BELINDA SULLIVAN: Proposed two-pot system a practicable solution for retirees

The National Treasury has released draft legislative amendments to enable the two-pot system, which will allow South Africans limited access to their retirement fund money. Access to savings before retirement will be balanced with long-term preservation of savings for retirement.

To effect the changes, the Income Tax Act will include new definitions for “savings pot”, “retirement pot” and “vested pot”. The final amendments, which will apply to pension funds, provident funds, retirement annuity funds, preservation funds, including public sector funds and defined benefit funds, are expected to be legislated from March 1.

Alexforbes supports the “two-pot” system, which will have a positive impact on people’s lives by providing a practicable and responsible solution to the real needs of members. The proposed reforms are necessary to balance members’ long-term retirement savings goals and to meet short-term financial needs (as has been highlighted following the Covid-19 pandemic).

Over the last 10 years there have been incremental changes to encourage savings and improve outcomes in retirement, which have led to the two-pot system, the most recent of which was annuitisation to improve preservation at retirement, effective March 1 2021.

What is the proposed two-pot system?

This system aims to find the right balance to help members save for retirement while allowing flexibility for short-term needs. The ‘two-pot’ proposal splits new contributions from the proposed implementation date into two pots of money. For example, let’s say you are a member who has a pensionable salary of R10,000 a month and the contribution rate is 15% (R1,500 per month):

• The first pot is for longer-term financial security — the retirement pot. This means R1,000 a month, less any fees and group insurance premiums, will go into the retirement pot (two-thirds). It must remain invested until retirement and used to buy a pension from a registered insurer, unless you have saved less than the minimum required amount of R165,000. This will improve retirement outcomes for most fund members.
• The second pot is for short-term financial relief — the savings pot. Using the above example, R500 a month, less any fees and group insurance premiums, will go then into the savings pot (one-third). You may withdraw money from the savings pot once a year at most while working. The minimum withdrawal amount will be R2,000, but if you withdraw all the savings in this pot before retirement you won’t have any money to withdraw as a cash lump sum at retirement.

Accessing the savings pot should be a last resort, particularly as any savings withdrawn from a retirement fund reduces your income at retirement. In addition, if you have used up all the savings in the savings pot you will not be able to access any cash at retirement from the retirement pot. Generally, it is advisable for you to make use of other savings vehicles for day-to-day savings or to finance non-retirement savings goals. Contributions remain tax deductible up to certain limits, that is the greater of 27.5% of gross remuneration or R350,000 per annum. Any contributions made in excess of these deductible allowances can only be allocated to the retirement pot.

The two-pot system will apply only to new contributions from the implementation date, and it will take time to build up savings that can be withdrawn in future. Based on the proposed minimum access of R2,000 per annum you will need to have accumulated R2,000 from the date of implementation before you will be able to have access. This means there is no seed capital from previous vested amounts allowed.

Money previously accumulated to the date of implementation plus the future investment return on this money will still be accessible in cash, but only on your exit from the fund.

Tax implications

The tax applicable to withdrawals will be based on how a member leaves the fund, and how much money they have withdrawn from the retirement fund over their lifetime. The draft legislation proposes a key change to the tax treatment of withdrawals from the savings pot. Any withdrawals from the savings pot will not be taxed in line with the withdrawal benefit table, but will be added to your income in the year of withdrawal and taxed at marginal rates. Withdrawals from the vested pot will be taxed in accordance with the withdrawal benefit tables.

Any lump sum at retirement from the vested pot will be taxed based on the retirement tax table. Where a member opts to take a lump sum at retirement from the savings pot this will also be taxed in line with the retirement tax table. Note that if you’ve used any of these allowances previously, even when retrenched, this will affect your future withdrawals and the tax you may have to pay.

When it comes to divorce, the divorce order will need to specify how much is to be paid from each of the three pots. On emigration, full withdrawals from the retirement, savings and vested pots can take place if an individual ceases to be tax resident for a period of at least three years. The vested pot will be taxed in accordance with the pre-March 1 2023 tax provisions, the savings pot will be included in gross income and the retirement pot will be taxed in accordance with the lump sum withdrawal tables.

Alexforbes’ view

At present, when an individual leaves employment they may access 100% of their accumulated retirement savings.  According to the Alexforbes Member Insights for 2021, only 9% of members preserve their retirement savings when changing jobs. This in turn leads to very poor retirement outcomes as the average replacement ratio is only 31%. This means that for every R1,000 earned by a member before retirement they will only replace R310 of income in their retirement. Therefore, these reforms are needed to meaningfully improve retirement outcomes.

Though the new system will allow access to the savings pot, this is limited to a third of contributions and growth thereon. The other two thirds must remain preserved at all times. Our modelling has demonstrated that the two-pot system will result in a new member accumulating more than double their fund value at retirement compared with the current system, while providing access to a portion of their savings annually.

Improving savings — some additional thoughts

The two-pot system takes into account the financial pressure members may be experiencing now and into the future.  However, to improve retirement outcomes into the future there are some additional ways to address these over the longer-term. For instance, the average member retirement fund contribution rate of 12.9% (after costs and risk benefits) is generally insufficient to achieve a 75% income replacement at retirement. There is also a need to reduce members’ debts, as the Alexforbes Member Insights 2021 showed that the debt-to-income ratio of the members was 69%, with 6% of members at high risk of financial stress. 

Alexforbes continues to follow this closely, providing input to assist in shaping the final legislation that will enable the new system. We will continue to apply our research, expertise and insight to ensure the public interest is considered in decision-making.

• Sullivan is head of corporate consulting strategy at Alexforbes.