South Africa’s retirement savings landscape is experiencing a major transformation with the introduction of the new two-pot retirement system, which was implemented on 1 September 2024. Shaheed Mohamed delves into these critical changes, explaining their impact on both current and future retirement fund members.
The two-pot system is designed to enhance retirement outcomes by ensuring that at least two-thirds of a member’s future retirement investment is preserved until retirement. At the same time, it allows members to access a portion of their investment once per tax year if they encounter financial distress.
Providing some level of access to funds under the new system will help alleviate the extreme measures some members have taken in the past to access their retirement investments during financial crises. There have been numerous instances where cash-strapped members resigned from their employment just to access the benefits in their pension or provident funds. This was detrimental because it often left them without work for a period as they sought new employment and any assets that were withdrawn and not replaced before retirement would reduce income in retirement. This was highly disruptive for employers, who then needed to source and train new staff, incurring significant costs.
The two-pot system prevents these scenarios, benefiting members, employers and the overall retirement savings rate in South Africa over the long term. While the ability to access funds in emergencies will provide relief to some members, the long-term success of the new system relies on most members refraining from unnecessary withdrawals.
How does it work?
As of 1 September 2024, new contributions to provident, pension, umbrella, retirement annuity and preservation funds are divided into two components (i.e. the two “pots”). One-third of new contributions go into a savings component, which is accessible before retirement in case of emergencies. The remaining two-thirds go into a retirement component, which is inaccessible until retirement and must be used to purchase a retirement income product at retirement.
Members retain their existing retirement rights on all contributions made before 1 September 2024 and growth thereon. The value of a member's retirement fund as of the end of August 2024, less “seeding”, remains invested and is allocated to what is called the “vested” component. All existing rights continue to apply to this component, but no further contributions are allowed.
What are the implications of withdrawing from the savings component?
While the two-pot system offers relief for members facing financial hardship, there are real consequences of pre-retirement withdrawals. Withdrawing from the savings component diminishes the full benefit of compounding. Accessing any part of the savings component before retirement will reduce the amount available at retirement for purchasing a retirement income product or to take as a cash lump sum. Additionally, withdrawals before retirement will be taxed at the member's marginal tax rate, which can push them into a higher tax bracket. Outstanding taxes due to the South African Revenue Service will also be deducted. It is important for members to understand that their product provider will pay the after-tax amount into their account, so they are likely to receive a lower amount than they requested.
What is the role of the employer?
Responsibility for staff retirement fund benefits often resides within the finance and/or human resources functions, with department heads typically being key decision-makers. Employers must educate their staff on the new two-pot system. As custodians of staff's retirement fund benefits, it is crucial for employers to educate their staff about the workings and implications of the new system. Management should involve the retirement fund consultant or product provider to inform their members about the pros and cons of the new system, especially the implications of withdrawing from the savings component. This ensures members make well-informed decisions regarding their retirement goals.
Employers should also understand the withdrawal process with the product provider. At Allan Gray, our approach has been to alleviate the administrative burden on employers by guiding members to submit withdrawal instructions via their secure online account. This not only simplifies the process for employers, but also helps mitigate fraudulent activity, which is more common with paper-based instructions. With the anticipated rise in withdrawal activity, there is an increased risk of fraudsters targeting unsuspecting members. Employers should inform their staff to be extremely vigilant in order to safeguard their funds.
It is important for employers to understand and communicate any additional fees under the new two-pot system, as some retirement providers levy an implementation fee and/or a withdrawal fee.
With over two decades of experience processing retirement fund withdrawals and member claims, we were prepared for these changes. Despite the additional costs incurred in setting up our systems and managing withdrawals thereafter, we decided not to charge an implementation fee nor a member withdrawal fee on our Umbrella Retirement funds at the outset – we will monitor activity for a period and make decisions based on data and experience.
To discover more about the new two-pot system, visit Allan Gray’s Two-pot retirement system info hub.