Why dipping into your retirement savings is not a good debt relief idea Dipping into your emergency funds can limit your retirement options; rather look at debt consolidation
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Why dipping into your retirement savings is not a good debt relief idea

Published: October 6, 2020
Categories: Debt Relief
Tags: Consolidation Loan, Debt Consolidation, Debt Management, Debt Relief

Covid-19 has done a lot of damage to our already battered economy and many people are struggling to make ends meet and to get out of debt. But before you cash out your retirement savings, think about the long-term consequences and consider other options.

Most employed South Africans contribute to a pension or provident fund through their employer. It can be difficult to see that deduction on your payslip every month, especially when the bills you have to pay are more than the money you bring home. However, that retirement saving is extremely valuable, and you will be very grateful for it when you retire one day.

When you change jobs, you have the option to cash out your pension fund and take the money, or to transfer it to your next employer or into an investment fund. Research shows that about 77% of South Africans choose to take their pension money and use it when they change jobs, instead of preserving it and keeping on saving. In fact, some people resign specifically to get to their pension cash when times are tough.

Their reasoning often is that if I can’t survive today, my pension will be of no use 10 or 20 years down the line. This is especially true in times like these when a global event has cost many people their jobs.

Let’s look at why you shouldn’t cash out your pension, and what other options you have to deal with debt.

The cost of using your pension money today

There are three costs linked to using your retirement savings before you reach retirement age:

  1. You pay a lot of tax. South Africans get a tax-free benefit of R500 000 at retirement. That means that you don’t pay tax on the first R500 000 you take as a lump sum. When you take the money early, you pay tax on it and your retirement tax-free benefit is reduced by the amount you take now. As a result, you will have to pay more tax when you retire.
  2. You lose the benefit of compound interest. Compound interest means you earn interest on the interest that your retirement savings are earning. The longer you save, the more interest you earn. The benefit of compound interest is massive. For example, if you started saving R2 500 a month now at an interest rate of 10.5% per annum, you could potentially earn R1 million in 13 years. Astoundingly, your contribution would only be R498 000; the rest of the money is interest that you would have earned.
  3. You could run out of money in your retirement. This is probably the most difficult consequence to think about because for many of us retirement is very far away. We tend to think we’ll solve that problem when we get there. Sadly, this is a very short-sighted way of looking at your finances, and it is not helpful at all.

But how do I survive now?

According to research, some 63% of people who cash out their pensions, use the money to get out of debt. The good news is that there are other ways to clear the debt. One of the best options is debt consolidation.

When you consolidate your debt, you take out one big loan to pay off several smaller loans, so that you are left with only one, more affordable repayment. In the process, you can settle your other debts early, which puts you in the position to negotiate settlement discounts with your credit providers. In exchange for getting their money early, most credit providers will be willing to give you a discount. As a result, the value of your consolidation loan will be less than the total of your previous debts, which means your single monthly repayment is usually less than what you used to pay before. You will also pay less interest on the lower, consolidated amount.

Debt consolidation is a good way to get out of debt trouble. The goal, however, should be to stay out of trouble. You can achieve this by:

  • Stop using credit cards or any other accounts that were settled by the consolidation loan. The best advice is to close the accounts and cut up the credit cards.
  • Being disciplined with your money and not borrow again. As soon as you have paid off your debts, creditors will be ready to offer you loans again – do not fall into the same trap.
  • Improving your financial knowledge and keep implementing and following healthy money habits.

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