Retirement fund tax warning from Momentum

Momentum Investments has warned South Africans against prematurely withdrawing savings from their retirement funds under the new two-pot retirement system. 

The asset manager explained that early withdrawals from the savings pot would be taxed heavily and disrupt the compounding process, significantly impacting the quality of life in retirement. 

Earlier this month, President Ramaphosa signed the Revenue Laws Amendment Bill of 2023 into law, formally establishing the ‘two-pot’ retirement system. 

This system allows members of retirement funds to access a portion of their savings without having to resign or cash out their pension funds. 

The new system aims to address the problem of South Africans withdrawing savings from their retirement funds prematurely, reducing the amount of money they have when they stop working. 

This system, which will be implemented on 1 September 2024, will limit these early withdrawals to a portion of the total savings. 

It will require all future contributions made to retirement funds to be split into two portions – 

• Two-thirds of your contribution will be allocated to a retirement component, which must be preserved until you retire.
• The remaining one-third will be allocated to a savings component, from which you can withdraw once per tax year before your retirement. 

The withdrawal amount will be limited to the value in the savings component at the date of withdrawal. 

The value in your savings pot will initially be seeded by R30,000, or 10% of your fund value at implementation, whichever is the lowest, transferred from your vested pot.

Significant tax implications

Hugh Hacking, the executive of structured investments and annuities at Momentum Investments, warned South Africans against early withdrawals from their savings pot. 

He explained that the money withdrawn from this pot will be taxed at marginal rates, which are higher than most people pay on average. 

“It’s important to recognise that when you withdraw your money, it will be heavily taxed, and so you’re going to get less out than you might have thought you’d get out,” he said. 

“That’s something that people do need to take into consideration. What’s also not clear at this stage is whether there might be transaction charges on those withdrawals as well.”

Hacking stressed that South Africans should only use these annual withdrawals in case of an emergency. 

He said it is always best to keep as much money as possible in your retirement savings for as long as possible to ensure you retire comfortably. 

Hacking’s warning echoes those of other asset managers, such as Coronation, who have also urged South Africans to leave as much as possible invested for as long as possible. 

Head of personal investments at Coronation, Pieter Koekemoer, said withdrawing funds from the lump sum pot annually is not an obligation but merely an option to help them through tough financial times. 

Preferably, South Africans should not withdraw any amount from their retirement fund to prevent them from interrupting the compound process. 

 withdrawing from your retirement savings early will also have severe tax implications. 

“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.

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.