Don’t cash in your future with the new two-pot system

South Africa’s retirement fund industry will be undergoing significant changes this year. The two-pot retirement system will be implemented from 1 September, and it will affect pension, provident, retirement annuity (RA) and preservation funds.

Why implement a new system?

1 Providing limited early access to retirement fund money for emergencies

The Covid pandemic caused widespread financial hardship, with many South Africans battling to meet their essential living costs. This highlighted the importance of having a mechanism in place whereby retirement fund members who are in dire need, can tap into a portion of their retirement savings during their working life. Currently, provident and pension fund members can only access their benefits before retirement by resigning from their employment, or if they are retrenched. Members of RAs are currently in an even worse position if they require emergency financial support as they have no access to their retirement assets prior to age 55.¹

2 Ensuring long-term preservation

Many members of retirement funds choose to withdraw their full fund value when changing jobs instead of preserving their retirement savings. Some employees resign from their employer primarily to get their hands on their retirement capital. Reasons include dealing with financial emergencies, paying off debt, funding a sabbatical/gap year, starting a business and building a house in which to retire. The sad reality is that fewer than 10% of South Africans can retire comfortably, with many having to rely on family members to make ends meet. SA’s retirement fund reforms aim to address the issue of long-term savings leaking out of the system, leaving many citizens with little or no money during retirement.

How will it work?

Effective 1 September, new contributions from retirement fund members will be split into two pots: a Retirement component and a Savings component. New rules will govern these two pots:

• Two-thirds of all contributions will be allocated to the Retirement component and one-third to the Savings component.
• Members won’t be able to have early access to the Retirement component (no withdrawals prior to retirement).² The full benefit in this pot must be used to purchase a compulsory annuity at retirement, which will provide the pensioner with an income.
• Members will, however, have limited access to the benefits in their Savings component before retirement. One withdrawal is allowed per tax year (minimum withdrawal of R2 000) and will be taxed at the member’s marginal income tax rate.

Figure 1 : New contributions will be split into two pots from 1 September 2024

Source: Ninety One.

What happens to existing retirement savings from 1 September?

Retirement fund benefits accumulated prior to 1 September 2024 will be separately preserved, in what is referred to as the Vested component. The money in the Vested pot will remain invested, so it will still have the opportunity to grow over time. What’s important to note is that members’ current rights will remain protected. The existing rules regarding withdrawals and options at retirement will continue to apply to this Vested component after the two-pot system is introduced. Rules governing vested provident fund benefits (pre-1 March 2021 contributions plus growth) will also continue to apply. ³

Figure 2: Retirement fund benefits accumulated before 1 September 2024 will be separately preserved

Vested component

Members’ current rights will remain protected The legislation as it exists currently will continue to apply

Source: Ninety One.

What will be the starting balance of the Savings component?

The starting balance may vary among retirement fund members, depending on the retirement fund value they have built up by the end of August 2024. A once-off amount, known as seed capital, will be transferred from a member’s Vested component to the Saving component. The seed capital will be 10% of a member’s fund value on 31 August 2024, subject to a maximum amount of R30 000. Effective 1 September 2024, members will be able to withdraw amounts from the Savings component at any time, subject to the limitations mentioned above.

Figure 3: A once-off amount will be transferred from the Vested component to the Savings component

*(Capped at R30 000)

Source: Ninety One.

Some examples

• If you have R60 000 saved, R6 000 will be transferred to your Savings component. You may withdraw any amount from R2 000-R6 000.
• If you have R300 000 saved, R30 000 will be transferred to your Savings component. You may withdraw any amount from R2 000-R30 000.
• If you have R1 400 000 saved, R30 000 will be transferred to your Savings component, because the starting balance may only be a maximum of R30 000. You may withdraw any amount from R2 000-R30 000.

Accessing funds from your Savings pot before retirement should be a last resort

While the new two-pot system will permit pre-retirement withdrawals from your Savings component, you should only consider doing so if you have a financial emergency and no other available funds. Building a substantial nest egg for retirement takes time. The money in your Savings component (seed capital and one-third of new contributions) should be allowed to grow over your entire working life. While a career typically spans 30-40 years, you may spend a similar period in retirement. As a rule of thumb, you will need pension capital of between 15 and 20 times your final salary by the time you retire.

Save, preserve and grow your money in all three your ‘buckets’

To secure a comfortable retirement you need to start saving early – as much as you can. Equally important, avoid accessing any of your fund benefits before retirement and ensure you grow the money in all your pots: your Retirement, Savings and Vested components. All three your fund ‘buckets’ are designed to help you save for retirement in a tax-efficient manner. Contributing to a retirement fund can help you pay less income tax. Your contributions are tax-deductible within certain limits.⁴ What’s more, the growth on your savings is tax-free: no income, dividends and capital gains taxes apply.⁵

Any pre-retirement withdrawals will be taxed

While you enjoy tax benefits if you contribute to a retirement fund, you will be taxed on withdrawals from your Savings pot. This means that you will end up with a lower amount in your pocket. You will pay tax at your marginal rate on any withdrawal from your Savings pot. It could even push you into a higher tax bracket. Furthermore, if you have an outstanding penalty amount owing to the South African Revenue Service for which an IT88 order was issued, this amount will be deducted from the proceeds of your Savings pot withdrawal. You may end up receiving a much lower amount than anticipated once tax and any applicable tax penalty amounts have been deducted. Let’s look at a hypothetical scenario to illustrate the impact of tax on a withdrawal.

Example: withdrawal after the implementation of the two-pot system

Mrs X unexpectedly faces car maintenance expenses to the tune of R60 000. Unfortunately, Mrs X does not have any available savings to fund her motor vehicle repairs other than the fund benefit she has accumulated in her Savings pot. Mrs X decides to withdraw the full amount of R60 000.

As withdrawals from the Savings pot are taxed according to the income tax table, the R60 000 will be added to her taxable income:

Taxable salary of R600 000 + R60 000 = taxable income of R660 000

This amount means the fourth row of the income tax table below is applicable to Mrs X. The R60 000 withdrawal will be taxed at a marginal tax rate of 36%.

The tax paid on the withdrawal = R21 600 (36% X R60 000)

This means that Mrs X will only receive R38 400. (R60 000 – R21 600).

Personal income tax table
1 March 2024 - 28 February 2025

Consider setting up an emergency fund to cover unforeseen expenses

Retrenchment, a business that goes belly-up or unforeseen expenses can plunge you into a financial black hole if you don’t have an emergency war chest to keep you safe financially. As a rule of thumb, ensure you’ve saved at least 6 months’ worth of income. Don’t dip into your emergency fund and remember to top it up regularly as your income increases. An emergency fund can help you avoid early withdrawals from your Savings pot, preventing you from cashing in your future.

Conclusion

The new two pot-system will introduce a lot of complexity as retirement fund members will have to consider which rules apply to their retirement ‘buckets’ when they wish to make withdrawals, resign or retire. A financial advisor can help you navigate the old and the new rules and highlight the tax and financial planning implications of accessing retirement fund benefits (pre- and post-retirement).

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¹ There are some exceptions, which are stipulated in members’ retirement fund rules. Receiving retirement fund benefits in cash may have tax implications. Currently, the withdrawal tax table applies to pre-retirement withdrawals, while the retirement tax table applies to lump sums received on retirement or following a retrenchment. For more information, please refer to your retirement fund rules.
² There will be some exceptions, as stipulated in members’ retirement fund rules.
³ Provident and provident preservation fund members who were 55 years or older on 1 March 2021 will not automatically form part of the two-pot system. Their current rights in respect of their fund benefits will remain protected and the legislation as it exists currently will continue to apply. However, they may choose to opt into the new system. If they do opt in, seed capital will be calculated and transferred to their Savings component.
⁴ Capped at R350 000 per annum.
⁵ However, lump sums paid to fund members who are retiring will be taxed according to the retirement tax table, and annuity income after retirement, will be taxed according to the personal income tax table.