Two-pot retirement system: before you withdraw, ask yourself

From today South African pension fund members can start to withdraw some of their retirement savings from their savings pots under the two-pot retirement system that came into effect yesterday. But just because you can, it does not mean you should.

Qualifying consumers with tax directives will be able to access approximately R100 billion in retirement savings now. The switch to the two-component retirement system now happens automatically, except for provident fund and preservation fund members who were older than 55 on 1 March 2021, who can choose to opt in.

Wesley Davids, executive for governance at PPS Investments, says the financial industry and employers have undertaken comprehensive education campaigns to widen people’s understanding of the implications and benefits of the two-pot retirement system‘s reform that will provide access to the savings pot to help consumers to pay off their debt, among others financial pressures. 

According to Sars, the level of household indebtedness or the portion of household income that is eaten up by household debt, averaged 63.2% from the first quarter of 2015 to the second quarter of 2023, with a spike to 75.2% during Covid lockdown when disposable income decreased significantly more than debt.

While the system, according to National Treasury, is meant to support long-term retirement savings while offering flexibility to help fund members in financial stress, Davids says these are five questions anyone with a pension, provident, retirement annuity and preservation fund should consider before withdrawing from the savings component to avoid unintended consequences to fund and receive a sustainable annuity income in retirement.

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1. Have I saved enough to retire comfortably after 65?

Unless you are among the 6% of South Africans the Association of Savings of South Africa indicates can retire comfortably, the answer is likely to be no, Davids says. “It is estimated that to retire comfortably in South Africa, you will need more than R7 million in savings and investments.

“Your age should certainly play a part in your decision, especially if you are approaching retirement as the benefits of compound investment growth become even more critical. Therefore, defining the life you want to live in your retirement should be your guiding principle.”

2. How can I make sure that my investment continues to grow?

While you cannot make new contributions to the vested component of your fund anymore, the vested component will continue to grow in line with investment returns on selected investment options.

Davids says investment growth earned within the savings and retirement component will remain there. “Initially, given the complexity and short timelines, some funds have opted to keep the same investment options across all components within a policy with enhancements such as differentiated investment options and strategies in the future for the various components.”

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3. I have many policies. Should I withdraw on one policy or all of them?

While you can access funds from the savings component per policy or retirement fund, consider the unintended consequences, such as the tax implications and what your net payment will be after tax and long-term investment growth benefits, he says.

4. What will it cost me to withdraw from my savings component vs preserving my savings until retirement?

Run the numbers before you take the decision. Davids says you must compare the tax implications which will affect how much you receive on a withdrawal to the more favourable tax incentive benefits from preserving your investment. For example:

• Withdrawal: Samantha is 35 and has a taxable income of R700 000 per year. She withdraws R30 000 from her savings component. She is taxed at 39% and only receives R18 300 as a net payment after tax.
• Preserve: Becky is 35 years old and preserves R30 000 over the 30 years until her retirement. Her investment (in a typical balanced fund with returns of 11% per year will grow to R685 000. The first R500 000 is tax-free and she will be subject to an effective tax rate of 3.5%.

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5. What are the consequences of life events on the components of my retirement funds?

• Emigration: you will be able to access the balances in the vested as well as the savings components on the day of emigration. The retirement component will not be accessible for three years after emigration.
• Divorce: divorce orders can currently be applied against a member’s retirement savings. This remains the same in the two-pot retirement system. A claim in terms of a divorce order against any members’ retirement interest will be affected pro-rata across all the members’ components. The legal principles relating to the division of estate does not change under the two-pot retirement system. Contact your financial adviser if you are in the process of getting divorced.
• Resignation: a withdrawal on resignation is taxed at your marginal tax rate and therefore you must consider transferring the value of your savings component into your retirement component to be annuitised for income in retirement.
• Retirement: a withdrawal at retirement is taxed according to the retirement fund lump sum benefits tax tables. Therefore, transferring the savings component into the retirement component can be annuitised for income in retirement.

Davids says it is important to consider all the angles, discuss the implications with your financial adviser and always consider the life you want to live in retirement. “People are living longer and must prepare adequately for that.”