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Coping with COVID-19: Why You should Not Rush to Withdraw Your Pension

BY Cytonn Investments · May 27, 2020 10:05 am

There are over 5.5 million persons who have been infected with over 346,000 deaths since the first COVID-19 was reported six and a half months ago. The figures are a little less scary when you look at Kenya’s numbers – 1,286 infected so far out of whom, 402 have recovered and 52 have died.

In terms of the global economy, it is fair to say that COVID-19 has had a significant negative impact. Estimates so far indicate the virus could trim global economic growth by as much as 2.0% per month if current conditions persist.

Various governments have closed borders and imposed travel restrictions especially to countries with high infection rates in a bid to reduce the risk of transmission of the disease. Kenya is currently in a partial lockdown with a 7 pm to 5 am curfew imposed countrywide.

Additionally, movement in and out of Nairobi, Mombasa, and three other counties as well as flights into the country have been restricted to a minimum. The government has also made it mandatory for citizens to wear masks in public at all times as it continues to conduct mass testing daily.

Businesses have had to close down or scale down operations in a bid to comply with the self-quarantine and social distancing instructions. As a result, supply chains have been disrupted globally & locally while the tourism, hospitality and social entertainment sectors have been the worst hit due to their reliance on people congregating.

The economic downturn and resultant strain on cash flows for businesses worldwide have seen many companies attempt to reduce their operating costs largely through temporary or permanent layoffs. According to the International Labour Organization (ILO), an agency of the United Nations, the pandemic is expected to have a negative impact on approximately 5.9% of the global workforce by the end of Q2’2020.

Many workers are now forced to seek alternative sources of funds to cater for their daily expenses with pension savings touted as a go-to option. This adversity coupled with the fact that the government is reducing tax rates upon withdrawal from retirement schemes has made workers seriously consider using their retirement money as a stop-gap measure. However, people should be forewarned that such a decision could have devastating effects in the foreseeable future.

In the illustration above, 25 years is equivalent of 300 payslips essentially missed on and that needs to be replaced.

The logic of retirement savings is exactly this; to be able to afford a comfortable retirement and live out the last years of one’s life in a dignified manner. On retirement, one should aim to have an income replacement ratio of about 75%. This means if you are earning Kshs 100,000, you should receive Kshs 75,000 upon retirement monthly to maintain the same standard of living as before you retired.

A case in point, assuming that one gets their first job and works all the way to Kenya’s normal retirement age of 60, which will be equal to 420 payslips. Say that the same person retires at 60 and lives all the way to 85 years old.

It is expected that during the productive period, one should save enough to cater for their 25 years in retirement expenses.

While withdrawing one’s pension savings especially after losing a job or experiencing financial trouble seems like a rational option, it is more self-defeating and short-sighted as we borrow money from our own future. This will negatively affect the adequacy of pensions upon retirement and lead to a lower quality of life after retiring.

Additionally, when saving in a retirement benefits scheme one enjoys tax relief on the contributions which reduces their tax liability meaning more money is attributable to them. Premature withdrawals erode this tax advantage of raising your PAYE.

A key aspect to retirement savings is consistency in contributions which in turn leads to maximum compound interest benefit. While making contributions during this pandemic period may not be wholly possible, it is expected that most workers will reduce or stop contributions till the effects die down and then resume when they are able to as opposed to withdrawing. Money that stays in a scheme continues to earn compound interest. Below is an illustration of how much loss in value one incurs should they withdraw from a scheme prematurely:

Scenario A: Kevin contributes 5,000 monthly in a retirement scheme which earns a constant interest rate of 10%. He started contributing at 27 years and decides to withdraw all his funds at 37 years of age. After regaining job stability he rejoins the scheme as an active contributor from the age of 38 to 60 when he plans to retire.

The amount is withdrawn at 37 years: Kshs 1,007,288.00

The amount at age 60 years: Kshs 4,512,845.34

Total: Kshs 5,520,133.34

Scenario B: Dorcas also contributes 5,000 monthly in a retirement scheme which earns a constant interest rate of 10%. However, Dorcas did not withdraw from the scheme but instead remained a member throughout from age 27 to 60 years when she plans to retire.

Total Amount at age 60 years: Kshs 14,046,893.91 (154% more than Kevin)

*The total amounts are pre-tax.

Evidently leaving one’s money in a pension scheme is more beneficial as it allows your money to grow, which ultimately sets you ready for retirement. Retirement if well planned allows one to transition into a more relaxed lifestyle, and having time to enjoy all the things we did not have time for before retirements, such as our hobbies, family and friends, travel, and recreational activities. It is therefore important to protect what you have saved or invested to ensure that you will have enough income throughout your retirement; after all, you worked hard to get to retirement.

Careful consideration is urged before the decision to withdraw from your pension savings and workers are asked to consider other means of obtaining funds before dipping into their pension pot.

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