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On 1 March 2024 there will be a radical change affecting everyone who is a member of a retirement fund. This is known as the Two-Pot Retirement System and applies to any member of an employer pension/provident fund, a retirement annuity, or a preservation fund.
In partnership with Liberty, we are running a four-part educational series to ensure that you understand what the Two-Pot Retirement System means to you.
In our final article in this series, we focus on the first-time retirement contributor.
READ: Personal Finance | How the Two-Pot system will affect a mid-career person
For a first-time retirement contributor who joins the retirement fund after 1 March 2024, the Two-Pot Retirement System will have the greatest impact.
To recap, from 1 March 2024 all retirement contributions, whether to an employer fund or a retirement annuity, will be split between a Savings Component and a Retirement Component.
. Savings Component: One-third of the member’s contributions will be paid into the Savings Component. The contributions, and all growth in the fund, would be accessible prior to retirement. Withdrawals may only be made once in a calendar tax year and only if the value of the Savings Component is at least R2 000 or more. Any withdrawals prior to retirement will attract fees and be fully taxable at marginal tax rates. At retirement, funds in the Savings Component could be taken as a cash lump sum and would be taxed according to the lump sum retirement tax tables.
. Retirement Component: Two-thirds of the member’s contributions will be paid into the Retirement Component. The contributions and growth will be preserved until retirement. On retirement the funds will be used to purchase an annuity income.
READ: Personal Finance | Why the Two-Pot Retirement System really has three ‘pots’
Analyses show that overall, the Two-Pot Retirement System will provide a better outcome for members of retirement funds than is currently experienced. This is because a portion of their retirement savings (the Retirement Component) must be preserved until retirement, unlike the current system where, in the case of employer pension and provident funds, all funds can only be withdrawn on resignation.
While members will still have access to the Savings Component, if members continually withdraw their savings each year, they could find themselves underfunded in retirement.
THE POWER OF PRESERVATION
Let’s consider the example of a 35-year-old who contribute R6 000 a month to her retirement fund. An amount of R4 000 would be paid to her Retirement Component and R2 000 would be paid to her Savings Component.
Based on an average return of 10% per annum, she would have around R13.5 million at age 65, assuming she never withdrew from her Savings Component.
READ: Money Makeover | When your retirement fund is not enoughAt age 65, R4.5 million would be available in the Savings Component as a lump sum. Her cash lump sum retirement benefit would be taxed according to the lump sum retirement tax table, and she would receive the first R550 000 tax-free. She would have R9 million in her Retirement Component which must be used to purchase an annuity income.
If she withdrew all her funds from her Savings Component before age 65, the withdrawals would be fully taxed at her marginal tax rate, and she would not have the R4.5 million in her Savings Component to provide a lump sum at retirement.
She would only have the R9 million in her Retirement Component by age 65 which she would be required to use to purchase an annuity income.
PLAN FOR FINANCIAL EVENTS
Rather than relying on your retirement fund for emergencies or other life events such as your children’s education, make sure you have other investments in place. You can put money away for emergencies in a notice account, purchase unit trusts or invest in a tax-free savings account for other medium-term goals.
These should be built into your financial plan, even if that means a slightly lower contribution to retirement investments. The Savings Component should only be accessed before retirement as a last resort.
PROS AND CONS OF TRANSFERRING TO THE RETIREMENT COMPONENT
The draft legislation currently allows members to transfer the funds in certain of their components to other components within the same retirement fund. While a member may never transfer funds from the Retirement Component to the Savings component, one can transfer funds from the Savings Component to the Retirement Component.
Members who do not intend to ever withdraw from the Savings Component may wish to transfer funds from their Savings Component to the Retirement Component especially if this is then invested in a higher return investment portfolio.
Before making this decision, remember that once the funds have been transferred to another component they cannot be transferred back. In addition, any funds in the Retirement Component must be used to purchase an annuity income and will not be available as a cash lump sum benefit at retirement.
It is best to get financial advice to ensure that at retirement you have the option to take both a reasonable, tax-efficient cash lump sum benefit as well as funds to purchase an annuity income to meet your living expenses.
