We’ve seen numerous retirement reforms in the past few decades, but the latest is bound to stir the pot(s). South Africa’s 2-pot pension system is scheduled to kick off in September 2024. What is the 2-pot system and how will it affect your retirement savings? What are the implications for emigrants? Fin Select explains the new retirement reforms and 2-pot pension system…
What is the 2-pot pension system?
The gist of the 2-pot system is a retirement reform aimed at hitting two birds with one stone. A long time in the making, this reform (the largest of its kind for SA) is crafted to address issues of over-indebtedness and poor retirement planning.
The two-pot system will allow South Africans to ‘split’ their retirement savings into two different pots.
One ‘pot’ will hold a third of pension contributions in an ‘investment vehicle’ that will allow a capped annual withdrawal before retirement (saving’s pot). The remaining two thirds will be retained in a retirement vehicle that’s only accessible on retirement (or death).
Didn’t we have pension reform a few years ago?
You may recall the previous retirement reform which came into effect in 2016. This reform was meant to encourage South Africans to save more for retirement. The Treasury found that lump sum withdrawal rules prompted many South Africans to use their retirement savings before retirement.
The reforms allowed withdrawal of 1/3 of pension certain pension products as a lump sum before retirement. Provident funds and public sector funds allowed withdrawal of the full amount and taxation was based on the withdrawal benefit table (as of 1 March 2009). The de minimis rule increased the annuitisation cap from R75 000 to R247 000.
Previous reforms failed to address South Africans’ financial needs – both pre- and post-retirement.
What’s the purpose of the new retirement reforms?
The government didn’t make an about-turn around early withdrawal. Instead, the reforms are aimed at addressing a South African economic conundrum. High unemployment rates and over-indebtedness are primary drivers for early withdrawal from retirement funds. Conversely, early access to retirement savings leaves people in a post-retirement bind.
The new reforms want to address this dichotomy by offering South Africans early access to a portion of their retirement savings while the remainer will be locked down until retirement. Furthermore, the pre-retirement access will be incremental – with one withdrawal allowed per tax year.
Another motivation for the 2-pot system is to reduce reliance on government support. The rationale is that access to emergency funds will reduce over-indebtedness while still ensuring a nest egg for retirement. The thinking is that saving for retirement is somewhat futile if people are living in financial distress pre-retirement. Hypothetically, the savings pot should encourage better investment behaviour. There’s a strong urge for South Africans to leave their savings pot untouched. Since this pot is interest-bearing, the Treasury sees it as a better alternative to taking out loans for emergency situations.
The vested pot: existing retirement savings
The two-pot system won’t affect retirement savings accumulated until 31 August 2024, save for a 10% kickstarter transferred to the savings pot.
The existing retirement – also known as the ‘vested component’ – will remain invested with the retirement fund(s). When a member resigns, they can access this component in line with the previous fund rules, or they can transfer it to a preservation fund. The vested component is the aggregate of retirement products. (How the seeding capital will be proportioned remains is not yet clear in the event of multiple retirement products in the vested pot).
The Treasury made exception for provident and provident preservation fund members who were over the age of 55 on 1 March 2021. These members can choose to structure their contributions to follow the two-pot design or remain on the existing system. There is also a concession for legacy retirement annuities or instance where the vested and retirement pot values are below a certain cap.
10% Seeding Capital for the savings pot
The vested pot will contribute seeding capital to the savings pot. This will be 10% or R30 000 of their fund value on 31 August 2024 (whichever is lower). This is a once-off contribution that won’t be repeated.
Annual withdrawal from savings pot
Individuals are allowed one withdrawal from their savings component per tax year for a minimum of R2 000. This withdrawal will be taxed at the individual’s marginal tax rate. There’s no maximum cap on the withdrawal – you can take a portion, the full amount, or nothing at all. Withdrawals from the savings pot will be available immediately once the 2-pot system kicks in.
Given the focus on saving, individuals will also have the opportunity to transfer funds from their savings pot to their retirement pot. In order to access the withdrawals, individuals need to be registered for tax even if they are below the tax threshold. A tax directive will be required for each payout, and administrators will withhold marginal tax on each transaction. Any outstanding taxes may be recovered from the member before withdrawals are granted.
Under the current rules, members must resign from funds in order to access lump sum withdrawals. The savings pot will essentially allow fund access without the need for resignation.
Which funds are included in the 2-pot system?
Since the treatment of retirement savings has been streamlined, retirement products are treated the same. This means that all pre-retirement funds will be included in the 2-pot system save for some legacy retirement annuities.
‘Legacy retirement annuity policy’ means any policy held by a retirement annuity fund entered into before 1 September 2024 with a pre-universal life or universal life construct, subject to such conditions [that] as the Financial Sector Conduct Authority may determine’
Revenue Laws Amendment Bill
Fund administration issues
It’s important to note that fund administrators have not yet drafted or implemented new fund rules. Administrators have until 15 July 2024 to submit their new rules. Following these submissions, rules will be vetted by the Financial Services Conduct Authority (FSCA). Given the tight deadlines, there’s great concern that some funds may not have sufficient time to make the necessary changes. A particular concern is how funds will manage possible mass withdrawals from the savings pot.
Under the present system, transfers and withdrawals are generally managed on an ad hoc basis as individual members retire or change jobs. Facilitating the switch to the new system while simultaneously making immediate payments to qualifying members is a tall task.
Funds who do not have their processes in place by 1 September 2024 risk losing their tax approval status when SARS completes their annual tax assessments. The minister of finance noted in his Budget Speech that SARS expects R5-billion revenue from 2-pot withdrawals in the next financial year. This number indicates that hundreds of thousands of South Africans are expected to withdraw their savings.
Chief Commercial Officer of Discovery Corporate and Employee Benefits, Guy Chennells, notes that these issues could see lead to labour relations crises. All funds aren’t in agreement on when the savings pot will be accessible. Michell Action, Old Mutual’s Retirement Reform Executive, stated that payouts from savings pots would not be immediately available. The government will need to clarify these divergent views of the new system.
Funds will also need to communicate all changes to employers who will, in turn, need to ensure their systems are in place and all options/changes communicated to employees in advance.
The government faces its own roadblocks for this system. The Pension Fund and Revenue Second Amendment Bills need to be signed and SARS needs to finalise system requirements. Furthermore, seeding calculations can only occur after August.
Lump sum changes on retirement
Important to note is that lump sum withdrawals will not be allowed on retirement if the savings pot is depleted. The funds saved in the retirement pot are reserved exclusively for purchasing a retirement income product. The only lump sum withdrawals allowed on retirement will be from funds left in the vested pot.
Members may commute one-third of the retirement interest in their vested component as a lump sum payment. The remaining two-thirds will be added to their retirement component to purchase a life component such as living annuity or a combination of annuities.
Where the total retirement interest of the two-third vested component and retirement pot is less than R165 001, a lump sum withdrawal may be allowed.
Taxation on lump sum withdrawals (retirement, death & severance benefits) are currently set at the following rates:
Pros and cons of the two-pot retirement system
There are various pros and cons of retirement reform.
One of the greatest issues lies with marginal tax. Withdrawals from the savings pot aren’t taxed according to withdrawal benefit tables. The savings pot is deemed an income, and whatever is withdrawn adds to the taxable income.
For example:
- Julia’s current taxable income is R370 000.
- If Julia makes no withdrawal from her savings pot, she is taxed R42 678 + 26% of her taxable income above 237 100. Her tax for the year is R77 232.
- Julia takes the full R30 000 withdrawal from her savings pot immediately. This places her taxable income at R400 000. Her marginal tax is now R77 362 + 31% of income above R370 500. Julia pays R86 507 to SARS.
Note: this is a fairly rudimentary example since taxation isn’t necessarily as straight-forward. It’s simply to illustrate that there may be a great difference in savings and losses.
There are other issues to the two-pot system.
Investment options may be limited
Employers and funds often offer a suite of investment options for one’s retirement savings. Members may be able to structure their contributions to invest in different savings vehicles. They can choose to spread their contributions over conservative, moderate or aggressive investment products.
If funds now need to make an allowance for three different pension pots, this may limit investment options.
Interest may be reduced
Most examples currently offered by the Treasury and fund administrators seem to apply a blanket interest rate in calculations. It seems unlikely that fund administrators will permit the same interest accrual for all three pots. Investors are usually rewarded for long-term investment with higher interest rates. Since the savings pot can essentially be withdrawn at any time, this poses a higher risk for administrators and investment products alike.
The savings pot is therefore likely to see either a lower interest rate, higher administrative charges, or both. Some investment houses would, for instance, offer incremental compound interest increases for products based on the term. This is usually structured on a 1-year, 5-year, 10-year and 20-year incremental increase. The Government Pension Fund has distinct benefits for those less than 10 years and those who’ve worked more than 10 years in the public sector.
Of course, the flip side of the coin is that admin deductions also tend to increase with the investment value. So, while interest may increase, deductions may also increase proportional to the investment value.
Each pot will require distinct administration and taxation
The vested component may very well consist of various funds that require distinct admin and tax treatment at present. Most South Africans, however, only have one pension product. Under the new system there will be three distinct vehicles – each with their own set of rules, interest and tax treatment. The exception being where an individual has no existing retirement product on starting employment.
This not only increases the administrative burden but could drastically increase peripheral deductions and fees levied for their administration.
Additional fees may be levied as ‘insurance’ on the respective products. This may increase insurance contributions overall as the collective insurance of respective investments may be higher than that of a single fund.
What is retirement age?
There seems to be a misconception that legislation prohibits working after a certain age. While most people retire at age 60 or 65, they can only be forced to do so if this is stipulated in the organisational policies. Where an employee is forced to retire without retirement age been agreed to, this constitutes immediate unfair dismissal. Indeed, while no retirement age is stipulated in the Employment Equity Act, there is a stipulation on ageism.
This is a bit of a retirement fund conundrum. Some funds stipulate that retirement must occur at a certain age, and yet this may not be in keeping with pension legislation. On retirement, individuals are required to reinvest 2/3 of their pension in a ‘life product’.
Under the new system, there would be a requirement for individuals to have access to their savings pot until retirement. This means funds will need to reconsider how their retirement rules are structured. Since lump sum withdrawals will no longer be allowed from the retirement component, the savings component will need to be accessible until the employee retires.
This could also see employers add stricter rules on retirement age, which may prevent capable individuals over 65 from employment opportunities.
A three-pot headache for South African expats
Many South African expats have retained their retirement savings in SA for fear that early withdrawal will deplete their overall value. While this generally holds true, it’s counterintuitive decision if you plan on remaining abroad indefinitely. It also makes little sense to continue with monthly contributions which will no longer feed your existing investment.
Fin Select can help you understand your options and facilitate all tax and transactional requirements.
Click to Call now, or send us a Direct Mail to discuss your options.
South African emigrants can transfer their pensions abroad
South Africans who have emigrated are allowed to commute their retirement products and transfer the proceeds offshore. But there are caveats to consider.
Individuals who emigrated before 1 March 2021
If you emigrated before 1 March 2021, you may be able to encash and transfer your retirement savings abroad immediately. The stipulations include:
- You must have completed formal/financial emigration recognised by the SARB before this date.
- Your withdrawals will be subject to withholding tax.
- You must be pre-retirement age unless the fund rules make a concession.
Individuals who emigrated on or after 1 March 2021
These individuals will need to comply with the three-year rule. Stipulations include:
- You must remain outside South Africa for an uninterrupted three-year period.
- Your tax affairs must be in order and tax emigration should be completed to confirm your non-resident status for tax purposes.
- Since the three-year rule is applied retroactively, you won’t be able to access your South African benefits for these three years.
For instance: many individuals living abroad use their single discretionary and investment allowances to transfer funds offshore. These benefits are, however, exclusively available to South African taxpayers. If you want to convince the tax man that you’re no longer a SA taxpayer, you can’t use your taxpayer benefits in the interim.
Tax rebates on retirement products
Another issue is that of tax rebates. South African taxpayers are allowed tax rebates on retirement products. The total rebate is the contribution x marginal tax rate. But of course, such rebates are only available to SA taxpayers.
Marginal tax, withholding tax, tax rebates and Capital Gains Tax may each have a bearing on the final amounts South Africans are able to transfer abroad. This, of course, will depend on their tax status and – in the case of emigrants – the date of tax/financial emigration.
Transferring your retirement savings after 1 September 2024
The retirement reforms still allow commutation and transfer of retirement savings abroad after 1 September. But this may further complicate a process which is already quite complex.
The Revenue Laws Amendment Bill allows for a tax-free lump sum withdrawal of R550 000. This is an aggregate ammount applicable to the full value of your collective retirement products. Given that the respective pots are likely to each carry their own interest rates and admin deductions, this could reduce your final retirement value.
Apply for tax emigration and get your funds out
If you don’t intend to return to South Africa, the best course of action is to apply for tax emigration. This will formalise your non-resident tax status and allow you to receive your retirement funds abroad.
Tax emigration does not affect your South African citizenship. You will still be deemed a South African and your passport will remain valid. You’ll simply no longer be considered a tax resident.
You can recover your losses by investing abroad
Your retirement withdrawal will be subject to taxation and you will be liable for certain administration fees to your fund administrators. That said – most countries offer commutation incentives for reinvesting the proceeds of your funds in new retirement products abroad. This may include tax rebates and interest boosts on your reinvestment.
South Africans temporarily abroad
Fin Select can also assist those who are temporarily abroad. Depending on your individual needs and financial portfolio. We can:
- Assist with double-taxation directives.
- Facilitate the Authorisation of International Transfer (AIT) process to transfer funds between R1-million and R10-million abroad.
- Offer expert advice and liaise with SARS, banks, insurers, fund administrators, the SARB and/or offshore investment/regulatory bodies.
- Facilitate access and transfer of your savings pot and any lump sums available pre-retirement – including tax compliance and directives.
- Negotiate the best forex rates when converting your Rands to a different currency.
- Provide tax and transactional services for businesses with import/export needs.
Let Fin Select manage your tax and cross-border financial needs
Fin Select is an authorised financial services provider with a global footprint. We are accredited and knowledgeable in all financial matters affecting South Africans abroad. Whether you’re temporarily in a different country or there for the long haul.
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Sources:
- Allan Gray
- South African Revenue Service
- South African Reserve Bank
- Government Employees Pension Fund
- FA News
- Momentum Metropolitan
- Pension Funds Online
- LegalWise
- Discovery
- Sanlam
- Alexander Forbes
- The Department of Public Service and Administration
- The National Treasury of the Republic of South Africa
- BusinessTech
- Liberty
- Moneyweb
- Top 1000 Funds
- Bowmans Law
- MIBFA
- University of Stellenbosch
- Pension Lawyers South Africa
- PKF
- Organisation for Economic Cooporation and Development
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