By: Siobhan Cassidy, MoneyMarketing Contributor
By giving access to some of their retirement savings while enforcing the preservation of the rest, South Africa’s new Two-Pot Retirement System, effective from 1 September, goes some way to reconciling two potential crises (immediate and future) for savers. Much has been said about the dangers of allowing access to a third of savings; less about the benefits of enforced preservation of the remainder. Although, according to some experts, the potential is revolutionary.
After 1 September, retirement fund contributions will be separated into two pots, two-thirds in a Retirement Pot and a third in a Savings Pot. Savers will be obliged to use the Retirement Pot to buy an annuity to provide retirement income; funds in the Savings Pot can be accessed via one withdrawal per tax year of a minimum of R2 000. The changes are not retrospective, which means a third pot, the Vested Pot, for those with savings accumulated before 1 September, will be subject to the old rules.
Withdrawals from the Savings Pot will be taxed at the member’s marginal income tax rate, which could even push an individual into a higher tax bracket. A second potential tax impact is on the R550 000 a saver is allowed to withdraw tax-free at retirement. Depending on withdrawals you have made, this benefit could be reduced.
Positive or negative?
Many have warned that allowing access to savings will undermine an already shaky system and potentially encourage an annual raid on the Savings Pot. Jacques Zaayman, Group Director at Prime Investments, the Johannesburg-based fund and product services provider, says, “In an investment where long-term real returns are in the single digits, allowing a double-digit withdrawal annually is akin to borrowing from your future with almost no prospect of being able to repay yourself.”
As Pieter Koekemoer, Head of Personal Investments at Coronation Fund Managers, has said: “While it is great to have this option in the event of genuine financial hardship, we believe investors need to understand the actual cost of access.” He explained that every R1 accessed early could cost savers up to R30 at retirement in nominal terms. “While the numbers become less dramatic when you shorten the
period between early access and retirement, they remain retirement-defining. Even for an individual making an early withdrawal 10 years before their intended retirement date, it would still cost them R3 in lost retirement benefits for every R1 taken out early.”
The enforced preservation part of the two-pot system means that savers, who have historically been allowed to cash out 100% of their savings in their company fund on leaving a job, will no longer have this self-defeating option. Prime Investments’ Zaayman says this narrows one of the biggest holes (if not the biggest) in a rather leaky system: cashing out when changing jobs.
According to data from Coronation, more than 10% of members of workplace retirement funds withdraw all their savings when changing jobs. “According to National Treasury, the net result of this leakage is that more than 60% of retirement fund members had accumulated pension pots of less than R50 000 in 2020. Put another way, the average fund member resets their retirement savings balance to zero every eight years in a system that enables compound growth to do its magic over three or four decades.”
“This action represents the most significant destruction of value and has a negative multiplier effect,” says Keri-lee Edmond, Analytics and Insights Manager at Old Mutual Corporate Consultants.
According to Palesa Mokoena, Technical Support Specialist at Glacier Business Development, the resignation rules under the two-pot retirement system present a major change for members of pension and provident funds who have become accustomed to the current system, which allows for full withdrawals each time they change jobs or leave their employer. “Many members may not be familiar with the concept of preservation and the workings of preservation funds,” she says. “Members who resign from their employer will therefore require financial education and support from their employers, funds and financial advisors in order to navigate their options under the two-pot retirement system, understand the implications for retirement savings, and make an informed decision.”
A doomed savings mentality
South Africa’s retirement savings crisis is well documented. Too many workers put off saving as long as they can, save at the lowest possible rate, and cash out their savings at the first opportunity. According to Treasury figures, which are borne out every year by the 10X Investments Retirement Reality Report, only 6% of South Africans can afford to preserve their lifestyle in retirement.
For many living in crisis, this talks to a problem for another time. The Covid-19 pandemic magnified and focused attention on a more immediate crisis. Many South African workers, who were putting their children to bed hungry and could not afford to educate them, were aware of a pot of money somewhere with their name on it: their retirement savings, which they could not access in even the most dramatic of crises.
It is not surprising that, as Edmond says, “in the time of Covid-19, we saw many South African employees resigning from their jobs, or couples going as far as to get divorced, simply to access their retirement funds in order to support their immediate financial needs”. She adds, “The ingenuity of the two-pot system lies in its ability to acknowledge the need for immediate financial access, reflecting our socio- economic reality, while still safeguarding long-term retirement goals. This marks a momentous shift in conventional thinking, and one which we believe will have a significantly positive effect on retirement outcomes into the future.”
Experts recommend saving 10 to 15 times one’s annual salary to provide a retirement income of 70-75% of previous income. Edmond says typical members of provident or pension funds save only 2.7 times their annual salary, and points to Old Mutual’s analysis showing that the new system could enable workers starting to save at age 25 to amass retirement savings of two to three times more than that. She
explains that the research indicates that the two-pot system could enable South Africans to save up to 9.5 times their annual salary by retirement, even if they use the entire savings component. If no withdrawals were made, savings could reach around 14.5 times annual salary, she adds.
Advisers will have a lot more to worry about than persuading people not to dip into their retirement savings. They will need to help clients understand the probabilities, the possibilities and the consequences of various choices. There is also potential for advisors to play a role in expanding the pool of savings. Prime Group’s Zaayman says the change really shines a light on the value of affordable and effective financial advice. And, as Keith Peter, Advice Manager at Old Mutual Personal Finance, has said: “For advisers, this is a chance to deepen customer relationships and improve financial outcomes for retirees.”
What’s the prognosis?
The two-pot system is likely to change the way South African workers view retirement saving. Research by Old Mutual Corporate, for example, shows that 40% of members will consider increasing retirement fund allocations after September 2024 due to the two-pot system. “This suggests that the perceived opportunity cost of investing in a retirement fund is now reduced, and members see the value of investing more, as they can access this money in an emergency,” says Samantha Jagdessi, Head of Advice & Best Practice at Old Mutual Corporate Consultants. John Anderson, Executive for Enablement and Solutions at Alexforbes, has noted that new system “enables saving with specific goals in mind, which has been shown to increase savings commitments”.
Advisers and the industry have their work cut out to encourage clients to leverage the best of the new system while avoiding any pitfalls. Ideally, workers will save as much as they can in their retirement funds, thereby accessing many benefits. These include tax breaks and tax-free growth and, in the case of corporate funds, lower fees than on individual investment products. Should savers need to access some of their funds for a crisis or, indeed, a priority such as a child’s education, they can do so. If they should happen to not need to access their savings, they get the benefit of a very healthy retirement fund.
