Educating fund members about pre-retirement withdrawals from their saving components is emerging as one of the most important aspects of the two-pot retirement system.
Roleplayers in the retirement industry are unanimous in emphasising that members should be discouraged from making any pre-retirement withdrawals. At the same time, the new system builds in the ability to withdraw all the money in their savings component once a tax year.
At a recent media briefing on the two-pot system, Ann Leepile, the chief executive of Alexforbes Investments, said members must be encouraged to preserve all their savings until retirement. They should be educated to regard their savings component as their “lender of last resort”, not as a discretionary savings account.
At the same, she said, one cannot ignore the reality that many South Africans’ only source of savings is their retirement fund.
It has been observed that, despite the country’s high unemployment rate and the punitive tax rates on pre-retirement withdrawals, members quit their jobs so they can use the savings in their occupational retirement funds to fund living expenses and pay off debt.
According to the latest Sanlam Benchmark Survey, 50% of respondents said they encashed all the retirement benefits on resignation, up from 31% in 2022 and 39% in 2023. The survey found that 33% of respondents used their encashed savings to manage their living expenses (2023: 25%; 2022: 23%), while 21% used the money to service, reduce, or settle debt (2023: 31%; 2022: 25%).
John Anderson, Alexforbes’ executive for solutions and enablement, said the two-pot system aims to strike a balance between enforced preservation and enabling members to meet immediate, short-term financial needs. He said this is “a delicate dance, but one that aims to benefit members in the long run”.
The system will “protect members from themselves” by “locking up” (in the retirement component) two-thirds of their contributions, plus the investment growth on those contributions, until they reach retirement.
Anderson said there are scenarios where it may make sense for members to exercise the option to make a pre-retirement withdrawal from their savings component – and still have a “reasonable” income in retirement.
It is essential that members who are contemplating a withdrawal from their savings component receive proper retirement benefits counselling or seek sound financial advice, so they are appraised of the trade-off between meeting a short-term financial need and forfeiting the investment growth and tax benefits that come with preservation. Withdrawals could result in a member having to live on a lower pension and reduce his or her standard of living in retirement.
Getting out of short-term debt
There are certainly bad reasons for withdrawing money from the savings component, such as to fund consumption expenditure and award oneself a “thirteenth cheque”. But using withdrawals to avoid or get out of short-debt can increase one’s take-home pay, and the money saved on paying debt can then be directed into retirement savings.
Anderson said Alexforbes has modelled scenarios in which people who do not have an emergency fund or discretionary savings can improve their overall financial situation by withdrawing money from their savings component. This is particularly the case if the withdrawal is used to pay off or avoid unsecured, high-interest-rate debt.
The table below provides the replacement ratios at retirement for someone who joins a retirement fund on 1 September 2024 (this person will have only a savings and a retirement component). There are two assumed contribution rates: 15% and 16%.
The replacement ratios in column on the far right assume the person withdrawals all the money in the savings component every year or shortly before retirement, while the column to the left of it provides the replacement ratios if the person makes no pre-retirement withdrawals. Obviously, the best outcome at retirement is achieved by full preservation and the worst by continually withdrawing everything.
Scenario 1 shows the replacement ratios if the person uses the savings component to pay off his or her student loan. Scenario 2 shows the outcome if the person makes a withdrawal every year to pay a child’s school fees from pre-school to matric. Scenario 3 shows the outcome if the person makes a withdrawal every year for three years to pay for a child’s tertiary education (fees of R60 000 a year).
Anderson said the three withdrawal scenarios do result in the person having a replacement ratio of less than 75%, which the commonly targeted ratio. But they do not result in replacement ratios that are unreasonably low.
The above examples are for illustrative purposes only, and it must be emphasised that members’ withdrawal decisions should be based on sound advice that considers their individual circumstances, including whether they have funds in their vested and savings components, how much they accumulated, the size and frequently of each withdrawal, their years to retirement, whether they can increase their contributions following a withdrawal, and the tax implications of a withdrawal.
Anderson said a benefit of the flexibility introduced by two-pot system is its potential to drive greater member engagement about managing their retirement savings. There is an opportunity for conversations around retirement to be integrated into a goals-driven financial plan. Members must be steered away from making withdrawals “just because they can” towards ensuring that pre-retirement access is based on a financial plan aimed at achieving a specific outcome.
Furthermore, members who make withdrawals should be encouraged to consider how they can boost their savings component by, for example, making ad-hoc additional voluntary contributions or increasing the percentage of remuneration allocated to retirement contributions. The need to top-up the savings component following a withdrawal is particularly important for members who either do not have a vested component or who have exhausted their vested component and whose only source of cash at retirement will be what is available in the savings component.
Responsible debt management
Earlier this year, Henri le Grange, a Certified Financial Planner at Old Mutual Personal Finance, said leveraging retirement savings for debt repayment, especially against high-interest liabilities, requires careful deliberation on its future impact.
“The allure of tapping into retirement funds to alleviate debt should be a measure of last resort,” he said. “Advisers must help customers weigh the costs, including potential taxes and fees, against the benefits of clearing debt.”
Le Grange said personalised, comprehensive financial strategies are essential to debt management.
“Advisers should only recommend using retirement savings to pay off debt in cases of really no alternatives, severe financial hardship, life-threatening medical emergencies, or during periods of unemployment.”
Le Grange said financial advisers can help clients to manage debt in the context of the two-pot retirement system by:
- Educating clients on debt types. Advisers can help customers understand the differences between secured and unsecured debt, as well as revolving and instalment debts, including the interest rates associated with each. This knowledge allows customers to make informed decisions about which debts to prioritise for repayment.
- Assisting clients to create balanced financial plans that include both repaying debt and establishing an emergency fund. This dual approach helps to mitigate the risk of falling back into debt because of unforeseen financial emergencies.
- Emphasising the importance of targeting high-interest debts first, such as credit card debt, using the avalanche method. This approach focuses on paying off debts with the highest interest rates first, which can lead to significant interest savings over time.
- Cautioning against early withdrawals. Advisers should explain the long-term consequences of using retirement savings for debt repayment, such as reduced retirement funds, and the potential for compromised financial security in retirement.
- Exploring alternatives. Before resorting to using retirement savings, advisers should guide customers through other debt repayment options, such as debt consolidation, negotiating for lower interest rates, and budget adjustments to allocate more towards debt repayment.
This is an absolute lie, it cannot ever make sense. If you do not have a retirement fund that you can access, then your brain will be forced to make other plans, ingenious legal plans, to be gainfully employed and even increase your income, within the ambits of the law. However since government purposed to bent over being pressured by low IQ voters and direct the publics focus, by suggesting this two pot rubbish. The most horrific heinous crime that ever were perpetrated was created and set in motion, by this two pot politicians creation, they have thrown down the gauntlet, on something that should never ever even been whispered, in the passages of a horror filled night mare. It is a fact the brain will only focus on what comes easiest and will pursue that option comes hell or high water, irrespective of what current legislation dictates. It will break down the good laws, laws that have been set up, as future security to protect their savings for what it was originally purposed for and that is for the public to retire independently. Independent from the government and family with self respect and honor. No more lying on the grass waiting for cooked duck to fall into your mouth! No it is now much easier, you must please sit back and be fed, no chewing or swallowing, it will be liquidized spiced to taste and you will be fed by tube. However the children of these recipients will hate them for what has been perpetrated against them. They and their children will without any say in this carry the brunt of this attack on their future finances and prosperity. They are going to go hungry so that their fathers may indulge, grow fat and die of heart attacks. They will become the recipients of disaster. Every recipient of Sassa, are already owned by government, as (subjects), slaves without any freedom or independence and will bow to any gods that government tell them to. The tail will wag the dog. This is the plans of narcissist. It is unavoidable that without savings a country is bankrupt and can be taken over by the Chinese or any other country who it will become indebted to. May the good Lord God help us.