Henri Le Grange
SOUTH Africa’s move to implement the Two-Pot Retirement System in September this year places financial advisers at the forefront of significant regulatory changes. Amid a backdrop of escalating debt challenges and a rising cost of living, the reform promises to balance short-term financial relief with long-term financial security.
Leveraging retirement savings for debt repayment, especially against high-interest liabilities, requires very careful deliberation of its future impact.
The Two-Pot Retirement System divides retirement savings into “two pots”, allocating funds into a readily accessible savings pot for pre-retirement emergencies and a locked retirement pot for post-retirement income.
I caution against the opportunity cost of tapping into retirement savings to pay off debt. A study in Chile using Monte Carlo simulations shows that a 10% early withdrawal from your pension fund can lead to a loss of $1.59 in future retirement savings for every $1 withdrawn, reducing monthly pension benefits by 7.26%.
The allure of tapping into retirement funds to alleviate debt should be a measure of last resort. Advisers must help customers weigh the costs, including potential taxes and fees, against the benefits of clearing debt.
Rather, champion an advisory-driven approach to debt management. Personalised, comprehensive financial strategies are essential. Financial planning should not be a one-size-fits-all affair. It’s about encompassing the entire financial picture of an individual.
Advisers should only recommend using retirement savings to pay off debt in cases of really no alternatives, severe financial hardship, life-threatening medical emergencies, or during periods of unemployment. Exploring alternative debt management strategies such as consolidation, home equity leveraging, and budget optimisation before dipping into retirement savings.
Six practical ways to help customers manage debt in the context of the Two-Pot Retirement System:
1. Explaining the Two-Pot Retirement System: Advisers can clarify the concept of dividing retirement savings into two pots: a savings pot that is somewhat accessible before retirement for emergencies and a retirement pot that is strictly for retirement income and cannot be accessed early. This system encourages balancing immediate financial security with long-term retirement planning.
2. Educating Customers on Debt Types: Advisers can help customers understand the differences between secured and unsecured debts, as well as revolving and instalment debts, including the interest rates associated with each. This knowledge allows customers to make informed decisions about which debts to prioritize for repayment.
3. Developing Comprehensive Financial Strategies: Financial advisers can assist customers in creating balanced financial plans that include both debt repayment and the establishment of an emergency fund. This dual approach helps mitigate the risk of falling back into debt due to unforeseen financial emergencies.
4. Prioritising High-Interest Debts: Advisers should emphasise the importance of targeting high-interest debts first, such as credit card debts, using the avalanche method. This approach focuses on paying off debts with the highest interest rates first, which can lead to significant interest savings over time.
5. Cautioning Against Premature Retirement Fund Withdrawal: Advisers should explain the long-term consequences of using retirement savings for debt repayment, such as reduced retirement funds due to early withdrawal penalties and taxes, and the potential for compromised financial security in retirement.
6. Exploring All Alternatives: Before resorting to using retirement savings, advisers should guide customers through other debt repayment options, such as debt consolidation, negotiating for lower interest rates, and budget adjustments to allocate more towards debt repayment.
Preserving retirement savings for their intended purpose is crucial. These funds are meant to secure financial stability and comfort for consumers when they no longer earn a regular income. Using them for purposes other than retirement could compromise their ability to maintain a desired standard of living in later years.
* Le Grange is the Old Mutual Personal Finance Certified Financial Planner®.
PERSONAL FINANCE