation or retirement annuity fund is important.  All the insurance companies and unit trust houses such as Allan Gray, Coronation, Sygnia, 10X and Stanlib (to mention a few) provide both retirement annuities and preservation funds

    D)Treatment of other investments
    With the pressure of a retrenchment people often forget about their other investments.  At times like this it is a good idea to review all your investments to see exactly what your situation is.  Most people tend to see their investments as many different “packages” but the secret of success is to view them as a whole.  There should not be a separate investment strategy for different bits, investments should be coordinated.

  1. Continued retirement planning
    Being retrenched does not change the fact that you are going to retire one day.  Yes it is a bump in the road but unless you are old enough and well enough off financially to retire you need to continue providing for your retirement.  This means continuing to save and to plan and monitor your progress towards your retirement goals.
  1. Examine the option of early retirement if you are 55 years old or older
    In South Africa retirement fund members may not retire before reaching the age of 55.  So this is only an option for anyone who is retrenched at or after reaching 55 years of age unless you have other none retirement fund saving that can hold you until you turn 55.

    A)Assessing whether or not you can afford to retire;
    1) What level of income can you expect from your pension fund amount?
    A good rule of thumb is to calculate income from your retirement capital as being an annual income of about 4.5 percent of the capital.  The reason for using what looks like a low estimate is because after earnings are withdrawn each year the capital must grow enough to replace that income and to provide for an inflationary increase in capital as well as costs.

    The more you draw and the higher your costs the more your investments need to earn for your capital to retain its purchasing power.

    2) Taking other investments and potential income sources into account
    All other investments can have the same rule applied so if you add pension and other assets and multiply by say 4.5 percent you will have a very good idea of what your annual income will be before tax.  This takes sustainability of the capital into account.

    B)Product choices;
    In terms of new regulations to the pension funds act the trustees of your fund will have identified a pension product (annuity) that you can choose if you find it difficult to make a choice in what are often difficult circumstances.  But you must make a clear decision to take up this option if you believe it is the best for you.  If you don’t decide you will not automatically be invested in that product.

    If you don’t understand the details of the product that the trustees have nominated you may well end up in a situation that does not suit you or your needs.

    There are two main pension product types. Unless you understand the pension products you can’t have a meaningful discussion with intermediaries, or institutions about the appropriate product.

    The first is a pension provided by an insurance company that offers guarantees that the pension won’t reduce and that payments will continue until the last dying of a pensioner or spouse dies.  This is known as a life annuity or a guaranteed pension.  There are several ways in which these products provide annual pension increases.

    If you opt for the guaranteed pension you can move to the next step which is getting quotations.  You can either do this by working via an intermediary which will probably cost you a once-off fee of between 1.5% and 0,5% of the capital that you invest.  These fees are negotiable and unless you can really see a purpose in paying a lot of money for the assistance you should not consider paying more than 0.5%.

    You can also approach life offices directly for guaranteed pensions but it is not always easy to find the right person and maybe an advisor is a good option.

    The second is the living annuity, an investment product with no guarantees, where the capital must be managed and where the pensioner takes all the investment risk.

    If you opt for the living annuity you are taking on a much more complex task.  The management of such a product is balancing investment performance against what you withdraw as a pension.  Investment returns are difficult to influence in the short term so the main management tool is the ability to reduce the pension that you draw.

    This aspect, the choice of pension product, is so important that it must be carefully examined in considerable detail to ensure that such a far-reaching decision is not taken lightly.

    C) Management aspects;
    For those who invest in a guaranteed pension there is very little management beyond ensuring that they complete their annual certificates of existence.
    The living annuity requires management of the income that a pensioner draws so not to deplete the capital too soon when investment results are poor.  There is an element of managing investments but that should largely be left to the money managers themselves once a strategy has been decided on.

  1. Taking the first step
    So like everything else in life the first step is to research the subject before moving to the next phase in your life. Ensure that you make decisions from a place of knowledge and not from a place of fear.

Good Luck!
Dave Crawford CFP®
23rd October 2018