Navigating the New Two-Pot Retirement System: What You Need to Know

The South African government’s introduction of the two-pot retirement system, set to be implemented on 1 September 2024, marks a significant change in how individuals save for their retirement. Designed to enhance financial security while also allowing for emergency access to funds, this system divides your retirement savings into three distinct components: the vested component, the savings component, and the retirement component. Here is a breakdown of what these changes mean for you, and how withdrawals could impact your financial future.

The Three Components: A New Structure for Your Retirement Savings

Vested Component:
- What It Is: This component consists of all your retirement savings accumulated up to 31 August 2024. It remains protected under the current rules, meaning no further contributions will be made to this component after the transition date. It will continue to grow based on investment returns.
- Withdrawal Options: If you leave your employer, you can withdraw this amount as a lump sum, or transfer it to another fund. However, any cash withdrawal will be taxed according to existing lump sum tax tables, potentially reducing the amount you will receive.

Savings Component:

- What It Is: This is where one-third of your future retirement contributions will go. The money in this pot can be accessed in times of financial emergency without the need to leave your employer.
- Withdrawal Options: You are allowed one withdrawal per tax year with a minimum amount of R2,000. However, it is recommended that you only use this in genuine emergencies to preserve your retirement savings. Withdrawals from this component are taxed at your marginal income tax rate, which could significantly reduce the amount you have available in retirement if accessed frequently.

Retirement Component:

- What It Is: Two-thirds of your retirement contributions will go into this component. The funds in this pot are strictly reserved for retirement and must be used to purchase a pension when you retire.
- Withdrawal Options: You cannot access any of the money in this component until retirement, ensuring that these funds are preserved for their intended purpose. This component is vital for ensuring you have a stable income during retirement.

How Will the Transition Work?

On 1 September 2024, a once-off transfer will take place, moving 10% of your retirement savings as of 31 August 2024 (or up to R30,000, whichever is lower) into the savings component. The remainder of your savings will stay in the vested component. From that point onward, your new contributions will be split between the savings and retirement components.

For example, if you have R150,000 saved by 31 August 2024, R15,000 will be transferred to your savings component, while the remaining R135,000 will stay in your vested component. Future contributions will then be divided, with one-third going to your savings component and two-thirds to your retirement component.

Tax Implications of Withdrawals

Savings Component Withdrawals:

Tax on Withdrawals: Withdrawals from the savings component are taxed at your marginal income tax rate, which could be as high as 45% for top earners. This means that for every R10,000 you withdraw, you might only see R5,500 after taxes if you are in the highest tax bracket.
Impact on Retirement Savings: Frequent withdrawals not only reduce your retirement nest egg but also miss out on potential investment returns. Over time, this can have a significant impact on your overall retirement savings, leaving you with less money during your retirement years.

Vested Component Withdrawals:

Tax on Withdrawals: When you withdraw from the vested component, the amount is taxed according to the lump sum withdrawal tax tables, which apply different rates depending on the size of the withdrawal. For instance, the first R27,500 is tax-free, but amounts above that are taxed at progressively higher rates, up to 36% for amounts over R1,089,000
Retirement Planning Considerations: While the vested component offers flexibility upon leaving an employer, cashing out large sums could push you into a higher tax bracket for the year, resulting in a larger portion of your savings going to taxes rather than your retirement.

Retirement Component:

Preservation Until Retirement: The retirement component is specifically designed to ensure that you have sufficient funds to purchase an annuity or pension when you retire. This component cannot be accessed until retirement, which helps protect your long-term financial security.
Mandatory Pension Purchase: At retirement, the entire amount in the retirement component must be used to purchase a pension. This ensures a steady income stream during retirement, but it also means you will not have access to this money in lump sum form, except under very specific conditions (such as if the total amount is less than R165,000).

Implications for Investors, Markets, and the Economy

The new two-pot system, while primarily aimed at safeguarding individual retirement savings, also has broader implications for the South African economy.

Investor Behaviour:
- The ability to access the savings pot may lead to significant withdrawals in the initial months after the system is implemented, with estimates suggesting between R50 billion and R100 billion could be withdrawn. While these withdrawals will be taxed, increasing government revenue, they could also reduce the long-term growth potential of individuals’ retirement savings due to the loss of compound interest.

Market Impact:

- While concerns about the potential market impact of large-scale withdrawals have been raised, the staggered nature of these withdrawals and existing cash buffers within pension funds are expected to mitigate any immediate disruptions. Additionally, the South African financial markets are robust, with the JSE’s large and liquid equity market capable of absorbing such activities without significant volatility.

Economic Growth:

- The compulsory preservation aspect of the new system is anticipated to have the most substantial long-term impact. By curbing the widespread practice of cashing out retirement savings when changing jobs, the overall pool of retirement assets is expected to grow, providing a more stable source of funding for fixed investments. This could, in turn, support higher levels of domestic investment, which is crucial for sustainable economic growth.

Why Is This Change Happening?

The government’s aim with this new system is twofold: to encourage South Africans to save more effectively for retirement and to provide a safety net for those facing financial hardships without the need to cash out their entire retirement savings prematurely. This balance between flexibility and preservation is designed to help South Africans retire with more financial security.

Key Takeaways for Your Financial Planning

Long-Term Focus: Even though you have access to the savings component for emergencies, it is crucial to prioritize long-term financial stability by keeping withdrawals to a minimum. Each withdrawal not only reduces your savings but also diminishes the power of compound interest on your remaining funds.
Tax Implications: Understanding the tax implications of withdrawing from your retirement savings is essential. Whether it is the immediate hit to your savings or the long-term effect of having less money invested, the impact can be substantial.
Economic Benefits: The two-pot system is not just about individual savings; it has the potential to strengthen the overall economy by increasing the pool of long-term savings available for investment in critical infrastructure and other growth-promoting activities.
Consultation: Consider consulting with a financial advisor to understand how best to adjust your retirement strategy, considering these changes. A well-informed strategy can help you balance short-term needs with long-term goals.

The two-pot system represents a significant shift in retirement planning in South Africa. By understanding and adapting to these changes, you can better secure your financial future while still having the flexibility to handle emergencies as they arise. Moreover, as the broader economy benefits from increased savings and investment, both individuals and the nation stand to gain.

Article by: Sean Pereira