RETIREMENT SAVINGS AND THE TWO-POT SYSTEM
Sometimes things change very quickly. South Africa has often dragged its feet when it comes to retirement reform and the whole issue over the two-pot system also seemed to be going along that same route. We had been preparing to write on this topic a couple of months back and then held off on our article as National Treasury had suggested postponing the implementation by a further year to give the financial industry time to prepare. Well, you can never discount the willpower of the politicians to curry favour amongst the voters in the lead up to a national election and with that Parliament indicated that the two-pot system will be implemented on 1 September 2024, even though final legislation has not been issued, and additional uncertainty that the industry systems will be ready. In this month’s Financial View, we look at the current proposals on the two-pot system and perhaps give some insight why it is seen as a short-term political gain.
What is the Two-Pot System
The commonly quoted statistic is that only 6% of South Africans will be able to retire comfortably. This is due to a number of reasons. The one obvious one is that people don’t save enough and put enough away towards retirement. The second, and more damaging, factor is that people access their retirement savings prior to retirement when they change jobs. The biggest contributor to building wealth is time – by accessing savings early it removes the benefit of time and the benefit of compounded returns.
There has long been talk of forced preservation to protect your retirement savings from early access so that it serves its primary purpose – to provide an income in retirement. But this has always been politically difficult as trade unions dictated that their members should be able to access their retirement funds, without needing to resign or retire from their jobs. {current legislation states that you can only access your provident or pension fund when your employment is terminated with your employer, whether through retrenchment, retirement, dismissal or resignation}. Often employees would resign merely to access their accumulated retirement funds.
With the competing challenges of still allowing early access but at the same time also protecting capital, South Africa came up with a hybrid system. Under this system, a portion of the funds can be accessed early, and the remaining portion is subject to forced preservation. These are the two pots, and the two-pot system enables you to access a small portion of your retirement savings (before you retire) for emergencies. The bulk of your savings will remain “preserved”, meaning you will have to keep the majority of your retirement savings invested until you retire.
It is important to note that the two-pot system applies to contributions towards your retirement savings from the effective date.
All future contributions to Retirement Savings from 1 September 2024
All future contributions after the effective date will be split between the two pots. The first pot is called the savings pot where one-third of your contributions will be allocated and which you will be able to access before retirement if required. The second pot is the retirement pot where the remaining two-thirds will be kept for funding your income in retirement. This pot will be preserved until the retirement date.
Accessing the savings pot
Each year members will be able to make one annual withdrawal from their savings pot. The withdrawal is set as a minimum of R2 000 with the maximum amount being the full amount of the savings pot. Administration fees are applicable for each withdrawal. Any withdrawal will be taxed as income at your marginal tax rate and not subject to the lump sum tax tables.
The critical thing to be aware of in terms of the savings pot is that this savings pot is the only source of a lumpsum when you get to retirement. All the tax benefits and incentives are currently contained within the lumpsum tax table as for example we see the first R550k taken as a lumpsum being tax free. If you keep drawing from your savings pot, you will pay a lot higher tax than if you allow it to remain intact until retirement.
Accessing the retirement pot
The retirement pot cannot be accessed prior to retirement and at retirement can only be used to purchase a pension via a living or life annuity i.e. a monthly pension, which will provide you a regular income after you retire.
Accumulated retirement savings as of 31 August 2024
This is where it starts to get very complicated……
Any funds that you have prior to implementation of the two-pot system now becomes the vested pot. (Magwitch comment – does this not make it a three-pot system??)
10% of your existing retirement savings value will be transferred from your vested pot to your savings pot as seed capital. This transfer is limited to a maximum of 10% of your retirement savings or R30 000. The retirement industry is concerned that there could be a significant number of immediate withdrawals of this seed capital.
The balance of the vested pot remains subject to the existing rules, prior to the implementation of the new two-pot system legislation. So, the vested pot after the transfer of the initial seed capital to the savings pot allows:
• Early access prior to retirement if one leaves your employer. This early access is subject to the lumpsum tax tables and not income tax at your marginal rate of tax.
• Access to a lumpsum at retirement based on whether provident or pension fund rules apply.
• Ability to transfer balance or portion thereof to a living or life annuity to provide a monthly pension.
Furthermore, if you were 55 or older on 1 March 2021 (the older date is when pension and provident fund rules were aligned) you will need to opt in to the two-pot system. It automatically applies for everyone else. We would advise against opting in for the two-pot system if you are within that age category – as it will impact your current tax benefits.
Is the two-pot system good for us?
Without a doubt the proposed two-pot system will improve retirement outcomes within South Africa. But it is going to take a long time for it to have a meaningful impact before members will have more in their retirement pot than their vested pot. Only at that point will the two-pot system prove that people will have more heading into retirement than previously.
The government is financially incentivised to encourage people to save for their own retirement. If you build up sufficient retirement capital, you no longer become eligible for an older-person state grant and potentially the reliance on the state can be reduced. The politicians however are pushing through the urgency of this as they want to provide the impression that they are giving the citizens access to money even if any withdrawal is going against the long-term intention objective of providing for retirement. This is what happens in the build up to the national election and often is about perception.
Useful Infographics to help understanding
Source: Old Mutual 2024
Source: Old Mutual
Conclusion
We think this is a good attempt to assist people that needs funds in the event of an emergency and that it will prevent people from resigning to access their funds. We recommend that it is only used in the event of an emergency and money should not be drawn from retirement savings to cover day to day costs or to go on holiday or the purchase of TV etc. In order for you to achieve your retirement goals, you need to contribute a percentage of your salary each month for as long as possible and not access your funds along the way. The higher the level of contribution, the easier it becomes for you to meet your objectives.
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