The FSCA has published a “best practice” guidance on how retirement funds should apply the two-pot retirement system to defined-benefit (DB) members, or to defined-contribution (DC) members who have a DB underpin at retirement.
The purpose of Communication 27 RF of 2024 is to ensure consistency across funds and to highlight the necessity of obtaining the Authority’s approval for alternative methods of allocating contributions to the savings and retirement components.
The Revenue Laws Amendment Act of 2024 amended the Income Tax Act to give effect to the two-pot system. From 1 September, funds that are part of the system must create a savings component and a retirement component.
In the case of DB funds, a member’s retirement savings must be split between the two new components, with the member’s years of pensionable service (as determined by the fund’s rules on or after 1 September) converted to an amount that the service is worth.
The total value attributed to the savings component on or after 1 September must be determined with reference to one-third of the member’s pensionable service. Furthermore, the fund must seed the savings component with a once-off transfer of 10% – limited to R30 000 – from the vested component calculated on 31 August 2024.
The total value attributed to the retirement component must be determined with reference to two-thirds of the member’s pensionable service.
Where a fund with a DB structure cannot allocate a member’s contributions to the savings and retirement components as indicated above, the fund may allocate contributions using an alternative “reasonable” method, provided it is approved by the FSCA.
Savings component withdrawals
The communication sets out the principles that funds must apply when a member decides to make a withdrawal from their savings component, which will reduce the member’s years of pensionable service.
The calculation of the capital equivalent for the service being sacrificed when a member opts to receive a part of their savings component must be financially neutral to both the fund and the member as of the effective date of the savings component withdrawal request.
After the member decides on the amount to be paid out, the fund’s valuator must calculate the service that the member is giving up. This service reduction corresponds to the value of the cash payment made and will reduce the pensionable service that will be used to calculate the member’s pension at retirement.
The fund must consider the actuarial reserve value that it would hold at the effective date of the member’s request, based on assumptions that are detailed in Communication 27. The greater of the actuarial reserve value and the minimum individual reserve in terms of section 14B(2) of the Pension Funds Act must be used in converting the lump sum into pensionable service.
The fund must clearly communicate the reduction in service to the member, ensuring that the member understands the impact of the withdrawal on their future pension benefits.
Other scenarios
The FSCA also sets out the principles that must be applied in the following three scenarios:
- Split accrual rates
For funds with split accrual rates, the actuarial reserve value (subject to a minimum of the prescribed minimum individual reserve value) must remain the same immediately before and after the effective date of the savings withdrawal benefit.
This may involve removing fewer years at a higher accrual rate or more years at a lower accrual rate. The fund’s rules should clearly specify how the service reduction will be applied.
- DC funds with a DB underpin
For DC funds with a DB underpin at retirement, both the DC savings component and the DB service must be reduced if a savings withdrawal is made.
The reduction in service is based on the conversion of the lump-sum payment to pensionable service. This reduction must be clearly communicated to the member, regardless of the comparison between the DC benefit and the value of the DB underpin at the time of the withdrawal.
- DB funds with additional benefits
Where a DB fund includes an additional benefit related to a DC payment – for example, when the rules treat additional voluntary contributions (AVCs) as a DC additional benefit), any savings component withdrawal should be proportionally deducted from both the DB value and the AVC value.
The reduction in the DB should be implemented as a change in pensionable service.
The methodology used to reduce the main member’s pension at retirement due to reduced pensionable service will also affect the contingent spouse’s pension on death after retirement because the spouse’s pension is typically a percentage of the main member’s pension.
Enquiries about Communication 27 should be sent to Giulia Tognon at the FSCA’s actuarial services department at giulia.tognon@fsca.co.za.
