Two-pot retirement system could boost household income by up to R79 billion

The Reserve Bank estimates that the two-pot retirement system that comes into effect in September will boost household disposable income by between R31 billion and R79 billion in the fourth quarter of 2024 adding 0.1 to 0.3 percentage points to gross domestic product growth in 2024 and 2025.

Reserve Bank researchers Nkhetheni Nesengani, Riaan Ehlers, Mish Choonoo, Annelie Van Niekerk and Theo Janse van Rensburg write in an economic research note that explores the possible impact of the two-pot retirement system on household consumption, real fixed investment, inflation, government debt and gross domestic product (GDP) growth that it will also reduce the government debt to GDP ratio by 0.5% in 2024/25 and by 1.0% in 2025/26.

Their hypothesis is that the partial, pre-retirement withdrawal of the two-pot retirement system will boost consumption and economic growth somewhat over the short term, while they expect that the reforms will increase the pool of retirement savings as employees will be unable to withdraw all their pension fund savings on resignation.

In a high withdrawal scenario, they found that GDP growth will increase by 0.3% in 2024 and 0.7% in 2025, while the government debt to GDP ratio will improve by 1.1% in 2024/25 and by 2.3% in 2025/26 thanks to the two-pot retirement system.

While this sounds like good news, they warn that the higher the withdrawal rates, the less funds will be available for people at retirement age. They add that these impacts are relatively small when compared with pension reforms elsewhere, such as in Chile, where pension fund rule changes allowed much larger withdrawals, causing pension assets to decline by 14% of GDP.

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What happened with similar pension reforms in Chile

For example, in the case of Chile, the International Monetary Fund (IMF) estimated that withdrawals accounted for 14% of GDP, after three pension withdrawal episodes between the third quarter of 2020 and the first quarter of 2021.

“These withdrawals halted growth in pension assets. Initially, net tax revenues increased sharply, rising by 40% in 2021 and 22% in 2022, as spending increased with the opening of the economy from Covid-19 related lockdowns,” the researchers say.

Real GDP growth in Chile was 11.7% in 2021, at least partly boosted by pension withdrawals. However, pension funds’ assets declined significantly and the government had to stop further pension withdrawals. As a result, consumption growth slowed significantly they say.

The researchers point out that South Africa’s savings rate is very low compared to Chile. In essence, according to the Association for Savings and Investments in South Africa (ASISA), only 6% of economically active South Africans can retire comfortably.

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What Sars data tells us about withdrawals before two-pot retirement system

Sars data illustrates that for each of the three years from 2016 to 2018, over 700 000 individuals opted to take out the withdrawal lump sum in cash before retirement, with an average of around R78 billion per year taken out of the retirement system through withdrawals made before retirement compared to an annual pension contribution of R246 billion.

“Taxation on early withdrawals is on average over R12 billion each year. Higher tax rates are levied as a disincentive to deplete assets before retirement. However, given the large number of withdrawals, the severe tax implications do not appear to be a sufficient consideration in minimising this behaviour,” the researchers say.

This large leakage reduces funds available for employees in retirement, contributing to low replacement ratios.

They also point out that the retirement industry is currently in a net outflow position, with annual withdrawals from pension funds exceeding annual contributions. “The reforms seek to minimise the net outflow over time, with the introduction of the two-pot retirement system.”

The magnitude of annual net outflow is expected to dwindle and the industry to reach a new steady state. Coronation Fund Managers believe that it would take roughly 10 years for the vested component to deplete, with the guiding principle that once the vested component has been accessed, it cannot be accessed again.

This new steady state is estimated to result in an outflow of roughly R40 billion to R50 billion per year in less than 10 years, on the key assumption that there is no additional seeding after the first year and that the availability of the savings pot might deter people to quit their jobs to access their vested rights, the researchers say.

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Two-pot retirement system expected to reduce outflow by R50 billion

“This is a reduction of around R50 billion compared to the current outflow levels. The withdrawals amount is therefore expected to bottom out and either reach a flat or net positive cash flow position over time.”

The researchers expect that the initial drop in pension fund assets due to the reforms will have positive shocks to consumption and GDP in the near term.

Turning to the possible impact on the economy, the researchers say implementation of the two-pot retirement system reforms will lead to several possible economic and fiscal repercussions that are fundamentally linked to how people will react to this new source of income.

“Outcomes will vary depending on the rate of uptake of the available funds as well as the intended destination of the funds, such as consumption or debt reduction.”

After investigating the scenarios of high and moderate withdrawals, the researchers say in their conclusion that international experience indicates that pension fund reforms can result in a substantial boost to economic activity.

“However, if the reforms are not well designed, their impacts could be short-lasting and result in a significant decline in pension assets over the long term.”

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Two-pot retirement system strikes good balance – researchers

According to their modelling, the researchers say the two-pot retirement system strikes a good balance by providing some short-term leeway for distressed consumers while over the long(er) term it will most likely result in improved retirement benefits as withdrawals will now be disallowed from the investment pot on resignation.

“This is also the main reason why government limits the initial withdrawal to the minimum of 10% or R30 000 rather than giving contributors access to the full portion in the vested pot. While we do not model the longer-term benefits to the fund members, as it falls largely outside the forecast horizon, they will be severely impeded if all the available savings component funds are used over the short-term, leaving members with considerably smaller than needed retirement funds.”

More specifically, they say all current indications are that the net outflow in pension funds should peter out in about eight to ten years and the pension fund assets would stabilise. “On the longer term, the economy at large would benefit from employees retiring with a larger pool of retirement savings stemming from the investment pot, which they will only be able to access on retirement.”

Under a high withdrawal scenario consumption increases substantially in 2024 and 2025 before reverting to the baseline before the impact of the two-pot retirement system.  However, the researchers say, a more likely scenario is for moderate pension withdrawals where households spending will add between 0.3% in 2024 and 0.7% in 2025 to real consumption.

“Government tax revenue will benefit from these withdrawals, with tax revenues rising by 0.3% of GDP in 2025 and 0.2% in 2026.”