Latest proposals on how the two-pot retirement system will work

Here is the two-pot retirement system in a nutshell: you have the option of withdrawing one-third of your retirement benefit in cash before you retire instead of when you retire.

Under the current retirement legislation, you can take up to one-third of your savings as cash at retirement. You must use at least two-thirds to buy an annuity.

Once the two-pot system is implemented, you can start withdrawing your one-third in cash before retirement without having to quit your job or resign from your fund.

National Treasury says the two-pot system is designed to ensure that fund members preserve most of their retirement savings until they retire. But doesn’t allowing members to withdraw up to a third of their savings each year contradict this aim?

The context is important. The current retirement regime is not preventing members from cashing out all their savings whenever they leave their jobs. Pre-retirement withdrawals are deliberately taxed more punitively than withdrawals at retirement, to discourage pre-retirement withdrawals. But this has not had the desired effect. Large numbers of fund members continue to cash out most or all their savings. As a result, they do not have enough money in retirement.

The two-pot system also acknowledges that in a country beset by high unemployment and low (voluntary) household savings rates, retirement funds (contributions to which may be compulsory) are the only source of substantial savings for most members.

The two-pot system will ensure that members preserve at least two-thirds of their savings until retirement. Unlike the current retirement regime, members will not be able to access this two-thirds by resigning. Note that this mandatory preservation applies to two-thirds of a member’s savings accumulated from the implementation of the two-pot system on 1 March 2024.

Modelling by Alexforbes and Sanlam, among others, has shown that allowing members to withdraw up to a third of their savings, while forcing them to preserve two-thirds, produces a better outcome at retirement than when members regularly cash out most or all their savings, as they can under the current regime. The key word here is “better”. The best outcome is achieved by preserving all savings until retirement.

Furthermore, the better outcome will be achieved by members who are in the two-pot system for a long time. Members who are close to retirement and who have been cashing out regularly will not derive much benefit from the system’s mandatory preservation. In fact, the ability to cash out each year (without having to resign) could leave them worse off.

Key aspects of the three components

National Treasury and the South African Revenue Service on Friday published the revised 2023 Draft Revenue Laws Amendment Bill and an accompanying explanatory memorandum. These documents contain the latest proposals for the two-pot system.

The two-pot system will require a retirement fund’s board of management (trustees) to create three components (as the pots are now called) within the fund: a savings, a retirement, and a vested component.

The savings component will enable members facing financial hardships to access a portion (one-third) of their retirement savings without having to resign from their jobs or funds. These withdrawals will be taxed.

There is no “means test” attached to withdrawals from the savings component, so although the intention is that members access this component only when they really need to, there is nothing to prevent them from mis-spending the withdrawals on things such as holidays. As has always been the case, members need to understand the adverse implications of not preserving as much of their retirement savings as possible until retirement.

Members need to remember that any cash they withdraw from the savings component pre-retirement will reduce the amount they can take as cash when they reach retirement. The impact of pre-retirement cash withdraws must be considered when planning for liquidity needs in retirement.

The retirement component will prevent members from withdrawing most (two-thirds) of their retirement savings when they resign from their jobs. The retirement component must be preserved until retirement.

It is important for members to grasp that the entire retirement component must be used to buy an annuity at retirement. They will not be able to take up to one-third of it as a cash lump sum.

The vested component will “ring-fence” the contributions (if any) of members who joined retirement funds before 1 March 2024 so that these contributions will continue to be subject to the existing (pre-two pot) legislation. Members will still be able to withdraw this component in full before they retire, but, as is currently the case, they will have to resign to do so. At retirement, they can take up to one-third as cash, while at least two-thirds must be used to buy an annuity.

Here are more details about the features of each of the components:

Savings component: pre-retirement access

Members will contribute one-third of their total contributions to the savings component. This one-third of a member’s retirement assets is available for withdrawal before retirement.

Members can choose whether they want to make any withdrawals from the savings component. If they wish, they can leave all the funds untouched until retirement.

Members will also be able to “seed” their savings component by transferring 10% of the benefit they have accumulated in their vested component by 29 February 2024, but the transfer is limited to R25 000.

Read: This is how much you will be able to transfer to your savings pot on 1 March 2024

A member will be allowed to make one withdrawal from the savings component within a tax year.

The minimum value of each withdrawal, before taking into account any charges or transaction costs, must be R2 000.

There is no limit on the amount a member can withdraw.

If a member who resigns from employment has already used their single withdrawal in a tax year, an additional withdrawal will be allowed if the member’s gross interest in their savings component is less than R2 000.

The ability to withdraw from the savings component will apply on a per fund or per contract basis. Where a member has multiple contracts in the same fund, the member may be allowed one withdrawal during a year of assessment from each of the contracts.

Withdrawals from the savings component will be added to a member’s taxable income and taxed at their marginal rate. Note that under the current retirement regime, pre-retirement withdrawals are taxed according to the withdrawal benefit table.

Members can make tax-free transfers from their savings component to their retirement component at any time, but members cannot transfer from their retirement component to their savings component. Therefore, members need to think carefully before transferring to the retirement component – the transfer can’t be reversed.

At retirement, the savings component will be paid out to the member as a cash lump sum. Alternatively, the member could transfer part or all of their savings component to the retirement component, enabling them to buy a bigger annuity.

If the member dies, their beneficiary can opt to receive the benefit in the savings component as a lump sum, or they can transfer it to their retirement component and receive an annuity.

Retirement component: compulsory preservation

Two-thirds of a member’s total contribution must be allocated to the retirement component.

The assets in the retirement component must be preserved until retirement. Withdrawals from this component will be triggered by the member reaching normal retirement age per a fund’s rules.

Once a member reaches retirement age, the retirement component will be paid in the form of an annuity (including a living annuity).

The current de minimis (R247 500) relating to the commutation of annuities will apply to annuities from the retirement component. The ability to commute an annuity (take it as a cash lump sum) will be determined with reference to the member’s interests in their vested component and their retirement component and will be determined on a per fund basis.

The current provisions relating to the payment of benefits to the beneficiaries of deceased members will apply to payments from the retirement component: the beneficiary will receive an annuity.

Individuals who emigrate from South Africa and cease to be tax residents can make a lump-sum withdrawal from the retirement component. The payment of the lump sum is subject to the three-year rule under the current regime that applies to members of a retirement annuity (RA) fund, a pension preservation fund, or a provident preservation fund.

Vested component: the benefit accumulated pre-two pots

Retirement funds will have to value a member’s retirement interest on the date immediately before the two-pot system is implemented (1 March 2024) because this amount will be subject to the current retirement regime after the implementation of the two-pot system.

Subjecting amounts in the vested component to the current retirement regime means:

• Members can make once-off withdrawals from preservation funds;
• Members can access their pension and provident funds if they resign;
• The mandatory annuitisation of two-thirds of a member’s retirement interest with effect from 1 March 2021; and
• The continued protection of members’ vested rights that resulted from the annuitisation reform that came into effect from 1 March 2021.

Members can make tax-free transfers from their vested component to their retirement component at any time, but they can’t make transfers from their retirement component to their vested component.

An individual who emigrates from South Africa and ceases to be a tax resident can make a lump-sum withdrawal from the vested component. The payment of the lump sum is subject to the three-year rule that currently applies to members of an RA fund, a pension preservation fund, or a provident preservation fund.

Members will not be able to contribute to their vested component, unless they are members of a provident fund who were 55 years or older on 1 March 2021.

Provident fund members who were 55 years or older on 1 March 2021

These members can continue contributing to their vested component until they retire from or leave the fund of which they were a member on 1 March 2021.

If they choose to keep contributing to their vested component, their full contribution will be allocated to the vested component. In other words, they cannot contribute to the savings component and the retirement component.

Provident fund members who were 55 years and older on 1 March 2021 who want to participate in the two-pot system will have to stop contributing to their vested component. Their contributions will be split between the savings component and the retirement component, as is the case with other retirement fund members.