Financial advisers whose clients insist on making an early withdrawal from their savings component should ensure their record of advice reflects that all alternative options were explored, and the client is aware of the impact of the withdrawal, says Lizl Budhram, the head of advice at Old Mutual Personal Finance.
Budhram was one of the presenters at FANews’s recent webinar for financial advisers on the two-pot system.
In the case of clients who have been members of retirement funds before the implementation of the two-pot system, advisers will have to “balance” the pre- and post-two pot systems because both will run parallel to each other.
All the existing rules, which apply to the vested component, will remain as important as the two-pot rules for many, many years until we reach a position where people retire with only the two new components: the savings and the retirement components, Budhram said.
She said the two-pot system is unlikely to have a significant impact on clients who are close to retirement, because most of their savings will remain in the vested component. But this is not the case for people who are at the beginning of or mid-way through the accumulation phase of their retirement journey. In their case, advisers need to bring the implications of the new two-pot rules into conversations about retirement planning “very clearly”, so the right retirement plans can be constructed.
Advisers also need to know how to advise clients about what they can access on resignation, death in service, retrenchment, or divorce. “Those are events that give rise to very new, different technical outcomes that the adviser would need to be aware of and be able to give the client information and guidance in terms of what to do with their retirement funds,” Budhram said.
It should also be recognised that early access, particularly if a client has multiple funds and the total amount withdrawn is not insignificant, or if the client gets into the habit of withdrawing regularly, will not only impact retirement planning but also risk planning, Budhram said.
Advisers will need to able to guide their clients to recognise how accessing the savings component will impact all the elements of the financial plan (such as life cover, disability cover, the estate plan), not only the retirement element.
Changing the mindset from ‘How much?’ to ‘Should?’
As we head towards implementation on 1 September and in the few months following, one of the key conversations with clients will be around whether they should access the money in the savings component.
Budhram said it is important to realise that the access opportunity per tax year is per contract. So, if a member has, for example, five different retirement annuity contracts and each is seeded with R30 000, the member can access up to R150 000 (before costs and tax). So, accessing the seeding amount can have a more significant impact on a member who has a number of contracts in a number of funds.
“It can make quite a dent in your retirement plan, in your retirement accumulation […] It’s really important to have the right conversations with clients in that position early, so that you can start steering the thinking and the decision-making that they don’t undo a lot of great accumulation over many years that’s putting them in a good position for retirement.”
Unfortunately, surveys show that most people are asking, “How much can I withdraw and when?” Budhram said advisers can play a crucial role in changing this mindset to, “Should I access?”
The real purpose of the savings component is liquidity in an absolute emergency. However, clients should be asking their advisers whether this is the best solution to addressing their liquidity needs.
The two-pot legislation does not define what is a financial emergency. The client and adviser will have to decide whether an event justifies a withdrawal, given that it will be subject to costs and income tax.
It is “really frightening” to see survey results that show people want to use savings component withdrawals for things that are definitely not emergencies. “That’s where really it’s important for the adviser to step in and to have the right kind of conversation from an educational perspective, as well as from a coaching perspective,” Budhram said.
There is a risk that clients or fund members will start falling into a behavioural trap where, come the first day of every tax year, they access what they can. Fostering the right kind of behaviour will require ongoing education and coaching, she said.
Furthermore, fund members who do not have a vested component and who continually withdraw from their savings component each year will have no lump sum at retirement. This will have a significant impact on their retirement plan because currently almost everyone takes at least part of the one-third lump sum at retirement. People who continually withdraw will have nothing in their savings component at retirement, which means there will nothing to which the retirement lump sum tax table can be applied. In this case, the up to R550 000 tax-free will not apply if the member does not have a vested component, Budhram said.
“It’s really important from a long-term planning perspective, to understand the impact of withdrawals.”
Explore other liquidity options
Advisers should dispel the misconception that with the introduction of the savings component, clients do not need an emergency fund. The savings component should not be regarded as a substitute for an emergency fund, Budhram said.
An emergency fund should be a separate solution that is not market-related and will not incur tax or costs if accessed immediately. She said the savings component is intended for retirement accumulation, and it should only be accessed at retirement or if a financial crisis cannot be met by the emergency fund.
Where clients want to withdraw from the savings component, advisers should drive the conversation around, first, whether the client really has a financial emergency and if they do, the alternatives to accessing the money in the retirement fund, Budhram said.
If the client is experiencing a genuine financial emergency, explore other options, such as a premium holiday or reduction, accessing other discretionary investments, a full or partial surrender, or taking out a loan against a discretionary investment. A key consideration is whether the alternative options are more beneficial from a cost or tax perspective.
“It’s really important if a member speaks to you and asks you, should I access my money, I do have an emergency, that you can show that you’ve considered all the other options available to the member before they take from the fund.”
In addition, Budhram said, because members can withdraw from all the funds to which they belong, it’s important to look at the various funds’ underlying investments and withdrawal costs and the prevailing market conditions.
“You may be required to give guidance and advice in terms of which fund is the best one to access. But do consider all the other options before you start recommending access in terms of the savings pot, primarily because of the cost and the tax implications of that.”
Advisers should also ascertain whether guiding and coaching clients on budgeting and better debt m management will enable them to meet a liquidity requirement rather than the “quick fix” of taking the money that is available in the savings component.
Where clients decide, following a conversation with the adviser, that they want to access the savings component because they have a dire financial emergency, it is important that advisers can evidence that they have explained the impact of the withdrawal on the client’s retirement and financial plans, Budhram said. This should include that the client has been aware of the consequences, which may be having to retire later or retiring on a lower income.
Disclaimer: The information in this article does not constitute financial planning or tax advice that is appropriate for every individual’s needs and circumstances.
Hi – Unless i got confused – on 702 today they discussed the fact that members will be able to access their funds directly via Digital access – and as such they have no need to get advice from Management of the company or even an Advisor. The discussion was around the “HIGH risk” of Hackers dep[leting Members Funds – and Members also just depleting their own funds — as they currently do by resigning to get access – quite often “egged” on by Shop Stewards “Financial Advice” – just because “its your money and you can do what you want” – with no vision of the future.
Unfortunately, it appears there is not even a requirement for members to receive retirement benefits counselling to make a withdrawal from their savings pot. Therefore, people who are not working with an adviser are likely to make poorly informed decisions that will cost them in the long run.