The Two-Pot retirement system
The much anticipated Two-Pot Retirement System is scheduled to take effect on 1 March 2024. This represents a significant change to the retirement savings landscape which is vital for advisers to understand. Here is a summary of what you need to know.
Why we need the Two-Pot Retirement System
- The intention of the Two-Pot legislation is to enforce a level of retirement savings preservation; and thereby ensure that retirement savings are retained for the purposes of retirement, even when someone leaves an employer. This intervention is desperately needed, with only a small portion of members currently preserving retirement savings, typically resulting in a replacement ratio in retirement which falls far short of the 75% generally required.
- The Two-Pot regime endeavours to address this issue, but also recognises that many households require occasional access to savings to cater for emergencies and unforeseen circumstances. The sad reality is that currently many people resign from employment to access their pension benefit as this is their only source of savings. This increases their future financial risk as they will most likely still experience financial hardship and will also now be unemployed.
- The aim of the Two-Pot system is to balance the opposing forces of long-term retirement saving with short term financial distress, in a manner that optimizes outcomes for Retirement Fund members. It does so by creating 3 “pots” – a ‘vested pot’ cater for retirement savings accumulated prior to the implementation date of retirement contributions, a ‘savings pot’ which members can access prior to retirement, and a ‘retirement pot’, which must be preserved until retirement and cannot be accessed as a cash withdrawal at all before or at retirement.
- The Two-Pot system is estimated to result in a new member accumulating more than double the value of their savings at retirement compared to the current system, while providing them with access to some savings annually.
The latest updates on the Two-Pot regulations
According to the latest draft regulation we expect the Two-Pot system to work as follows:
Retirement Funds to which the Two-Pot regulation will apply.
Pension and Provident Funds, Preservation Funds and Retirement Annuity Funds are required to comply with the Two-Pot regulations. This includes both defined benefit and defined contribution Funds, and most notably Public Sector Funds, including the Government Employee Pension Fund (GEPF).
Certain legacy retirement annuity policies will be exempt from the Two-Pot requirements, including:
- Pre-universal life policies and/or conventional policies with or without profits;
- Universal life policies with life and/or lump-sum disability cover; and
- Reversionary bonus or universal life policies as defined or referenced in the insurance legislation.
“Pots” are now “Components”
In the latest draft released in July of this year, the regulation now refers to the “pots” as “components”.
The Vested Component
Any retirement savings which have already accumulated prior to 1 March 2024 are classified as a member’s Vested Component. This may consist of a member’s ‘vested benefits’ resulting from provident fund contributions prior to 1 March 2021 (“T-day”) plus growth, and non-vested benefits. The member will retain all his/her current rights of access to those benefits after 1 March 2024, namely:
- A full withdrawal may be taken on resignation or retrenchment from an employer Pension or Provident Fund
- The member may make one full or partial withdrawal from a benefit preserved in a Preservation Fund.
- On retirement, the entire value of the T-day ‘vested benefit’ (Provident Fund contributions made prior to 1 March 2024, plus growth) may be withdrawn in cash, and a maximum of 1/3rd of the T-day non-vested benefit may be withdrawn in cash.
Provident fund members who were 55 on 1 March 2021 (‘T-Day’) and who have remained in their original provident fund and who have only accumulated ‘vested benefits’ will be able to elect to continue making contributions to the Vested Component from 1 March 2024 onwards. If they don’t make such an election, their contributions from 1 March 2024 will be split into the Savings and Retirement Components according to the new rules.
The Savings Component
- One third of a member’s Retirement Fund contributions (net of charges and risk premiums) will be allocated to the Savings Component, which can be accessed before retirement. The Savings Component is intended to address the need for those Retirement Fund members in financial stress to access their benefits in the Savings Component on an annual basis, and thereby prevent them from having to resign from employment or completely withdraw from the Retirement Fund.
- A member can make a single withdrawal from their Savings Component every tax year, of a minimum of R2000 and up to 100% of the value in the Savings Component.
- Savings Component withdrawals will be processed at an account level, meaning if the client has multiple accounts/contracts with a Fund they can withdraw from each separately.
- Savings withdrawal benefits will be taxed at a member’s marginal tax rate.
- Any balance remaining in a Savings Component when a member retires may be withdrawn in full, or partially or transferred to the Retirement Component and fully used to purchase an annuity to provide an income in retirement. Withdrawals from the Savings Component at retirement will be taxed using the lump sum retirement tax tables.
The Retirement Component
- Effective 1 March 2024, two thirds of a member’s Retirement Fund contributions (net of charges and risk premiums) will be allocated to the Retirement Component, which can only be accessed as an annuity at retirement. The Retirement Component is intended to address the need for all Retirement Fund members to save more for retirement.
- The Retirement Component may only be accessed as a cash lump sum before retirement in the event of the member’s emigration, or the cessation of South African tax residence as per the current “3-year rule” or, if the member is a non-resident, on the expiry of a South African work or visitor’s visa.
- When a member retires, they cannot access any part of this component in cash but must use the full value to purchase an annuity. If however, at retirement, the value of the member’s Vested Component together with the value of the member’s Retirement Component jointly falls below R247,500, the member may take the full value of these two components in cash.
As of 29 February 2024, Retirement Funds will be required to “seed” a portion of 10% (up to a maximum of R25 000) of the member’s accumulated retirement savings at that date, into the member’s Savings Component. This will be available for members to withdraw immediately following the Two-Pot implementation on 1 March 2024.
The principles regarding taxation of Retirement Fund savings will remain in place, namely:
- Retirement fund contributions will continue to be tax deductible up to the current limits.
- The investment returns on a member’s benefits in the three components will be exempt from tax; and
- Withdrawals taken from the three components are subject to tax.
This method of deferred taxation is intended to incentivise retirement savings.
The draft legislation states that savings withdrawal benefits taken from the Savings Component will be taxed at the member’s marginal tax rate, by way of Retirement Fund administrators applying for a tax directive from SARS for each withdrawal.