Last Updated on 15/02/2024 by Carl-Peter Lehmann
Navigating the plethora of options can be daunting, especially when planning for retirement. In South Africa, preservation funds play a pivotal role if you’re serious about securing your financial future. Whether you’re a seasoned pro or just starting out in the world of work, understanding preservation funds can be a game-changer. Let’s dive in and explore what these funds are, their benefits, including taxation perks, and the investment options available.
What Are Preservation Funds?
At their core, preservation funds are retirement savings vehicles designed to protect the money you’ve already saved. Think of them as a safe haven for your pension or provident fund benefits when you switch jobs. Instead of being tempted to cash out your retirement savings (and face the hefty tax consequences), you can transfer them into a preservation fund. This move isn’t just about saving for a rainy day; it’s about ensuring you have a stormproof shelter when retirement comes knocking. In any event, the ability to cash in your pension or provident fund in full when resigning from your employer is changing with the advent of the new two-pot retirement system.
Read More: Latest Updates on the new Two Pot Retirement System
Pension Preservation Funds vs. Provident Preservation Funds
In South Africa, you’ll find two main flavors of preservation funds: pension and provident, each tailored to safeguard your retirement savings with distinct tax perks. Pension preservation funds cater to those transitioning pension fund savings, allowing a cash withdrawal of up to one-third upon retirement, with the balance used to buy an annuity. Provident preservation funds, traditionally offering full cash withdrawal, now align with pension fund rules for any contributions and growth from 1 March 2021 onwards—though your pre-existing benefits remain fully accessible (taxes may apply). This streamlined approach ensures your retirement nest egg benefits from a structured, tax-efficient withdrawal strategy..
Interesting Facts:
- South Africa has just under 7 million individuals that contribute to a pension fund, provident fund, or retirement annuity fund according to SARS.
- We now have an active taxpayer base of around 26 million people (from a population of c. 60 million), which means less than a third of taxpayers are making any form of formal retirement savings.
- There are around R250 billion in contributions annually being made to these approved retirement savings vehicles by employers and individuals.
Taxation Benefits of Preservation Funds
One pivotal aspect of preservation funds is their tax treatment, which sets them apart as a financially savvy choice. When transferring money from your pension or provident fund to a preservation fund, no tax is payable. However, it’s crucial to note that you cannot make direct contributions to these funds in the traditional sense. Instead, preservation funds are designed to receive transfers of your existing pension or provident fund savings when you change jobs or leave your employer.
This approach ensures that your hard-earned retirement savings continue to grow tax-free until you decide to retire, without the option for additional contributions like you would with a retirement annuity. Should you make a withdrawal from your preservation fund (pre-retirement) as is currently allowed, you pay tax according to the withdrawal tax tables which are penal and something we don’t recommend.
At retirement you are entitled to a tax-free lump sum withdrawal up to a specified limit (currently R550,000 which applies across all your retirement savings), a benefit that can boost your financial well-being in your later years. Moreover, the investment growth within the preservation fund is exempt from income, dividend, and capital gains tax, underscoring the fund’s role as a powerful tool for wealth accumulation.
Preservation Fund Investment Options
Investing through preservation funds offers a variety of options, allowing you to paint your financial future with broad strokes. However, it’s essential to recognize that these investment choices are not without their restrictions.
The Role of Regulation 28
A crucial element in the investment landscape of preservation funds is their adherence to Regulation 28 of the Pension Funds Act. This regulation is designed to protect investors by limiting the exposure of retirement funds to certain types of assets. In essence, Regulation 28 caps the amount of your fund that can be invested in higher-risk assets like equities and offshore investments, promoting a diversified and risk-managed investment strategy.
We’ve openly expressed our reservations about Regulation 28, especially for investors eyeing retirement many years down the line. Our stance is straightforward: Anyone many years away from retirement, should have the ability to allocate 100% to equities to maximize capital growth. The biggest risk we all face at retirement is not having enough so as a thirty or forty year old, being forced to have things like bonds in your portfolio makes very little sense.
What does this mean for you? Your retirement savings are invested in a balanced and prudent manner, reducing the risk of significant losses due to market volatility, but also essentially capping your upside potential.
Tailoring Your Portfolio Within the Guidelines
Given the regulatory framework, preservation funds still offer a spectrum of investment choices, from conservative to more growth-oriented options. You have the opportunity to select a portfolio that aligns with your risk tolerance, investment horizon, and financial goals, all within the safe confines of Regulation 28. Whether you’re inclined towards a more cautious investment approach or seeking higher growth potential there’s a strategy to fit your needs. If you have a long-term investment time horizon, we always recommend opting for a balanced fund that offers the highest long-term growth potential (has the maximum equity allocation).
Choosing From the Best Balanced Funds for Your Preservation Fund
Remember a preservation fund is just the shell or wrapper that houses investments. Within that you want to choose investments that can grow and help you achieve your retirement goals. We have therefore looked at the best performing balanced funds in the SA Multi-Asset-High-Equity Category because they offer the opportunity for the greatest long-term growth.
The High Street High Equity Fund is a small, boutique fund that leads the pack with a very impressive 14.83% annualised return over 5 years. More established balanced funds by Aylett, ABAX and Fairtree are closely grouped and are now widely regarded as amongst the best balanced funds in South Africa.
The Aylett Balanced Fund is the best performing balanced fund in South Africa over 10 years with an 11.01% p.a. return. The ABAX Balanced Fund is next at 10.93%. The Long Beach managed Fund also features amongst the top performers over 5-and-10 year time frames. *Retail share classes used.
The Henceforward Approach
Constructing an investment portfolio is a lot more nuanced than simply choosing the best fund based on past performance. So while we like all the funds listed above, how we construct investment portfolios for clients involves a lot more thought and planning. Nevertheless, we understand that changing jobs can be a pivotal moment in your financial journey. That’s why we stand by our clients every step of the way, ensuring a seamless transition for their retirement savings. When you find yourself navigating the complexities of a career move, we’re here to guide you through choosing the optimal preservation fund option. But we do a lot more than that – because our approach is client-centric, focusing on maximizing your wealth and securing your financial future with strategic, informed decisions using holistic financial planning strategies.
Who Do We Work With?
We work with professionals and executives who are serious about achieving their retirement goals and operate on a unique flat-fee service model so we can remain impartial and offer unbiased advice that serves your best interests.
The Bottom Line
Preservation funds in South Africa offer a compelling mix of tax efficiency, flexibility, and investment options, making them a cornerstone of retirement planning. By transferring your pension or provident fund benefits into a preservation fund, you’re not just saving for the future; you’re investing in a secure and prosperous retirement. Remember, the journey to financial freedom doesn’t have to be a solo voyage. Consulting with a financial planner can help you navigate these waters, ensuring your investment choices align with your retirement dreams. Let’s chart a course towards a future where your retirement is not just secure but thriving.
Consider Reading: If you’re a member of the Old Mutual SuperFund and are resigning or retiring we help you assess your options.
Carl-Peter Lehmann
Carl-Peter is a Director and Partner at Henceforward. He is a CERTIFIED FINANCIAL PLANNER and Investment Professional with over 20 years experience. Helping his clients achieve their retirement goals is something he takes very seriously.
