The importance of an emergency fund in the two-pot era
The two-pot retirement system, which was implemented on 1 September 2024, aims to combat both immediate and long-term hardship by allowing limited access to retirement funds, while enforcing preservation, with the aim of improving retirement outcomes.
But, says Tebogo Marite, communications specialist at Allan Gray, while access to the savings component may provide welcome relief to those in dire need, as a retirement fund member, it is vital to be mindful of the unintended consequence of unnecessary early access, which can prevent investors from reaching long-term investment goals.
“Your retirement savings are intended for a very specific purpose: funding your income in retirement. Despite getting access to a component for emergencies, it is important to guard against thinking of your savings component as your emergency fund. Depleting your savings component annually will result in you having one-third less on which to retire,” she cautions.
She says a critical starting point is to protect yourself against the risk of unknowns by building up an emergency fund.
How to set up an emergency fund
“Aim to accumulate at least three times your monthly salary. This should be invested in a low-risk unit trust, such as a money market fund or an interest fund, which will preserve your capital over the short term and offer easy access when needed.”
Ultimately, you should aim for your emergency fund to be sufficiently sized to buy you enough time to manage and recover from a crisis without the need to dip into your long-term investments.
“It is not prudent to rely on long-term investments – including the savings component of your retirement funds – as they are specifically intended to meet long-term goals and are typically invested accordingly, with relatively high equity exposure.”
However, she reminds investors that while equities are the best way to ensure your portfolio beats inflation over the long term, market ups and downs are to be expected. This means that equities are not well suited for short-term savings or emergency funds, because if you need cash during a market downturn, you may be forced to sell at a low, locking in losses.
“An appropriately invested emergency fund can help you avoid this scenario.”
Avoiding temptation to withdraw for non-emergency purposes
Marite says withdrawing for reasons other than financial distress can cost you more than you think down the line – both in terms of losing out on growth and due to the punitive tax implications.
Example: You are about to turn 40 and decide to make a withdrawal of R30 000 from your savings component to fund your birthday party. After all, you are only going to retire at 65 and can easily replenish the amount.
Consider the following:
- You may only be withdrawing R30 000 today, but assuming above-inflation returns of 5% per year, your withdrawal is just above R100 000 of your future retirement savings, in today's money terms.
- You are unlikely to receive R30 000 in your bank account. The funds will form part of your gross income for the tax year and will be taxed at your marginal tax rate, which means you will only receive the after-tax amount.
- You could be pushed into a higher tax bracket for the year of assessment.
“By setting out clear investment objectives and building emergency reserves that are separate from your long-term investments, you can preserve your long-term investments for their intended purpose, while having enough to protect you against the unpredictability of life,” concludes Marite.