Two pots: fund members must understand the implications of withdrawals

It is expected that many eligible fund members will take advantage of the opportunity to withdraw from their retirement funds once the two-pot retirement system takes effect next year. It is important for members to understand who will be eligible to withdraw and the implications of withdrawals on their retirement planning.

Members should manage their expectations

Much of the reporting on the two-pot system has highlighted concerns about whether administrators have enough time to make the required changes to their IT and administration systems by 1 March 2024. The complexity of the changes should not be under-estimated.

The main challenge is that the two-pot legislation has not been finalised. It is uncertain whether further concessions around accessibility will be granted for phase one of the system. Clarity is still required on how many aspects of the draft legislation will be implemented. And all affected retirement funds will have to change their rules, which will have to be approved by the FSCA.

Administrators are doing the best they can, based on the current draft legislation, to get ready by 1 March 2024. But, considering what must be done in a short time, things may not run smoothly from the get-go.

Members who want to withdraw from their savings pots should not be surprised if a fund is unable to process their request immediately on 1 March 2024 or soon thereafter. Even if their systems are in place, it is likely that administrators will be inundated with a flood of withdrawal claims come March next year.

In addition, many members seem to be fixated on the prospect of getting R25 000 in March next year. The R25 000 is the limit on what can be transferred into the savings pot. The seeding of the savings pot is 10% of the value of a member’s retirement savings on 29 February 2024. To withdraw R25 000 on 1 March next year, a member will need to have savings of at least R250 000. Furthermore, the minimum required withdrawal is R2 000, so members who have less than R20 000 saved when the two-pot system is introduced won’t have enough to withdraw immediately.

Michelle Acton, the executive for retirement reform at Old Mutual, says only 350 000 of the 650 000 members in the employer-sponsored funds administered by Old Mutual are expected to be eligible to withdraw on March 1 next year.

Annual withdrawals are on a per fund or per contract basis

Members need to understand that the seeding of 10%/R25 000 does not apply to the aggregate of all their retirement savings. Every retirement fund, including preservation funds and non-legacy retirement annuity (RA) funds, is required to create a savings pot and to seed it, subject to the abovementioned criteria. A member who meets the eligibility criteria can withdraw from the savings pot of each fund on 1 March 2024.

Similarly, annual withdrawals from the savings pot apply on “a per fund or per contract” basis. Where a member has multiple contracts in the same fund, the member is allowed one withdrawal during the tax year from each contract.

“Contracts” refer to RAs. Rowan Burger, the head of strategic finance at Momentum Metropolitan, says an individual may have a number of RAs with the same provider. The RA contracts are different, but all the assets may be invested in the same fund.

For example, an individual may have taken out an RA with Southern Life, Metropolitan, and Momentum, and all these contracts are now in the Momentum RA Fund because of corporate activity. This individual can withdraw from each RA contract (three) instead of the number of funds he or she is in (one), Burger says.

To use another example, Person A is a member of an occupational retirement fund and of two (non-legacy) RA funds. Each tax year, Person A can make three separate withdrawals from the savings pots of each of these funds, as long as at least R2 000 is withdrawn from each pot.

Is this really an emergency?

Members needed to be educated so that they access their savings pots only as a last resort, for absolute financial emergencies, says Michelle Acton, the executive for retirement reform at Old Mutual.

That members are being permitted to access their retirement funds to get them out of a financial squeeze underscores the need for South Africans to have emergency savings, which they should build up using an appropriate savings vehicle, she says.

In this regard, members need to understand the difference between a genuine financial emergency that arises because of an unforeseen event and not having enough money because of poor financial planning.

Avoid withdrawals at the beginning of the tax year.

Old Mutual expects that savings pot withdrawal claims will spike every March, at the start of the new tax year, Acton says. But members should avoid making a withdrawal early in the year. If they withdraw at the start of the tax year and spend the money and then run into a financial emergency later in the year, they cannot make another withdrawal. This advice is particularly sound when one considers it is not uncommon for South Africans to experience a financial squeeze in January, after excess spending during the holiday season.

It’s not ‘use it or lose it’

Members do not “forfeit” the amount in their savings pots if they do not make a withdrawal once a year. Money that is not withdrawn in a year, along with further contributions, will accumulate in the savings pot. Members can withdrawal the full amount from their savings pots once during any tax year from 1 March 2024.

Impact on the lump sum at retirement

Pre-retirement withdrawals from the savings pot may seem essential or inconsequential at the time, but members need to consider the long-term implications. As Acton puts it, “it’s all retirement money”.

It needs to be reiterated that withdrawals from the savings pot will reduce the cash lump sum available at retirement. Members cannot commute any portion of the savings in their retirement pot; all of it must be used to buy an annuity. (Members with savings in their vested pot – savings accumulated before 1 March 2024 – will still be able to take up to a third of their savings in cash at retirement.)

As Blessing Utete, the managing executive of Old Mutual Corporate Consultants, points out, there is invariably a need for some liquidity during the transition from working to retirement. For example, many members rely on their one-third lump sum to settle debt or buy a smaller vehicle when they retire.

More importantly, members do not have to take the full one-third; they can use some of all of it to buy a bigger annuity. Members who have used up all the money in their savings pots may regret not having preserved it so they can buy a bigger annuity.

Tax implications

Under the current system, pre-retirement withdrawals are subject to the tax rates in the retirement lump-sum table. Although these rates are more punitive than the rates that apply at retirement, the first R27 500 is tax-free.

Under two pots, money withdrawn from the savings pot will be added to a member’s income and taxed at their marginal rate. A consideration of the tax implications of these withdrawals includes whether they will push the member into a higher tax bracket.

The fund’s administrator will deduct the tax and pay it over to the South African Revenue Service; the member will receive the after-tax amount.

Withdrawals won’t be free

Members can expect to pay a fee to the fund administrator for processing withdrawals. Administrators will probably communicate these fees closer to the implementation date. However, estimates of R90 or R100 per withdrawal have been used as examples.

It seems administrators do not want members who choose not to withdraw cross-subsidising members who withdraw regularly, which would “punish” those who preserve their savings.