Two-pot retirement system: financial lifeline or long-term liability?

The two-pot retirement system gives South Africans the opportunity to withdraw a portion of their retirement savings before they actually retire and offers a lifeline for many. But when does it stop being a financial lifeline and become a long-term liability?

According to Sars, it received 2 664 279 applications for two-pot retirement system withdrawals in the first five months after it was implemented in September, resulting in a staggering R43.42 billion withdrawn from retirement funds.

However, Stian de Witt, head of financial planning at financial advisory firm NMG Benefits, cautions that consumers must consider a two-pot retirement system withdrawal from several perspectives before you accept it as a solution for short-term financial challenges.

“The first consideration is that two-pot retirement system withdrawals are always taxed and the applicable tax rate may be much higher than you think. Two-pot retirement system withdrawals are taxed on your marginal rate, which is the rate relevant to the last rand you earned and is often much higher than your ‘average’ tax rate.

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Steep tax for two-pot retirement system withdrawals

“However, if you wait until retirement before withdrawing, a portion of this withdrawal will be tax-free. Taking money out of your retirement savings early not only incurs steep tax, but it also means that you are reducing the amount that you could potentially withdraw tax-free if you wait.”

De Witt says another important consideration is that your retirement savings are there to support you when are considered too old to earn an income. “Tapping into your retirement savings now will reduce the amount available to carry you through your retirement years.

“An early withdrawal under the two-pot retirement system will immediately erode the capital amount available for your retirement and because you will also start losing out on compound interest, the long-term effects will be significant.”

He points out that the implications could entail having to downscale your lifestyle, become financially dependent on others, or rely on social grants.

While there are risks attached to early two-pot retirement system withdrawals, De Witt acknowledges that accessing some of your retirement savings might be a sensible, viable option if you face a medical emergency, job loss, eviction, loss of assets or legal trouble, or if you have excessive, high-interest debt.

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Best way of dealing with two-pot retirement system withdrawal’s consequences

However, he says, the best way to avoid dealing with the long-term consequences of withdrawing from your retirement fund early is to proactively strengthen your short-term financial security. De Witt’s advice is to partner with a financial adviser who can help you to budget and plan properly.

“Start by spending less than you earn and saving every month for an emergency fund that can cover three to six months’ worth of expenses. You should also avoid taking on unnecessary interest-bearing debt as it is one thing to take a bond on your house, but another thing entirely to buy luxuries on credit cards.

“Withdrawing savings under the two-pot retirement system should be a last resort, not a default option. Remember that retirement is a marathon, not a sprint and so you should focus on ensuring that you have enough at the finish line instead of using up your fuel too soon.”