Pension-backed lending: The good, the bad, and the ugly

Victor Bucarizza, GIB Financial Services Limited

Earlier this year the Democratic Alliance proposed the Pension Funds Amendment Bill, 2020 that would amend Section 19 of the Pension Funds Act to allow for South Africans to use up to 75% of their pension fund as security against a bank loan to alleviate financial pressure due to Covid-19 or other similar emergencies; currently the act allows this use exclusively for home loans. This amendment was not supported by Treasury.

Cosatu suggested amendments to the Bill to limit the use to 30% and/or R30,000 of one’s pension fund. They also recommended that a straight cash withdrawal be an option for pension fund members, and for this withdrawal not to be taxed.

Let’s explore some of the challenges and opportunities that these proposals may offer.

Risks

South Africans are already in a retirement crisis where the majority of individuals do not save adequately for retirement. So much so that retirement reforms have had to step in to dissuade early withdrawals from retirement funds.

This ability to cash out funds prematurely (as Cosatu suggests) can lead to unintentional misuse and even intentional abuse; the cap does work to limit this.

The recommendation for these withdrawals to be tax-free do create an unintended incentive for everyone to make their maximum withdrawal and then simply reinvest the money, gaining another tax deduction on those funds. Monitoring the use of funds would become a burden that may not be efficient to maintain.

Any early withdrawal of funds simply exacerbates the retirement problem for that individual. The reduction in retirement assets is not just what is taken now, but also the future growth that those funds would obtain, which for younger individuals can be a substantial amount.

Opportunities

If structured diligently, these changes can offer solutions to much needed problems.

The obvious first one is that of cash flow relief for those dealing with the devastation of Covid and general economic pressures. However, this comes at the cost of retirement strain (as noted above). One can argue that this short-term cash injection can provide enough liquidity to speed up the re-employment process, provide sufficient cushion to prepare financially, and prevent negative externalities that come with poverty. Simply put, this can be enough of a lifejacket for the vulnerable.

This amendment may also offer access to lower-interest debt for the broader population. Average South Africans could look to consolidate their most expensive debt into a pension-backed loan; this could reduce their monthly payments, and multiple charges associated with various loans. Since the loan would have a pension as security, lending institutions would be willing to offer more competitive rates than for ordinary personal loans or student loans. Many members have made early withdrawals from their pension funds to cover cash shortfalls between jobs, pay off their home loan, or start new business ventures; all the while triggering hefty taxes in the process. These are a few examples where a low-cost pension-backed loan could be a more useful tool.

Additional considerations

Not all pension funds currently provide for pension-backed home loans in their rules; this is largely due to the administrative burden it places on the trustees. The administration would be immense if a large number of members applied for Covid relief simultaneously and the systems may not be adequately set up to manage this. This would trickle down to delayed processing and backlogs for multiple members requiring this money hastily. This would also impact regular operations of pension fund administrators, hindering other members.

It would be foolish to suppose that the consequences of a lack of retirement savings of an individual falls solely on their shoulders. Unfortunately, the costs are borne by their family members and the state – ultimately the rest of society.

Conclusion

Pension-backed lending or early withdrawals may present some advantages for South Africans to leverage off one of their largest assets; their retirement savings. However, it comes with a host of challenges that would need to be thoroughly considered before execution. It also should not be considered in a vacuum, as there are other potential solutions to solving cash flow crises that may be preferable.

Ultimately, government should be mindful not to cause unintentional harm to the very people it is looking to support with these changes. It is those individuals who are already financial stretched who stand to benefit the most from the successful implementation of such a plan, but also who would suffer the most