One thing you must do to prepare for the two-pot retirement system 

Savers who want better financial outcomes in retirement from the new two-pot system must have a fully funded emergency savings account. 

This account must be able to pay for any unforeseen expenses to avoid an early withdrawal from your retirement savings.

Withdrawing money early would break the compounding process and negatively impact your quality of life after your career. 

Allan Gray’s Tebogo Marite recently explained that the new two-pot system makes an emergency savings fund even more important for financial well-being. 

The new two-pot retirement system is set to be implemented from 1 September, giving South Africans early access to a portion of their savings prior to retirement. 

This new system aims to enhance outcomes in retirement 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 the implementation date, all new contributions to retirement funds will be split into two components. 

One-third will be allocated to a savings component, which members can access once a year before retirement, and the remaining two-thirds will be 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 will go into a vested component, and the existing rules will continue to apply.

One of the major drawbacks of this system is the negative impact of early withdrawals, even from your savings pot, on retirement outcomes. 

Early withdrawals will still be heavily taxed at your marginal rate and will interrupt the compounding process, reducing your income in retirement. 

These negative effects are shown in the graph below, courtesy of Allan Gray. 

Marite urged South Africans to have a fully funded emergency fund to prevent the need for withdrawals in an emergency. 

Despite having access to a component for emergencies, it is important not to think of your savings component as your emergency fund.

Depleting your savings component annually will result in you having one-third less on which to retire.

Marite explained that an emergency fund should be viewed as insurance for you and your investments – a pool of capital you can use to pay unforeseen expenses without having to tap into your investments.

She gave several points to consider when setting up an emergency fund and how much money you should allocate towards it. 

Individuals should allocate a portion of their income to a low-risk unit trust, such as a money market fund, which will preserve their capital over the short term and offer easy access when needed. 

You should aim to build up at least three times your monthly salary in an emergency fund to cover any potential loss of employment. 

Accumulating a healthy emergency fund may take some effort, including lifestyle adjustments, such as paying off expensive credit card debt and sticking to a monthly budget. 

Commit to “paying yourself first” and then set up a debit order so you don’t have to battle old habits each month.

For example, if you earn R25,000 per month after tax and other deductions and want to build up three months of reserves, you will need to set aside R4,167 per month for 18 months to accumulate R75,000. 

Ultimately, your emergency fund should be sufficiently sized to buy you enough time to manage and recover from a crisis without the need to dip into your long-term investments.

It is not prudent to rely on long-term investments – including the savings component of your retirement funds – as they are intended to meet long-term goals and are invested accordingly.