Allan Gray retirement fund warning

Thousands of South Africans plan to withdraw money from their retirement funds when the two-pot system kicks in later this year, jeopardising millions in returns.

Allan Gray’s Belinda Carbutt, a specialist in the company’s savings and investments team, recently calculated how much South Africans could stand to lose if they withdraw money from their retirement savings under the two-pot system.

South Africa’s new retirement system will be implemented on 1 September 2024. It will establish a “two-pot” system that gives members early access to some of their savings.  

This is the most substantial change to South Africa’s retirement system since 1994. Members can now withdraw funds from their savings pot once a year. 

The new legislation mandates that all future contributions to retirement funds be divided into two sections –

• Two-thirds of each contribution will go into a retirement component, which must remain untouched until retirement.
• The remaining one-third will be directed into a savings component, which allows for one withdrawal per tax year before retirement.

Additionally, a separate ‘pot’ will be created for individuals with existing retirement funds to retain the value of all contributions made before the new system’s start date of 1 September.

While the savings component is designed to be accessed as a lump sum upon retirement, members can withdraw up to 100% of their savings component once per year before retirement. The minimum withdrawal amount is currently set at R2,000.

This new system is largely seen as a positive development for the industry. It aims to improve retirement outcomes by enhancing the preservation of funds until maturity while offering some flexibility by enabling access to cash from the savings component.

However, many asset managers have warned that withdrawing retirement savings should only be exercised in emergencies.

Generally, it is rarely advisable for someone to withdraw money from their retirement savings, as doing so disrupts the compounding process that allows your money to grow until retirement.

The two-pot system recognises this while acknowledging that many South Africans are facing difficult times and may need access to that money now to serve their immediate needs.

However, Carbutt explained why it is important to understand the intention behind the changes so that South Africans do not get caught up in the noise and make the wrong decision when 1 September arrives.

“The new system aims to improve retirement outcomes overall by ensuring at least two-thirds of a member’s retirement savings are preserved until retirement while giving them some access to their retirement savings if they find themselves in financial distress,” Carbutt explained. 

“In many cases, retirement fund members withdraw all their retirement savings when given the option to, such as upon termination of employment.” 

“In other cases, members find they are not able to access their retirement savings even if they find themselves in financial hardship. The two-pot system aims to address both issues.”

She explained that the new system will essentially allow you to “ink your cross” annually, giving you the option to make a partial withdrawal from your retirement funds. 

“While this is naturally a tempting thought, it is important to understand the intent is for emergency access and should not impact the way you think about your long-term retirement savings,” she warned.

However, it seems that many South Africans do not plan on heeding Carbutt’s warning.

Sanlam’s Benchmark research has shown that almost 60% of South Africans said they would access funds from their two-pot savings component when the new system starts in September.

Not only will withdrawing money from your retirement savings interrupt the compounding process and threaten your returns, but it will also come with very high tax rates.

Sanlam’s consulting actuary, Ryan Campbell-Harris, recently explained how early withdrawals will result in hefty tax obligations. 

Should a member decide to access their savings pot before retirement, the withdrawal transaction will be treated as additional annual income and taxed at the member’s marginal income tax rate.

All administration costs of the withdrawal transaction will also be deducted from the savings withdrawal benefit.

Campbell-Harris said this will significantly impact the amount a member receives when withdrawing from their retirement fund early and the tax they pay.

Carbutt used the example below to illustrate just how much South Africans stand to lose if they choose to withdraw from their retirement savings.

Example

On 31 August 2024, Siphokazi Kumalo’s pension balance was R100,000. On 1 September 2024, this will be allocated to Siphokazi’s vested component. 

Siphokazi’s savings component will then be seeded with R10,000 – 10% of R100,000, capped at R30,000 – from her vested component. 

This amount will be available for withdrawal from 1 September – less tax deducted at Siphokazi’s marginal tax rate and amounts owing to the South African Revenue Service. 

However, Carbutt said it is important to note that this is not a “use it or lose it” scenario: The amount can remain invested until Siphokazi retires. 

The vested component will now have a balance of R90,000.

Moving forward, the savings component will receive one-third of Siphokazi’s monthly contributions, with the remainder invested in the retirement component. 

If Siphokazi’s retirement contribution in September 2024 is R3,000 per month, R1,000 will go to the savings component and R2,000 into the retirement component.

Siphokazi has the option of one withdrawal per tax year of at least R2,000, up to the full amount available in her savings component. 

It is important to note that if Siphokazi decides to withdraw, her withdrawal will be taxed at her marginal tax rate. This tax is deducted before the withdrawal is paid to Siphokazi.

The table below, courtesy of Allan Gray, compares two different outcomes over the next 30 years until Siphokazi retires at age 55. 

The high road is where Siphokazi stays focused on the long term and does not access her savings component. The low road is where she withdraws the available amount every year.

In summary, Carbutt said there are three important benefits of taking the high road:

• Compounding: Siphokazi has 53% more in retirement savings.
• Flexibility: Siphokazi has an option to take a cash portion at retirement. This will be six times greater than the amount in cash she would have received if she were to withdraw monthly before retirement.
• Tax savings: Siphokazi will have an effective tax rate of 11% by staying focused on the high road compared to 31% (her marginal tax rate) for cashing in her savings component in the low road scenario. This equates to paying a third less in tax.

“The new system gives you flexibility; however, it is this flexibility that can also undo your long-term financial strategy,” Carbutt warned. 

“Remember, these reforms are intended to assist members in financial distress. Guard against being tempted to view this as a slush fund for consumption to be accessed on an annual basis. Depleting the savings component equates to using up one-third of your retirement investment.”

“Not electing to withdraw, but rather choosing to stay the course for the long term, will result in better retirement outcomes as the amount in the savings component will benefit from tax-free growth.”