In a significant overhaul of its retirement savings landscape, South Africa has introduced the two pot retirement system, set to take effect on 1 September 2024. This innovative approach aims to strike a balance between providing financial flexibility and ensuring long-term retirement security. Let’s delve into the intricacies of this system and explore its implications for South African savers.
Why the two pot pension system?
During the COVID-19 pandemic, many people lost their jobs. The government realised that the current pension and retirement products restricted people from accessing funds to be used for basic necessities. Scenarios such as international crises and pandemics needed to be accommodated – the laws and legislation needed to be changed.
Is the two pot system for retirement annuities too?
Yes, the two-pot retirement system applies to retirement annuities in South Africa. The system will take effect on September 1, 2024, and will also apply to pension, provident, and preservation funds.
What Is The Two-Pot Pension?
Despite its name, the two pot pension system comprises three distinct pots. These are the savings-, retirement- and the vested pot. All contributions before 1 September 2024 will go into the vested pot. The current rules will continue to apply to the vested pot.
After 1 September 2024, the contributions will be split between the retirement and savings pot. 33% will be placed in the savings pot, whereas 66% will be placed in the retirement pot.
The Savings Pot is designed to provide access to funds for immediate financial needs. It allows two pot retirement system withdrawal once per tax year, with a minimum withdrawal of R2,000. On the other hand, the retirement pot focuses on preserving long-term savings for retirement. Access to this pot is restricted until retirement age.
How does the two pot system affect my retirement?
At retirement, the two thirds retirement pot needs to be fully invested in a retirement product (like a life or living annuity). The other one third in the savings pot can be taken out in cash. If you have no money in the savings pot, then no money can be withdrawn at retirement.
Your retirement savings in the vested pot will be subject to the old laws governing retirement and pension funds. At retirement, you can take one-third of your vested pot. The rest need to be invested in an annuity.
Tax and the two pot system
The system maintains tax incentives for contributions. Contributions up to 27.5% of taxable income or R350,000 annually (whichever is lower) remain tax-deductible, providing a strong incentive for individuals to maximize their retirement savings.
The tax treatment of withdrawals under the two pot retirement system is nuanced. Pre-retirement withdrawals from the Savings Pot are taxed as normal income at the individual’s marginal tax rate. This higher tax rate serves as a deterrent against frivolous two pot retirement system withdrawals. At retirement, the tax treatment becomes more favourable. Up to one-third of the total savings can be withdrawn as a lump sum.
Will I still get R 550 000 tax free?
Current legislation allows for a tax free lump sum of R550 000 to be withdrawn. However, when money is withdrawn from the savings pot, it will not be eligible for this tax break. The money is taxed at your normal tax rate.
Withdrawals from the Vested Pot will follow old rules and therefore withdrawals will accumulate to your tax free portion at retirement.
Who is Affected by the Two-Pot Retirement System?
The two pot retirement system applies broadly across South Africa’s retirement landscape, including both defined contribution and defined benefit funds. Notably, the Government Employees Pension Fund (GEPF), which is a defined benefit fund, is also covered by this new system. However, due to the GEPF’s defined benefit nature, the calculation methods for its two pots may differ from other funds. For GEPF members, the allocation of contributions to the savings and retirement pots is based on the member’s pensionable service.
Despite its wide application, there are some exceptions to the system. Legacy annuity policies and inactive funds are exempt. Additionally, pensioners and provident fund members who were 55 years or older on 1 March 2021 are not automatically included in the two pot retirement system. However, these individuals have the option to opt in if they wish to participate. This exemption likely aims to minimize disruption for those nearing retirement under the previous system.
Why the two pot pension system is bad
While the two pot retirement system offers numerous benefits, it also presents several challenges. According to a report by 10X, only six percent of South Africans will retire comfortably. This is a massive risk that withdrawals from the savings pot could significantly deplete retirement savings, potentially compromising long-term financial security.
From an administrative perspective, pension funds and administrators face the challenge of overhauling their systems to accommodate the new structure, potentially leading to increased costs and operational complexities – someone has to pay for the changes!
As of March 2024, South Africa’s household debt-to-income ratio was projected to be around 65%, which includes an estimated R300 billion in debt owed to municipalities. The average South African consumer spends about 62% of their take-home pay on debt servicing, and middle-class South Africans have an average indebtedness of R152,715.
Withdrawing funds to pay for current debts is basically ‘spend tomorrow’s money to pay for today’s debt‘.
The tax implication and lump sum that can be withdrawn will also need to be considered.
Conclusion
By offering a blend of accessibility and preservation, it addresses some of the key challenges faced by South African savers. For more detailed information, individuals can refer to the National Treasury FAQ and the two pot retirement system explained in the Investec Explanation available online.
