South African retirement fund tax warning

South Africans will withdraw billions of rands from retirement funds next month as the new two-pot system gets implemented. 

While this will boost the local economy and provide much-needed relief for consumers, it will come at a hefty price as withdrawals will be taxed at individuals’ marginal tax rates. 

Early withdrawals, even under the two-pot system, will also negatively impact financial outcomes in retirement. 

Reserve Bank researchers said the two-pot reform was urgently needed to allow some access to retirement funds, without employees having to resign, while simultaneously preserving funds for retirement. 

The new two-pot system will be implemented on 1 September, after which all contributions to retirement funds will be split between three components or ‘pots’ –

• The vested pot contains all retirement fund contributions made before 31 August 2024, with a once-off seed capital transfer of 10% or R30,000 transfer from this pot into an individual’s savings ‘pot’. The remaining funds stay invested. 
• The savings pot will contain one-third of all annual retirement contributions made after 1 September, and individuals will have full access to these funds before retirement. Withdrawals from this fund are restricted to one per tax year and are taxed at an individual’s marginal tax rate. 
• The retirement pot contains the remaining two-thirds of annual retirement contributions and any future capital growth. Individuals are not allowed to access the funds before retirement. 

The study published by the Reserve Bank expects withdrawals to range between R31 billion and R79 billion in the fourth quarter of 2024. 

These withdrawals will gradually slow to a steady state of around R40 billion to R50 billion. 

This will have significant positive short-term effects on consumer consumption and GDP growth. The additional tax the government collects on these withdrawals will also help ease its financial pressure. 

However, the researchers warned that early withdrawals would have a negative impact on retirement financial outcomes. 

They also said that expectations of significant financial relief from these withdrawals are misplaced, with tax and administrative fees eating up a large portion of the amount taken from the savings pot. 

In absolute terms, the researchers expect South Africans to withdraw a maximum of around R100 billion from retirement funds after 1 September. 

After-tax, this amount will be whittled down to only R79 billion. 

However, this appears to be a relatively conservative estimate of the tax implications of withdrawing early from your retirement. This calculation also does not include administrative fees levied by asset managers to withdraw funds. 

Sanlam consulting actuary Ryan Campbell-Harris calculated that taxes and transaction fees can consume nearly half of the withdrawal amount. 

He gave an example of someone who withdraws R10,000 from their retirement fund under the new two-pot system. 

Assuming this individual earns between R370,000 and R512,000 a year and is taxed at a marginal rate of 31%, they will lose nearly half of the withdrawal amount to tax and transaction fees. 

This member will receive only R6,762 of the R10,000 withdrawal. R200 will go to the transaction fee, and the rest will be lost to tax. 

Head of personal investments at Coronation, Pieter Koekemoer, said South Africans should try not to withdraw 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.