South Africa’s multi-billion pension boost

The newly implemented two-pot retirement system is set to give South Africa’s economy a significant boost thanks to increased spending.

This is according to Sygnia Investment Committee chair Professor Haroon Bhorat, whose comments come after the two-pot retirement system was recently implemented in South Africa.

South Africa’s new retirement system kicked in on 1 September. It allows South Africans to access a portion of their savings before retirement. 

This new system aims to enhance retirement outcomes by forcing individuals to keep the majority of their savings invested until maturity. 

In effect, it aims to address the problem of South Africans resigning from their jobs as a desperate measure to access their pension and provident funds for emergency expenses. 

From 1 September 2024, all new contributions to retirement funds were split into two components. 

One-third is allocated to a savings component, which members can access once a year before retirement, and the remaining two-thirds are allocated to a retirement component, which will be inaccessible before a member retires.

At retirement, this must be used to purchase a retirement income product. 

Existing retirement savings have become a vested component, and the existing rules continue to apply.

Bhorat said the core aim of a well-designed public and private pension fund system is to mitigate against income loss at retirement, using forced savings during an individual’s working life. 

“In essence, a retirement funding system is about designing the optimal income-smoothing system to service an individual throughout their lifetime,” he said.

However, Bhorat explained that positive and negative economic shocks will invariably lead to a need for pre-retirement liquidity.

“In simple terms, all unforeseen and sudden events – ranging from the loss of a job to the purchase of a new home – may require an individual to make a lump-sum cash injection,” he said.

“Failure to do so may result in elevated debt levels for the individual and their household and cause undue socioeconomic hardship.”

With this in mind, national governments around the world have considered the possibility of allowing members to access their retirement funds prior to retirement. 

He said countries like Singapore, Chile, the US, the UK and New Zealand already have schemes like this in place or are considering implementing them. 

“The core thinking in designing South Africa’s two-pot retirement system is that easier access to retirement savings will allow households to use these savings to buffer against shocks,” he explained.

Bhorat referred to research that has shown that the limited early availability of retirement savings can increase the overall welfare of affected individuals. 

For example, Singapore’s mandatory defined contribution plan has shown that early access allowed individuals to pay down credit card debt and sometimes hold onto withdrawals to invest in property. 

However, he noted that there are also considerable dangers in accessing pension savings early.

“In poorly designed schemes, pension savings can be depleted such that they provide inadequate retirement incomes, while early access to funds may be poorly utilised by financially illiterate households,” he said.

In South Africa, the behavioural response to the National Treasury’s two-pot pension system remains to be seen, but the South African Reserve Bank (SARB) research team has run a basic macroeconomic simulation. 

In this simulation, the SARB assumes two withdrawal rates, which it terms “High” and “Moderate” withdrawal scenarios.

The SARB’s only other behavioural assumption is that higher-income households will not withdraw as much because of the tax implications. 

For the high withdrawal scenario, they project that South Africans will extract an additional R100 billion from the savings portion of their pension funds in Q4 2024 – this is in addition to the historical resignation portion of R110 billion expected for 2024 as a whole. 

In 2025 and 2026, the withdrawals fall to R40 billion and then rise to R42 billion.

The figures for the moderate withdrawal scenario are significantly lower at R40 billion in 2024, R20 billion in 2025 and R21 billion in 2026. 

Bhorat said the macroeconomic effects of the two-pot system are particularly interesting. 

The core assumption in the SARB model is a positive expenditure and tax shock to the South African economy by as early as the fourth quarter of 2024. 

“Much of the economic stimulus thus revolves around the aggregate demand injection to be realised from these funds,” he explained.

Specifically, the SARB model expects consumption expenditure to increase, bringing moderate inflationary risks – the risk of interest rate hikes – all as GDP is projected to tick up slightly.

In the high withdrawal scenario, GDP is projected to grow by 0.3 percentage points in 2024 and by 0.7 points in 2025.

Assuming GDP growth of 1% this year, that means the projection is for GDP growth of 1.3% this year and 2.7% for 2025.

“These are not insignificant changes, and they could have materially positive real economy multiplier effects,” Bhorat said. 

The moderate withdrawal scenario projects GDP to grow by 0.1 percentage points in 2024 and 0.3 points in 2025. This would lead to GDP growth of 1.1% and 2.3% in 2024 and 2025, respectively. 

“Holding the inflationary risk constant for now – the two-pot system is, in essence, a consumption kicker – offers a significant boost to short-term GDP growth in South Africa,” Bhorat said.

“Notably, however, the effect is decidedly short-term in both models: by 2026, the effects from the new system are completely muted.”

In addition, he warned that the model does not cover concerns around the longer-term impact of individuals who make early withdrawals having a smaller pool of savings on which to retire.