The impending shake-up of South Africa’s failed retirement system may be the solution to our critical under-saving crisis, argues Kyle Hulett, Head of Investments for Sygnia Asset Management.
“South Africans are not saving enough for retirement!” the headlines declare at least once a year, followed by industry pundits such as myself citing shocking statistics – such as that 90% of retirees are unable to maintain their standard of living after retirement.
Hair-raising stats like this, taken from a January 2022 study by Genesis Analytics and the Financial Sector Conduct Authority (FSCA), are published year after year but have done little to scare under-saving South Africans into changing their ways. This is evidenced by the same study’s finding that two-thirds of retirement fund members have less than R50 000 saved.
If insanity is doing the same thing over and over and expecting different results, we need to try something new to incentivise 90% of South Africans to save adequately for retirement. This is why I welcome government’s new “two-pot” retirement system, which is set to be introduced on 1 March 2024 (not on the initial and somewhat unrealistic date of 1 March 2023).
It is a long-overdue revamp of a system that is clearly ineffective, a fact reiterated in November when South Africa slipped further down the Mercer CFA Institute Global Pension Index. South Africa dropped three places this year, ranked 34 of the 44 pensions systems that the index benchmarks.
Many details still need to be finalised before the new two-pot system is promulgated with the annual budget in March 2023, but the broad aims already agreed upon will put structures in place to entice South Africans to save for retirement and preserve their savings until retirement. It will also provide South Africans with another tax-free savings vehicle if they max out their annual or lifetime tax-free savings allowance.
Enforced preservation with more flexibility
The two-pot system will apply to all members of pension and provident funds, umbrella funds and retirement annuity funds who were under the age of 55 as of 1 March 2021.
It is designed to address the Achilles heel of the current retirement system, which is that members can cash in their entire savings if they change or lose their jobs. This all-or-nothing pre-retirement withdrawal rule radically reduces members’ chances of achieving their retirement goals. And because early withdrawals count toward each member’s once-off R500 000 tax-free lump sum withdrawal allowance, large pre-retirement withdrawals sabotage a member’s retirement outcome.
The two-pot system will change this by splitting retirement savings: two-thirds of contributions will go into a retirement pot and one-third into a savings pot. The retirement pot cannot be touched until retirement, even if the member loses or changes their job, and it must be annuitised at retirement. However, members will be able to withdraw from the savings pot once every 12 months, provided they have a minimum of R2 000 in savings.
This much-needed change strikes the right balance between allowing access to savings while ensuring the majority of savings are preserved for retirement.
Carrot-and-stick tax strategy
The system also uses tax to incentivise members to preserve savings by allowing for tax-free growth in both pots while encouraging additional savings into the retirement system. Conversely, it disincentives dipping into the savings pot by charging heavier marginal tax rates on all withdrawals.
You can currently cash in 100% of your retirement savings at “withdrawal rates”, which are lower than the marginal tax rates. The first R25 000 is tax-free, but the remainder is subject to a rating scale: 18% from R25 000 to R660 000; 27% from R660 000 to R990 000; and 36% from R990 000 and up.
Under the two-pot system you will only be able withdraw from the savings pot once every 12 months, and that will be at a higher tax rate. If you wait until retirement to withdraw from the savings pot, however, you will benefit from more favourable taxation: the first R500 000 is tax-free, while the remainder will be subject to the more favourable withdrawal rating scale.
This strongly incentivises members to wait until retirement to access funds from their savings pot, thus strengthening long-term preservation and improving retirement outcomes.
New withdrawal rules
If you are fired or retrenched, you will be able to withdraw all funds from your savings pot, taxed at marginal rates, but you will also be able to transfer funds from your savings pot to your retirement pot, which cannot be accessed until retirement.
If you resign from your job, you will still be able to make a withdrawal from the savings pot once every 12 months at marginal tax rates, provided you have a minimum of R2 000 in savings. The retirement pot may not be touched until retirement age.
On retirement, the process is mostly the same as under the current system. The retirement pot must be paid out as an annuity and will be taxed at the marginal rate. The savings pot can be paid out as a lump sum subject to the current tax tables, it can be added to the retirement pot or it can be annuitised.
Tying up the loose ends
It is still not clear what the investment restrictions on the two pots will be and how the restrictions will work: will the savings pot require a different investment strategy given its shorter time horizon and higher liquidity requirements? And will Regulation 28 be applied to the combined two pots or to each pot separately?
Another important detail still to be decided is how much of their existing retirement savings (pre-1 March 2024) a member can access without termination of employment, retrenchment or leaving the fund.
Treasury is also considering whether members who are retrenched will be allowed to access a portion of their retirement pot under special conditions. For example, the member would need to have exhausted their UIF and must have no other income.
Lastly, the current retirement system will remain in place for members who were 55 or older as of 1 March 2021. However, discussions are underway about whether these “older members” should be given the option to partake in the two-pot system, which would allow them to access a portion of funds via their savings pot.
Savings pot vs TFSAs
Should members wanting to save more than the minimum retirement contribution do so via a tax-free savings account (TFSA) or by adding funds to their savings pot?
A TFSA should be your first port of call for extra savings, as it allows you to invest 100% offshore and thereby diversify your investment portfolio, whereas both the savings pot and the retirement pot will be limited to 45% offshore exposure. In addition, you may withdraw from a TFSA at any time with zero tax applied, whereas savings pot withdrawals will be subject to marginal tax rates.
However, should you reach the R36 000 per year tax-free savings limit or your R500 000 lifetime limit, the savings pot is a good alternative. It will allow you to grow savings tax-free but offers access to the funds if required. The only difference is that withdrawals from the savings pot will be at marginal tax rates rather than being tax-free.
A brighter retirement future
The new two-pot system is clearly the shake-up South Africa’s under-performing retirement system desperately needs. Incentivising saving and ring-fencing a higher proportion of savings for retirement should improve the retirement outcome for millions of South Africans. Likewise, being able to access a portion of savings without retiring from the fund will be a major incentive to preserve retirement savings, while the marginal tax rate on withdrawals from the savings pot will cause people to think twice before dipping into their retirement savings.
All in all, I expect the new two-pot system to eventually flip those scary stats so that 90% of South Africans (hopefully more) will one day be able to retire comfortably.