Government’s R43 billion retirement tax jackpot

The government is set to collect up to R41 billion in additional personal income tax in the current financial year from implementing the new two-pot retirement system. 

As South Africans withdraw money from their retirement funds in the following financial year, a further R32.4 billion will be collected, resulting in increased tax collection. 

Last month, the Pension Funds Amendment Act was signed into law by President Ramaphosa, initiating the biggest change to the country’s retirement system since 1994. 

The new two-pot system aims to address challenges with South Africa’s existing retirement funds that resulted in poorer financial outcomes for retirees. 

One of the major problems with the country’s existing retirement system is that employees tend to resign to get early access to their pension savings, breaking the compounding process and negatively impacting their income in retirement. 

SARS data shows that each year, around 700,000 individuals opted to take out an early withdrawal lump sum in cash before retirement. 

This translated into roughly R78 billion being taken out of the retirement system annually. 

To discourage early withdrawal, higher tax rates are levied on lump sums taken out before retirement. This generates around R12 billion for the government annually. 

However, researchers at the Reserve Bank said this does not appear to be an effective mechanism to limit early withdrawals. 

Thus, reform was needed to reduce the significant ‘leakage’ out of the system, which contributed to low replacement ratios in retirement. 

To address this, the two-pot system aims to enable South Africans to access some of their retirement savings early, limiting the annual withdrawal to a pot containing only a third of all contributions. 

From 1 September, contributions to retirement funds will be split into two ‘pots’ – a savings pot and a retirement pot. This is shown in the graphic below, courtesy of Allan Gray. 

A third 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.

Despite bringing the mechanism of using higher tax rates on early withdrawals to encourage better financial decisions to an end, the new two-pot system will create billions in additional revenue for the government. 

While early withdrawals will no longer be subjected to higher tax rates, they will be taxed at the individual’s marginal tax rate. 

This means the withdrawal will be treated as additional income and subjected to personal income tax. 

Head of personal investments at Coronation, Pieter Koekemoer, gave an example of how this would look in practice. 

Assuming your annual taxable income is R240,000. Whatever withdrawal you make from your savings pot will be taxed at a rate of at least 26% or more than a quarter of the money you access. 

If you withdraw at retirement age, the first R550,000 lump sum will be taxed zero. This principle also applies at the higher end of the income scale.

For a R10 million lump sum withdrawal at retirement, your effective tax rate will be 33% compared to the early withdrawal rate of 45%. This is assuming you earn more than R1.8 million in that tax year. This is a 12 percentage point difference in tax payable.

Other experts have warned that when administrative fees are added to this equation, nearly half of the withdrawal amount will be lost. 

With South Africans expected to withdraw up to R100 billion from their retirement funds in the fourth quarter of this year, the government is set to collect billions more in tax. 

Reserve Bank research showed that the government could collect up to R41 billion in additional personal income tax in the current financial year alone. Next year, it could collect R32.4 billion more. 

The government will also benefit from increased spending, boosting corporate income tax collection and VAT receipts. 

Data showed that this will result in around R2 billion in additional revenue in the current financial year. The expected additional revenue is shown in the graphs below, courtesy of the Reserve Bank.