Bold steps to change retirement savings in South Africa
The South African retirement industry’s Two-pot system (Two-pot) represents a bold change to the accessibility and preservation of retirement savings in South Africa. Two-pot will come into effect on 1 September 2024 despite the industry’s efforts to delay its launch to 2025.
From 1 September, ongoing retirement fund contributions will be invested into two distinct components: one-third in an accessible portion (a savings pot) and two-thirds to be invested in a long-term portfolio preserved for retirement (a retirement pot). An amount equal to the lesser of R30,000 or 10% of a member’s current retirement fund balance as of 31 August 2024 will be allocated to the savings pot on 1 September, and the remainder will stay in a separate “vested” pot.
Contrary to popular belief, retirement fund members will not be able to withdraw one-third of their retirement savings. Rather—and the distinction is important—the Two-pot system will allow retirement fund members to access a small portion of their contributions annually from their savings pot while restricting early withdrawals from the retirement pot.
Why Two-pot came about
The financial health of many South Africans has been hindered by a combination of a poor national savings culture, a credit culture that has led to national over-indebtedness, and high unemployment, which places a significant burden on the earnings of the few employed to stretch beyond what is financially prudent. These three factors led to two dominant outcomes that Two-pot seeks to address:
- Serial Withdrawal of Retirement Savings
There is a tendency for retirement fund members in South Africa to withdraw, rather than preserve, their retirement savings despite the tax implications. The chart below shows a growing number of individuals cashing in their retirement savings before retirement (withdrawal lump sum) and although not as high, a large number of individuals are also receiving a lump sum on retirement (retirement lump sum).
Chart 1: SARS data shows an increasing withdrawal trend
Data from SARS over the period also indicated that approximately R78bn of pre-retirement withdrawals are claimed, a sizeable portion of the total R246bn annual contributions made to SA retirement funds. The withdrawal trend is resulting in substantial leakage from the country’s retirement savings pool and creates a potential burden for the Government and its grant system.
- Emergency access in times of financial stress
Many South Africans experience the need to access their savings before reaching legal retirement age, given a period of financial stress. This is specifically the case when a person has debt obligations they are unable to meet for a brief period of time, given specific circumstances.
Ironically, these two challenges that Two-pot seeks to address are at odds with one another. Two-pot was drafted to encourage South Africans to protect their retirement savings and avoid serial withdrawals while also providing South Africans access to a portion of retirement savings in times of financial distress.
Good or Bad?
Ideally, individuals saving for retirement should avoid withdrawing any funds from their retirement savings before reaching retirement age. This is important because dipping into one’s savings early could result in a shortfall of funds at retirement, making it difficult to meet financial needs during retirement. The frequency of multiple withdrawals also matters. According to the Labour Market Dynamics in South Africa Report of 2020, the median job tenure was slightly over four years. The more recently published Career Junction Employment Insights (May 2023) suggests an average tenure of just under three years. These statistics indicate that the average South African invested in a retirement fund that allows full withdrawal on resignation or retrenchment has been able to withdraw their full retirement savings every 3-4 years. The below chart is for illustrative purposes and compares the value of accumulated savings for a fully preserved retirement plan vs one where withdrawals take place every four years during the early years of a career. The difference in accumulated savings after 40 years is significant!
Chart 2: Comparing accumulated retirement savings: full preservation (no withdrawals) vs three early withdrawals
By imposing the preservation of two-thirds of ongoing fund contributions until retirement age (the retirement pot), the Two-pot aims to ensure that retirement fund members have higher accumulated retirement savings than is currently the case. This is particularly true given the rise in popularity of provident funds, which, until 1 March 2021, allowed members to withdraw 100% on resignation or retrenchment.
The chart below illustrates that even if the member withdrew from their savings pot every year for financial reasons, they would still be a lot better off at retirement than if they had withdrawn 100% three times pre-retirement.
Chart 3: Illustrative benefit of Two-pot on accumulated savings
Importantly, Two-pot is not designed to benefit retirement savers who have the discipline to consistently contribute without withdrawing from their funds before retirement. It is designed to protect and benefit the average South African who frequently changes employment and withdraws their retirement savings each time. It also acknowledges that a member may need to access a portion of their long-term savings today if experiencing significant financial stress.
Caveat Subscriptor
Caveat subscriptor – Latin for “let the signatory beware.” There are a number of factors to be mindful of as the Two-pot launch date approaches:
1. One-Third of What?
There has been some uncertainty regarding savings withdrawals and the “one-third.” When the bill comes into effect, only the lesser of 10% or R30,000 of the member’s retirement fund savings as at 31 August 2024 will seed the savings pot and thus be available for withdrawal (subject to a minimum withdrawal of R2000). Important to bear in mind is the size of the retirement benefit of most South Africans. According to ASISA, “61% of fund members had an average retirement fund value of R37,000 or less in July 2020.” This means 61% of South Africans can expect access to R3,700 as the Two-pot becomes effective. Alexforbes confirmed that 24.7% of its members would not qualify to access anything at all on 1 September because they have less than R20,000 in retirement savings, meaning the savings pot would be seeded with less than R2,000.
2. 1 September is a significant challenge
The 1 September launch date poses practical challenges for the implementation of Two-pot. Retirement funds and fund administrators have indicated they are unlikely to be ready to process the expected volume of withdrawals from the launch date. For example, the Motor Industries Retirement Fund which typically processes 5,000 transactions a month, expects 100,000 withdrawals soon after 1 September. Furthermore, SARS has indicated the requirement to calculate tax and issue a directive for each retirement withdrawal will be onerous and means implementing a complete software overhaul. Current systems are not built to accommodate the expected number of withdrawals.
From a Retirement Fund perspective, a change to formally registered rules for each Fund is required to allow for annual withdrawals. These rules need to be drafted and submitted by each Fund to the FSCA. Retirement Funds had until 15 July 2024 to submit changes for approval, yet only 58% of registered funds met this deadline. The submission deadline has been extended to 31 July 2024; however, a considerable number of funds may still struggle to meet this revised date, meaning their members will not be able to withdraw immediately as Two-pot is launched.
3. Enter pots four and even five
Two-pot poses a significant challenge for fund administrators. Going forward, administration is not only required for two pots, but likely three or four per person and, in limited cases, even more.
A savings pot and a retirement pot will be created for ongoing contributions. A member’s accumulated retirement savings as at 31 August 2024 will then fall into a third pot, the vested pot. The fourth and fifth pots arise due to a legislation change effective 1 March 2021, which essentially harmonised the retirement withdrawal rules between provident and provident preservation funds and retirement annuities and pension funds. Administrators had to calculate a vested value – a provident-vested value – as at 28 February 2021, which was the accumulated benefit of a member’s provident savings to which new rules of withdrawal would not apply (a fourth pot). If, on 1 March 2021, a member was 55 years or older, and remained a contributing member of a provident fund, this member would be exempt from the new provident rules. This “exempt pot” is also exempt from Two-pot. These pots are summarised in the table below:
The administrative systems will need to account for various pots and enable the implementation of a member’s withdrawal from the “correct” pot. The ability to keep track of the value of each pot and account accurately for the different tax treatments is both challenging and costly to execute, given the requirement to upgrade systems.
Conclusion
The Two-pot has been designed to support the long-term financial well-being of most South Africans, given the mechanism to ensure that at least two–thirds of retirement savings are maintained and compounded. Long term, asset managers should benefit given higher accumulated savings, and the burden on the State should ease with a lower level of early withdrawals. Ideally, retirement savers should avoid withdrawals and allow their Two-pot savings portions to build up. Withdrawals should be made in case of emergency instead of withdrawing a small amount annually. The intended goal of the savings pot is to ensure people can access savings in times of financial stress while restricting withdrawals from the retirement pot will preserve them for retirement. While the benefits are clear, the largest challenge of implementing Two-pot lies with the administrators, given the burden of accounting for these changes.