Government’s R41 billion retirement tax bonanza

The government is set to benefit greatly from the implementation of the new two-pot retirement system next month, with R5 billion in additional tax revenue from early withdrawals pencilled in. 

However, researchers from the Reserve Bank estimate the benefit to be closer to R41 billion, depending on the amount withdrawn. 

The new two-pot system will be implemented on 1 September and promises to improve South Africans’ retirement outcomes. 

The system aims to prevent South Africans from changing jobs to access their pensions in case of emergencies. 

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, this has proven ineffective at forcing South Africans to keep their savings invested until maturity. 

Thus, the two-pot system will give South Africans access to up to a portion of their savings, termed the savings ‘pot’, once a year. 

The retirement ‘pot’ will receive two-thirds of contributions and will only be accessible at maturity, when it has to be used to buy a retirement income product. 

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.

This is shown in the graphic below. 

Old Mutual Wealth investment strategist Izak Odendaal explained some of the impacts the ability to access early withdrawals will have and why the government is the big winner. 

Estimates from the government and various financial institutions suggest that somewhere between R50 billion and R100 billion will be withdrawn in the first month or two after the two-pot system takes effect. 

This will largely be a one-off event, as future withdrawals will be based on one-third of new contributions from September onwards and will, therefore, be spread out over time.

This will result in the government collecting billions in additional tax revenue as early withdrawals will be taxed at marginal rates. 

In the February Budget, an additional R5 billion in tax revenue was pencilled in due to two-pot withdrawals. However, the estimated size of withdrawals expected by asset managers has grown since then.

Reserve Bank researchers said last month that the government could collect R41 billion in additional personal income tax in a high withdrawal scenario. 

Odendaal said this is not the end of the government’s benefits, as early withdrawals will put more cash in consumers’ hands. 

This will increase consumer spending and thus result in the government collecting billions more in VAT on sales. 

Furthermore, increased consumer spending will boost South Africa’s economic activity, resulting in a much larger GDP. 

As a result, the government’s debt-to-GDP ratio will decline slightly due to early withdrawals from the two-pot system. 

The expected additional revenue the government might collect is shown in the graph below, courtesy of the Reserve Bank research department. 

How much tax you will pay

The head of personal investments at Coronation, Pieter Koekemoer, gave an example of how this would work in practice. 

Koekemoer said South Africans should avoid withdrawing any amount from their retirement funds to avoid paying hefty taxes and interrupting the compounding process. 

“You will essentially lose the tax benefits you received from the government when you contributed towards your retirement annuity,” Koekemoer warned. 

If you wait until retirement before withdrawing your money, the preferential retirement lump sum tax tables will apply. 

However, if you withdraw early, the more punitive marginal tax rates will be deducted from your withdrawal. This can significantly impact your retirement.

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.