Preservation funds: Keep your retirement savings on track

Changing jobs comes with some important decisions, especially regarding whether or not to make use of a preservation fund for your employer-sponsored pension or provident fund money.

A preservation fund allows you to ‘preserve’ and potentially compound these savings, which have been growing in your pension or provident fund. If you instead choose to withdraw your pension or provident funds, you risk losing the potential growth that may otherwise have been the case over the long term. This could then ultimately impact your long-term retirement outcomes.

In this article, we look in more detail at the importance of using a preservation fund to keep your retirement savings on the right path to provide for your retirement years.

What is a preservation fund?

A preservation fund is a long-term retirement savings vehicle which allows you to both preserve and potentially grow these savings over time. Your savings can be transferred across to your preservation fund from your employer-sponsored pension or provident funds when changing roles, without triggering a tax event. You will need to ensure that your provident fund is transferred to a provident preservation fund and your pension fund is transferred to a pension preservation fund.

All growth within the preservation fund is tax-free. This may mean there are more returns available to reinvest and then potentially compound over time. At retirement, which is currently from age 55 in South Africa, your savings can then be used to purchase an annuity (either a life annuity or a living annuity), which will then provide you with an income for your retirement years.

Why cashing out can derail your retirement

The tax impact of early withdrawal

Early withdrawals may be taxed at a higher rate than if you wait until retirement age to withdraw your savings. Please see the SARS tax tables below, which have been taken from the SARS website:

The compounding cost

By withdrawing your hard-earned capital, you will not be able to take advantage of the power of compound growth over time. It can be tempting to withdraw the cash and have it in hand, but this needs to be rationally weighed up against keeping your savings invested and allowing them 20 or more years of potential compound growth.

To illustrate this, consider an investor who withdraws R200,000 when changing jobs, compared to an investor who preserves the full amount in a preservation fund. If that R200,000 remained invested and grew at 10% per year, it could grow to more than R1.3 million over 20 years.

On the other hand, by cashing out early, the investor loses the initial capital and the significant potential growth that could have been generated over time. We can see how even a single withdrawal can have a major impact on long-term retirement outcomes.

The Two-Pot retirement system

It’s also important to be aware of the new rules regarding preservation fund withdrawals. The Two Pot Retirement System was implemented in September 2024, and this has brought with it some changes.

All contributions will now be split between two ‘pots’, namely, the ‘retirement pot’ and the ‘savings pot’. Two-thirds of contributions will be going to the retirement portion, and one-third will be allocated to the savings portion. While preservation funds do not receive new contributions, existing balances were partially allocated to a savings component when the system was introduced. The savings component of the preservation fund will grow at the same rate as the total fund. There is also a third portion, which is called the ‘vested pot’, for contributions made before the implementation of the Two-Pot system.

If the total fund grows by double the size, both the savings pot and the vested pot will also grow by double the size. You are able to withdraw from your savings pot once per year for a minimum amount of R2,000. These withdrawals are taxed at your marginal tax rate, and an administration fee will also be applicable.

You are not able to withdraw capital from your retirement pot. This pot is only accessible from retirement age. Please consult the latest FSCA guidance on the Two-Pot Retirement System.

Asset allocation: The engine behind long-term growth

What is asset allocation?

Asset allocation is the mix of the different asset classes in which your underlying savings are invested. This is usually a mix of equities, real estate (property), bonds and cash. Each of the asset classes presents different characteristics. At 10X, you have the freedom to adjust your underlying portfolio by choosing from a selection of carefully designed funds, each with a different mix of assets and geared towards different investor profiles.

Equities are likely to generate the best returns over the long term, as well as being the most volatile of the asset classes. Equities have historically produced returns above inflation, by around 7% annually over the long term (based on JSE All Share Index performance versus CPI from 1960-2020); however, past performance does not guarantee future results.

Real estate can provide a good hedge against inflation as well as produce some good returns. Bonds may add some stability to your portfolio, but they may also produce some lower returns. While generally seen as a more conservative option, this does not mean bonds will never outperform expectations. Cash will produce the lowest returns of all the asset classes, but it will also be the most stable of the assets.

Aligning asset allocation

Your aim should be to align your asset allocation with your investor profile, which looks at your investment timelines and your risk profile. Your investment timeline is how long you have until retirement and how long you anticipate having the capital invested. Your risk profile focuses on your appetite for risk. In other words, how comfortable you are as an investor with some short-term market volatility.

You will also want to keep focused on your long-term financial plans and goals, ensuring that your selected asset allocation aligns well with this. A portfolio that meets with your asset allocation and that is also well-diversified can help you to balance both risk and reward as you move through the different economic cycles.

Asset allocation plays the biggest role in the performance of your preservation fund, accounting for over 90% of returns, as seminal research from Brinson, Singer and Beebower shows. At 10X, we offer our investors a range of well-diversified funds allowing you to choose a fund that aligns well with your investment timelines, risk profile and long term financial goals. Please visit the funds page for the most up-to-date fund information.

Regulation 28 explained

Preservation funds are governed by Regulation 28 of The Pension Funds Act. This act puts in place some caps in order to help investors avoid poorly diversified portfolios. Current regulations state that you may have up to 45% invested offshore and up to 75% invested in equities. Diversifying offshore may be a good hedge against local market instability and any depreciation of the Rand.

Fees: The silent threat to your retirement savings

Sometimes, investors fail to fully appreciate the importance of fees when it comes to retirement savings. While a 1% or 2% difference in fees may initially seem insignificant, it can have a major impact on retirement outcomes.

Types of fees in a preservation fund

There are a few kinds of fees that you might see deducted from your preservation fund. Let’s have a look at some of these fees:

• Management fees: These are the fees charged for the running of the fund.
• Advisor fees: An advisor will provide you with advice and other services. They may charge both an initial and an ongoing fee for this.
• Administration fees: There may be administration fees charged for activities such as tax, compliance and reporting.

Why a 1 or 2% difference matters

Let’s have a look at an example which highlights the effect of fees (1% vs 3%) on your preservation fund over the long-term. Let’s assume the following factors for our example:

• Investment period of 30 years
• Investment of R100,000
• Return of 12% per annum
• An inflation rate of 6%

Example 1 (1% Fees): Real investment value is R398,578.

Example 2 (3% Fees): Real investment value is R231,004.

We can see how a small difference in fees leads to major differences in retirement outcomes. This example is for illustrative purposes, and real results may vary. You can learn more about the impact of fees by reading our fees blog.

10X makes use of a low-cost and transparent fee structure, which is simple for all investors to understand. We use an index-tracking investment strategy alongside a more active approach to asset allocation. This is more cost-effective due to the reduced number of activities associated with this investment strategy, which results in lower fees being passed onto you, the investor. At 10X, fees charged on retirement products are usually 1% or less, depending on the product selected and the amount invested. Please explore our products for the most up-to-date fee information.

How to evaluate whether you’re paying too much

Your Effective Annual Cost (EAC) is a standardised metric which was introduced in 2015. This shows you the total fees and costs of owning an investment product over one year. All factors being equal, a higher EAC would mean that less of your investment returns can be reinvested and potentially grow and compound over time, while a lower EAC may mean that more returns may be reinvested and allowed to potentially grow over the long term. The EAC is usually expressed as a percentage, and it can be found on your investment statement or requested from your service provider.

The EAC of an investment is just one factor to consider when comparing different service providers. As a part of our free online suite of tools, we offer a handy EAC calculator that can be used to compare the EAC of your investments with the EAC of 10X products. H2: Common preservation fund mistakes to avoid Let’s have a look at some preservation fund mistakes that you would look to avoid:

1. Not reviewing fees: It’s vital that you regularly review your fees and EAC to ensure that your fees are not too high. Understanding exactly what you’re paying for is a key part of being a responsible investor.
2. Selecting a very conservative asset allocation early on: Your asset allocation needs to be carefully selected in order to align with your investor profile and financial goals. Including growth assets, such as equities, may help produce better returns in the long term.
3. Not reviewing your preservation fund annually: You would ideally want to review your preservation fund each year to ensure that your selected choices still match. As circumstances change, your financial goals and timelines may change too, and it’s your job to ensure your asset allocation still aligns with your investor profile.
4. Withdrawing cash: You would ideally want to keep all of your savings invested to allow the capital to potentially grow and compound over time. Withdrawing your money may mean that you miss out on the potential growth of your savings.

What happens at retirement?

From the age of 55, you are able to retire from your preservation fund, although many South Africans will choose to keep savings invested for longer. Under the Two-Pot system, each component of your preservation fund has its own rules at retirement. The retirement pot portion must be used in full to purchase a life or living annuity. No lump sum withdrawals are allowed from this pot. Up to one-third of the vested pot can be withdrawn as a lump sum, and the remaining two-thirds must be used to purchase an annuity. Cash withdrawals from age 55 will be taxed according to the retirement lump sum tax tables below, as taken from the SARS website:

The remaining portion of your savings must be used to purchase either a life or a living annuity. This annuity will provide you with an income for your retirement years.

Preservation funds: The power of staying invested

Keeping your savings invested by means of a preservation fund when you change employers requires discipline. It can be tempting to withdraw the cash when the option to do this arises, but the wise choice is to keep your savings invested. This will allow you to potentially grow your capital over time and potentially improve your retirement outcomes.

You would want to ensure that you keep a careful eye on fees and asset allocation so that this remains well-aligned with your long-term financial plan and goals.

At 10X, we offer a low-cost and transparent preservation fund which allows you access to a range of well-diversified funds. To find out more, don’t hesitate to get in touch with the experienced and helpful investment consultants at 10X!