Two-pot retirement system raises concerns about public awareness and long-term impact

With only nine working days until the two-pot retirement system takes effect, the retirement fund industry is concerned about whether pension fund members truly understand what the new regime entails.

“Despite the huge amounts of communication and information around the new system, a lot of people still don’t properly understand the retirement system,” says Michelle Acton, retirement reform executive at Old Mutual.

Shaun Duddy, head of product development at Allan Gray, told Moneyweb that although the two-pot is a “net positive” for the retirement landscape in South Africa as a whole, it does not mean people will magically be able to retire comfortably.

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“Two-pot promotes additional preservation, but people still need to do what they’ve always been required to do: contribute towards retirement from as early as possible, over a reasonable amount of time, and follow an appropriate investment strategy.”

The new regime comes into being at the beginning of September. Under this system, a retirement fund member’s contributions are divided into a savings component accessible once in a tax year, and a retirement component. For existing retirement fund members, a third component – the vested pot – contains the member’s contributions up to 31 August 2024.

The savings component will be initially seeded with the lower of 10% of the value of the retirement fund or R30 000 as at 31 August. From there on, two thirds of any new retirement savings will be preserved in the retirement component, which can only be accessed once a member reaches retirement age.

‘Borrowing from your future self’

The rationale behind the new system is to promote retirement preservation among those who save for retirement. At present, a large number of pension fund members opt to withdraw the full amount available in their retirement funds when they resign or change jobs.

“The scary thing is that 80% to 90% of members of occupational [employer-managed] funds are taking the cash when they leave their jobs. That is why studies show that only 6% of retirement fund members can retire comfortably,” says Acton.

Under the new system, every retirement fund member will now have some level of secure income at retirement because of the compulsory element as well as access to a portion in case of emergency.

Acton points out though that members who access their savings before retirement are in fact “borrowing from their future self”.

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Old Mutual’s research shows that even though South Africans agree that it is important to save for retirement, people’s actions do not correspond with that belief.

“Especially now with two-pot, we see there’s a bigger focus on accessing the money versus how much I need for retirement.”

Allan Gray’s Duddy says people need to realise that any money withdrawn from the savings pot and consumed (in other words, not saved somewhere else), is money that will not be available upon retirement.

The high cost of paying back the money 

There is also a significant cost if members decide to ‘replenish’ the money that was taken from the savings pot.

Duddy explains: “Exactly how much will depend on the withdrawal amount, and how long you wait before you replace it. But say you start your retirement journey on 1 September 2024, and you withdraw from your savings component religiously along the way, you’ll get to retirement with only two-thirds of your assets.

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“If you decide you want to top it up so that it is back at 100%, you will need to contribute 50% of what you already have in your retirement fund to get back to the full amount you would have had if you didn’t withdraw from the savings pot.”

Besides the extra cost of contributions, a retirement fund member who withdraws from the savings pot along the way will also have missed out on investment returns “every day, month, or year in which you don’t replace it”, Duddy notes.

Two-pot retirement system: Marginal tax rate

Apart from the forfeited benefit of returns on investment, as well as the loss of compound interest and the tax benefit of contributing to a retirement fund, there is also the marginal tax issue associated with the two-pot system.

Withdrawals from the savings pot will be taxed at the marginal rate, which is significantly higher than the existing tax rate applicable to early retirement fund withdrawals.

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Acton says there seems to be a limited understanding of what exactly the “marginal tax rate” is.

“More education is needed on how the marginal tax rate is calculated. People also don’t understand why the money is taxed in the first place, and often they don’t view it as Sars [South African Revenue Service] applying the tax, but rather the service provider.”

Stay the course

Duddy says a risk associated with the two-pot system is that retirement assets could potentially be viewed differently.

“To date, retirement fund members will have regarded it as a single pot of money in which they’re saving for retirement.

“But now there will be a distinction – a retirement component which they can’t touch, and a savings component, which they ideally shouldn’t touch although they have the opportunity to do so once a year.”

There is concern that retirement fund members may now start to think ‘differently’ about the savings component from an investment allocation perspective.

“You may argue that just in case you need to withdraw from the savings pot, you’re going to allocate this portion to lower-risk, shorter-term investments – for argument’s sake, a money market fund,” says Duddy.

“But when you invest for retirement, you should ideally try to generate as much real returns as possible and you’d want to invest greater amounts in riskier assets, like equities.

“Any allocation to [shorter term] low-risk assets could potentially mean you will reduce your returns significantly.”

Acton emphasises that the advent of the two-pot system does not require pension fund members to change their investment strategy.

“The ultimate purpose of your savings pot is that it is a savings vehicle for your lump sum that you take at retirement. Your retirement pot is the income you’ll earn at retirement.

“With that in mind, the default strategy is that both of these pots need to be long-term investments,” says Acton.

“Why would you want to invest your savings pot more conservatively? If you do that, you’ll reduce your expected returns [in the savings pot].”

Two-pot retirement system: You don’t have to act

Both Duddy and Acton point out that the new retirement regime does not require any action from retirement fund members who do not want to access money from their savings pot.

“There is a lot of talk about what is changing, but it’s also worth noting what is staying the same,” says Duddy.

“If you are contributing at a good level, consistently and you are investing appropriately, two-pot is a non-event. Continue what you’re doing. For a lot of people, two-pot does not require any action.”

This article was republished from Moneyweb. Read the original here