This article was first published in the third quarter 2016 edition of Personal Finance magazine.
Retrenchment-proofing both your skills and your finances is the best way to equip yourself to deal with the shock of an employer announcing that it no longer needs you. However, it takes a great deal of foresight, time and money to ensure that you have multiple skills (so you would be in demand by employers, or able to generate an income by freelancing or running your own business), or to develop skills that are so sought-after that that they protect you from retrenchment in the first place.
Often, your ability to adapt is affected by retrenchment taking place later in life. It is certainly never easy to weather this particular storm, but it is not impossible to protect yourself by factoring the risk of retrenchment into your financial planning.
The best defence is an emergency fund, and many financial experts advise their clients to save the equivalent of at least six months’ income in such a fund. This can be a high target for young people who are still working their way up the income ladder and are paying off expensive items, such as a car or a home. If you have a mortgage bond on your home or have bought a car on credit, you may wonder about the wisdom of tying up money in an account that allows you to access it quickly, because the interest you earn is unlikely to exceed the interest you are paying on your loan.
The compromise, for a homeowner, may be an access bond into which you can pay additional savings, thereby lowering what you pay in interest on your loan, while ensuring that the extra funds are available immediately if you are retrenched.
Taking out retrenchment cover, as this article explains, is an expensive way of protecting yourself against the risk of losing your job. As retrenchment is relatively common in South Africa, the probability of a life assurer having to pay you the benefit is high, so the premiums are also high.
Another limitation of cover for retrenchment is that assurers typically require you to have been employed by your current employer for at least a year before you qualify for the benefit.
If retrenchment takes you by surprise before you have had a chance to put in place the perfect plan to deal with it, take stock of what you have:
* How much do you have in an emergency fund?
* Do you have any leave owing to you?
If your employer allows it, one measure you can consider is to defer as much leave as possible, so that you would have some breathing space in the event of retrenchment. You could take the leave, which is usually the best option, or you could opt for payment in lieu of the leave. Bear in mind, however, that there is a risk associated with deferral: if the company is liquidated, it might be unable to pay you what is owed.
Taking a period at the end of your tenure as leave is likely to be the best option if you receive allowances that are paid while you are on leave, but which you would lose if you were paid out. A lump sum paid to you in lieu of leave might also result in additional tax, because leave pay is taxed as ordinary income.
* Will you receive a pro-rata bonus? If so, how much of your regular income will this cover after tax (at ordinary income tax rates)?
* Will you receive any benefits from retrenchment cover, and if so, how much will you receive and for how long?
* Do you have any credit life cover that will cover your debts in the event of retrenchment?
* Do your debt repayment plans include any payment holidays in the event of retrenchment?
* What can you claim from the Unemployment Insurance Fund? Although benefits are limited and claiming is a hassle, whatever you can claim can go towards stretching your income as far as possible. If you have been contributing to the fund for more than four years, you could receive payments ranging from 38 to 60 percent of your gross remuneration, to a maximum of R14 872 a month for up to 238 days.
* What will you receive as a severance package? Will it be the standard one week for each year of employment, or better? What will it amount to after tax? Remember that only R500 000 of any or all lump sums received over your lifetime (including severance packages and retirement fund lump sums) is tax-free.
Take a view
Get a clear idea of your financial and employment prospects in the event of retrenchment. You know your skills and the state of the industry in which you work. You also know how easily you last found work and how easily colleagues with similar skills have found other jobs.
Your age and your experience are important factors – you will be in the best position if you are highly experienced and in the prime of your career, and you will be at a disadvantage if you are just starting out, with little experience, or nearing the end of your career. Establish a best- and worst-case scenario in terms of how long it may take you to find a new job.
Make a plan
With a good idea of what income you are likely to receive at the time of retrenchment, and some idea how long it might take you to get back on your feet, make some plans.
Whatever you do, do not spend your retrenchment package on anything you have long been wanting – such as a new car or a holiday – until you are sure you can get back on your feet again, and do everything possible to avoid dipping into your retirement savings.
The obvious advice you will hear from anyone you care to ask will be to cut down your expenses. In her book, The best pocket guide ever for family finances, financial planner Jillian Howard suggests that, right from the moment you get a whiff of the possibility of retrenchment, you should urgently reassess your budget. “Cancel all expenses that are not absolutely necessary and stop spending money on luxuries. Rather use this money to make extra payments towards any debt you may have. Do not upgrade your cellphone (even if it’s due – you can keep it on a month-to-month contract for a while), or renew any other contracts until the crisis is over.”
Gerald Mwandiambira, a financial planner in the Old Mutual financial planning agency franchise Sugar Creek Wealth, has similar advice in his blog AskGerald.co.za: reduce your expenditure on entertainment and luxuries, such as satellite television subscriptions and the more extravagant groceries. A conservative approach without radical cuts to your budget could see you through, if your period of unemployment is likely to be short and if you can do some temporary work to bring in some income while you wait for the right job to come along.
Whatever your position, a review of your expenses with a view to making efficiency cuts is never a bad thing: can you buy cheaper insurance without compromising on cover, for example? Or could you get a cheaper security service?
Mwandiambira says if your debts are not settled by credit life insurance and if you need to pay them, but do not have the cash, you may need to make some payment arrangements with your creditors. He says you should remember that no company is obliged to accept any arrangement, and it will do so only to try to retain your business. Be polite and reasonable with the people you deal with, he says.
If you have multiple cars, or any other assets that are unencumbered by debt, Mwandiambira suggests you consider selling an asset to release cash. If you are going to need every cent you can find to survive a lean period, review all your contracts, but watch out for penalties if you stop or reduce any contractual savings, such as a life assurance retirement annuity (RA).
Medical scheme cover
Be particularly careful about your medical scheme membership. If you stop paying your contributions, your membership will be terminated, unless you have some kind of premium waiver for retrenchment. If your membership is terminated for more than three months and you are over the age of 35, you could face punitive late-joiner penalties on your contributions for the rest of your life.
Remember that an open medical scheme cannot cancel your cover just because you have been retrenched; you lose your cover only if you do not pay your contributions. Some schemes may give you a month’s grace if you inform them that you have been retrenched, but you will have to make up the shortfall later.
Some restricted medical schemes allow you to continue your membership of the scheme after retrenchment until you become a member of another scheme. If yours does not, you will have to join an open scheme promptly, even if you have not found another job.
If your employer has been subsidising your contributions, you will need to make arrangements to continue paying the contributions in full after your retrenchment. If you cannot afford to pay your contributions without your employer’s subsidy, consider a cheaper option; if your circumstances are dire, take an option that offers cover in a state hospital. At least you will be able to upgrade again later without incurring a late-joiner penalty.
You could benefit enormously for the rest of your life if your employer is among the few that still provides a subsidy for post-retirement medical expenses.
Also consider that when you lose your job you will also lose your group life and disability cover. If you can afford to convert your group life and disability cover on your retirement fund into an individual policy without medical underwriting, this could be a valuable benefit, particularly if you have health problems and are unlikely to obtain the cover at the same price in your personal capacity, according to Ian Beere and Cameron McCallum, independent financial advisers with Netto Invest.
When it comes to cash benefits, Beere and McCallum suggest you take your severance package, particularly the portion you can take tax-free, and invest it in a conservative investment that can fund an income over the short term – for example, a money market fund or an enhanced income fund.
Howard says one of the dangers of retrenchment is that your retirement savings can seem like a life jacket in a sea of uncertainty. Currently, it is still possible to cash in your savings when you are retrenched, but, as Howard warns, if you don’t preserve these savings, you will have to save a lot more when you do find a new job, to catch up. Most people never catch up and retire with far less than they need, she says. That said, you may find yourself with no other option but to raid your retirement nest egg.
If you can’t decide whether you need to draw on your retirement savings, your best bet is to defer your decision, Beere and McCallum say. Many retirement funds now accommodate deferred pensions, which means you can leave your pension invested in your fund until you retire and draw it out to fund a pension. This enables you to live off your severance package and any other savings until those are depleted and only then draw on your retirement savings.
If your severance package doesn’t exhaust the tax-free allowance of R500 000 and you still need to draw from your retirement savings, use the balance of the tax-free amount first. If you draw from your retirement savings and subsequently find work and no longer need the money, you can re-invest it in a discretionary investment, such as a unit trust fund, for use when you retire.
Once you have taken the full R500 000 tax-free allowance, you will pay tax on your withdrawals, starting at 18 percent and progressing to 27 percent and 36 percent.
If you can’t or don’t want to leave your retirement savings in your original fund, you could transfer them to an RA, without any tax liability. But this is something of a gamble, because you cannot access the funds in an RA until age 55 and you may not know when you will be re-employed. Another option is to transfer your savings to a preservation fund. Again, you won’t pay tax, but you will have the right to make one withdrawal – which could be a 100-percent withdrawal – from the fund at a later stage, before retirement.
Remember, however, that if you don’t transfer your retirement savings to a preservation fund, it will count as the one permitted withdrawal, and you won’t get another opportunity.
Later withdrawals from a preservation fund, even if you are still unemployed, will be taxed as a withdrawal, which means that only the first R22 500 is tax-free.
If you are over the age of 55 and you are a member of a pension fund, you can consider taking early retirement, Beere and McCallum say. You can put the two-thirds with which you are obliged to buy a pension in a living annuity, from which you can withdraw the minimum of 2.5 percent a year. If you are re-employed, you can use the 2.5 percent you are withdrawing to contribute to an RA. The contributions are tax-deductible.
Beere and McCallum warn that if your company is facing liquidation and is unable to pay its final contributions to your retirement fund, the fund could be liquidated and this could seriously delay you being able to access your money. In the meantime, you could borrow against your pension money, but this is expensive and you would lose a huge amount of money to transaction costs, they say.
If you are thinking of using your severance package or retirement savings to fund a business, be very sure of your business plan. The capital you require could quickly deplete both these resources and leave you financially exposed in future. The business would have to give you a much higher income than you had before to provide you with enough money to replace your retirement savings at a later stage of life.
Retrenchment brings out a host of emotions that can cloud your thinking. Reaching out for help from a professional, such as a financial adviser, life coach or medical practitioner, may seem to be an expensive option in the circumstances, but it might help you recover from the crisis of retrenchment much more quickly than you would otherwise do.