Dispelling misconceptions about the two-pot retirement system

Alexforbes is concerned about the misconceptions and the lack of information about the two-pot retirement system, which is scheduled to be implemented on 1 September.

The financial services group held a media briefing yesterday in which it set out essential aspects of the two-pot system, particularly in respect of pre-retirement withdrawals and how these withdrawals will be taxed.

There is even confusion over who will be affected by the two-pot system.

Essentially, the new system applies to the build-up phase of retirement – when members are contributing to their funds. The system, therefore, does not apply to pensioner members, said John Anderson, the executive for Solutions and Enablement at Alexforbes. (Of course, a person could be a retiree and receive a pension while continuing to contribute to, for example, a retirement annuity fund.)

Another class of people who are automatically excluded from the two-pot system are members of provident funds who were 55 years or older on 1 March 2021 and have remained a member of the same provident fund. These members can choose to opt into the two-pot system. They have until 1 September 2025 to decide.

The two-pot system will apply to pension, provident, preservation, and retirement annuity (RA) funds. It will apply to defined-benefit and defined-contribution funds. It will not apply to beneficiary funds and unclaimed benefit funds.

The two-pots legislation also provides for the exemption of “legacy” or “old-generation” RA funds. Essentially, legacy RAs are contracts held by an RA fund entered before 1 September 2024 that include a pre-universal life or universal life component. These funds can apply to the FSCA for an exemption from the two-pot system.

Two-pot system with three pots?

Fiona Rollason, the group head of legal and insurance, went through some of the main regulatory and technical aspects of the two-pot system, highlighting the areas of misunderstanding and miscommunication that Alexforbes frequently encounters.

The name of the new system has created confusion. Only people who join a retirement fund for the first time on 1 September will have two “pots” – itself a misnomer because the final legislation calls them “components”. These members will have a savings component and a retirement component.

People who have been contributing to a retirement fund before 1 September 2024 will have three components: savings, retirement, and vested.

Another class of members who will have only two components in a fund are deferred pensioners (people who resigned and opted to leave their money in the fund until retirement). These members will have a vested component and a savings component. They will not have a retirement component, because they are no longer making contributions. Their savings component will consist entirely of the seed capital.

Vested rights will not be taken away

The purpose of the vested component is to protect members’ rights that were in place before 1 September 2024. Nevertheless, as Rollason explained, there are misconceptions about how the two-pot system will affect members’ savings accumulated before 1 September.

Members will continue to have the same rights to access their retirement benefits on resignation, retrenchment, or dismissal after 1 September as they do now. In these instances, they can still withdraw the savings in their vested component as a cash lump sum. Therefore, it is unnecessary for them to resign, based on the misconception that if they don’t access their benefits now, they will not be able to do so after 1 September.

Pre-retirement withdrawals from the vested component will still be taxed according to the withdrawal benefit tax table, where only the first R27 500 is tax-free.

Another misconception is that members who leave their accumulated savings in the vested component will be worse off when it comes to investment returns. Although no further contributions can be made to the vested component from 1 September, the money in this component will remain invested and continue to earn returns.

The same annuitisation requirements will continue to apply at retirement to benefits in the vested component.

At retirement, the cash lump-sum withdrawal of up to one third of a member’s savings will still be taxed according to the retirement fund lump-sum benefits table. The first R550 000 is tax-free.

Confusion about minimum and maximum withdrawals

From 1 September, one-third of a member’s contributions will be allocated to the savings component, and two-thirds to the retirement component. This split is compulsory across all funds that qualify for the two-pot system.

The rand amount of the allocations to the savings and retirement components is net (after) the deduction of administration expenses and any group risk cover.

The money in the savings component can be accessed before retirement (in the case of an occupational fund, without having to resign). Members of RA funds will now also have access to their savings before retirement (without specific extenuating circumstances having to apply).

At retirement, any money remaining in the savings component can be withdrawn as a lump sum or transferred to the retirement component (and used to buy an annuity).

Members are permitted one withdrawal per tax year, not calendar year. The tax year starts on 1 March and runs to the end of February. The two-pot system starts on 1 September, which means members will have six months within which to make their first withdrawal (if they choose to do so).

The minimum withdrawal is R2 000. The Actuarial Society of South Africa has pointed out that this threshold may disqualify certain members from making a withdrawal when the two-pot system takes effect on 1 September. They will have to wait until the funds in their savings component have built up to R2 000.

Read: No savings pot withdrawal in September if your balance is less than R2 000

If a member terminates his or her membership of a fund and has already made a withdrawal within the tax year, the member can make an additional withdrawal in the same tax year only if the balance in the savings component is less than R2 000.

Some people have misunderstood the cap of R30 000 on the seed capital to be the maximum annual withdrawal from the savings component. But there is no maximum withdrawal. The savings component will continue to grow as one-third of contributions are added to it, and investment returns are earned on these contributions. Members can withdraw whatever is in the savings component, subject to the R2 000 minimum.

It’s not ‘use it or lose it’

The annual withdrawal from the savings component is not “use it or lose it”. Members who choose not to make a withdrawal do not forfeit access to the amount they could have withdrawn in subsequent years. The balance in the savings component remains available for withdrawal in any subsequent tax year.

A member is entitled to make a savings component withdrawal from each fund of which he or she is a member that falls under the two-pot system. For example, a member who belongs to an employer-sponsored umbrella fund and two RA funds can make a withdrawal from each of these funds’ savings components (subject to meeting the R2 000 threshold in each fund).

Take note of the tax implications

Alexforbes emphasised the importance of members understanding the tax implications of pre-retirement withdrawals from their savings component.

These withdrawals are taxed at a member’s marginal tax rate (personal income tax table applies). The relevant tax rate is applied after the fund administrator has deducted its fee for processing the withdrawal.

The two-pot system retains the tax deduction that can be claimed on retirement fund contributions. The deduction is limited to 27.5% of the greater of the amount of remuneration for PAYE purposes or taxable income (both excluding retirement fund lump sums and severance benefits). The deduction is further limited to the lower of R350 000 or 27.5% of taxable income before the inclusion of a taxable capital gain. Members who make pre-retirement withdrawals, which are taxed at their marginal rate, may effectively be squandering the benefit they received from the tax deduction on their contributions.

At retirement, lump-sum withdrawals from the savings component are taxed according to the retirement fund lump-sum benefits table. The first R550 000 is tax-free.

Pre-retirement withdrawals do not erode the R550 000 tax-free benefit. But these withdrawals do erode the cash members will have available at retirement. Therefore, withdrawals may result in a member not having enough money available to take full advantage of the R550 000 tax-free benefit at retirement.

A pre-retirement withdrawal could push a member who is at the upper end of his or her marginal tax bracket into the next tax bracket.

The South African Revenue Service (SARS) has indicated that if a member who makes a pre-retirement withdrawal owes SARS tax, it may not only deduct tax at the marginal rate but also the outstanding tax.

Rollason said this may not always be the case – for example, SARS will not deduct arrear tax if the member has entered a repayment plan with SARS – but it is a possibility, and members who owe SARS tax should be prepared for the “shock” of a higher deduction.

Fund administrators will have to provide SARS with a member’s tax reference number and annual income, so the marginal tax rate can be determined. If the tax deducted is higher or lower than a member’s actual income (as determined during a member’s annual tax assessment), either the member will have to pay in more tax or SARS will owe the member a refund.

The administrator will deduct a fee

Many if not all fund administrators will charge a fee to process withdrawals from the savings component, Anderson said. Different providers have decided on different payment models, either a fixed fee or a sliding scale.

Alexforbes has decided on a sliding-scale fee, based on 2% of the amount withdrawn, subject to a minimum fee of R100 and a maximum of R600. Therefore, members of an Alexforbes-administered fund who decide to withdraw the entire seed capital of R30 000 in September will pay R600.

Anderson said it seems most administrators intend to charge an average of about R350 per transaction.

Alexforbes settled on a sliding scale in attempt to share the cost fairly across different generations of members and different types of members. Retirement funds are pooled schemes, “so we’ve tried to ensure there’s some level of cross-subsidy and there is some fairness in the costs over time”.

He believes market forces will result in providers reviewing their fees once they have a better idea of the number of transactions and the amounts involved.

Seeding is a once-off event

The savings component will be seeded using the accumulated savings in the vested component. The seed capital will therefore reduce the balance of the vested component and will reflect in the savings component.

Seeding is a once-off event – it occurs only when the two-pot system is implemented in September this year.

The seeding amount – the money transferred from the vested component – is 10% of the accumulated savings valued on 31 August 2024, and the maximum transfer is R30 000.

The seeding is not a minimum of R30 000, nor is it one-third of the amount in the vested component.

Fund members do not have to do anything for their savings component to be seeded. The fund administrators must, by law, perform the seeding.

Implications for liquidity at retirement

It is important for members to realise that the entire benefit in the retirement component must be used to buy an annuity at retirement.

An exception is if 100% of the amount in the member’s retirement component plus two-thirds of the amount in the member’s vested component is R165 000 or less.

The other exceptions to the annuitisation rule are if the member has ceased to be a South African resident for a continuous period of three years or if the member left South Africa on the expiry of a work or visit visa.

The requirement to use the entire benefit to purchase an annuity has important implications for liquidity (availability of cash) at retirement, particularly for members who join a fund from 1 September 2024. At retirement, their only liquidity will be what is available in the savings component. Members who belonged to a fund before 1 September can withdraw whatever is available in the savings component plus up to one-third of the benefit in their vested component as a cash lump sum on retirement.

Members cannot access the money in the retirement component before they retire, even if they are retrenched. Members who are retrenched will have access to the money in their savings component and vested component (if they have one).

National Treasury has undertaken to explore, in the second round of the two-pot reforms, how members can be granted limited access to their retirement component on retrenchment.