The golden rule of realising value out of your retirement savings is to
save consistently from all your incomes. FILE PHOTO | NMG
The aim of having a
pension plan is to afford consistent income in retirement; however,
there are occasions when a contributor can access all or a portion of
their money before retirement.
The most common types of
early withdrawals occur when retirement fund members change jobs or
resign and they need some kind of money to stay afloat.
Research
shows that people typically move jobs between five to seven times
throughout their career life, and one of the biggest retirement mistakes
one can make is to cash out pension fund whenever one changes jobs.
The option to cash out one’s pension is a big temptation which
many people cannot resist and it is a matter of great concern. People
will give all kinds of explanations for cashing out, from “I have to pay
off my debts,” or “I am okay paying the tax, “I will make up for it
later,” or “I’ll get another investment with better returns than my
pension fund.” Then upon reaching retirement, with barely enough money,
not preserving the capital becomes one of their biggest regrets.
Many
members exercise the option of taking their money without fully
understanding the devastating impact “premature withdrawals” will have
on their long-term pension plan and their future.
While
this may seem like a quick cash-flow remedy, cashing out your pension
not only borrows from your future for early gratification but is also in
actual fact an act of self-sabotage of your financial position in
retirement.
Pension consultants at Enwealth Financial
Services observe that many retirement fund members are unaware of the
severity of having to pay hefty penalties and tax. Although the
penalties for early withdrawals vary depending on the service provider,
legislative taxes still apply.
According to a tax
report released by Deloitte and the Kenya Revenue Authority, all early
withdrawals are subject to normal Pay-as-You-Earn. Constant withdrawals
out of your pension fund and relatively low contributions will
significantly result in paying more tax for each withdrawal, leaving you
with less and less money to retire on.
Taxes aside, premature withdrawal from a retirement plan can
cause the fund member to lose on compound interest. When you withdraw
early, you not only lose your savings but also you miss out on the
accumulative interest you would have earned over time.
This
is referred to as opportunity cost, a popular term used by investors
where one misses out on compounding interest over time.
To
put this into perspective, imagine you started working at 25 years of
age and started your long-term savings towards retirement at the start
of your working life. Assuming you save Sh1,000 per month over your
entire working life without “breaking into the vault” for 25 years until
age 50, your savings would grow to Sh1,233, 324.90 based on an average
annual net return of nine per cent. However, if after 10 years you
choose to change jobs, cash out your retirement to, for example, upgrade
your phone, car and to start saving afresh at your new company, the
consequence is that when you retire you would have saved only Sh398,000,
that is 68 per cent less to retire on.
The golden rule
of realising value out of your retirement savings is to save
consistently from all your incomes and preserve your benefits to realise
the benefits of compound interest over time.
Cashing
out your money during the journey is tempting but will invariably not be
worth it in the long run. It is also wise to utilise pension funds as a
vehicle to effectively diversify your investment and manage your tax
liabilities and lastly not to forget that the objective behind savings
is to attain financial security and freedom in retirement.
Nelson Kuria, Chairman, Enwealth Financial Services Ltd.
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