The "Two-Pot System", effective from 1 September 2024, is a new way of managing retirement savings. It is the final step in the revamp of retirement-focused investments(pension, provident and retirement funds).
What were the other major changes?
In March 2021, the rules applicable to provident funds were aligned with those of retirement annuities and pension funds, mainly that you could not longer withdraw your entire lumpsum in cash when retiring. you are only allowed to take 1/3 as cash, and will have to purchase and annuity product with the remainder
In February 2022, offshore investment limits were increased from 30% to 45%
Two-Pot system splits up your contributions to retirement investments into two pots, a savings pot(1/3)and a pension pot(2/3).
Savings Pot. One third of your contribution is allocated to this pot. You can access money in this pot before retirement, making it similar to a savings account within your pension fund. You are allowed to withdraw from this pot once a year, minimum R2000, maximum is whatever the balance of the account. Withdrawals from this pot are subject to your marginal tax rate, which means you'll pay tax on the amount you withdraw, potentially reducing the net amount you receive.
Retirement Pot. The remaining two-thirds of your contributions go into this pot. This pot is locked until retirement age, ensuring you have funds for your later years. It's designed to prevent people from cashing out their entire pension when changing jobs or before retirement, which has been a common issue leading to insufficient retirement savings.
The Two-Pot System aims to:
- Encourage Savings by making one pot accessible, it might encourage people to save more, knowing they can access some funds before retirement.
- Secure Retirement by locking away the majority of funds, it ensures there's something left for retirement, addressing the issue of people spending their entire pension prematurely.
Public reaction to the Two-Pot System has been mixed, with some feeling it restricts their access to their own money, while others see it as a necessary measure to secure their financial future.
Why I Love The New Two-Pot System
In the long run, it will improve retirement outcomes. A commonly reported statistic is that only 6% of south Africans are able to retire comfortably. A comfortable retirement is measured as the number of people that are able to retire and earn 75% of the salary received in their final working year. Because people will not be able to resign or change jobs and have full access to their retirement funds, they will have more money at retirement. This is likely to improve the 6% statistic
Lower Number Of Individuals On The Social Grant System. The forced and inaccessible pension pot should result in a reduced the number of individuals who worked during their economically useful life, and later do not have enough savings and investments to sustain themselves in their retirement years.
Forced Discipline on those who do not save for and by themselves. A lot of people may feel entitled to their own money, but the simple truth is that a lot of people no not save or invest for themselves when they have to. They just simply don't!
Better Rewards For Discretionary Investors. Knowing that a person will not be able to access their entire pensions under the Two-Pot System, any person that wants to have funds before retirement, will have to make sure they have their own investments that they can benefit from during their working lives
It Reduces The Gap Between The Low- and High-income Earners. Below is the old pension system tax tables for early withdrawals from pension and provident funds.
Individuals who were on higher tax brackets were able to aggressively contribute to retirement investments, get a marginal tax benefit(39%, 41% and 45%), and then only pay a maximum of 36% tax when accessing/withdrawing their funds. Under the new Two-Pot System, you pay marginal tax upon accessing your funds, taking away the opportunity to arbitrage through tax bracket differences as you will pay tax equivalent to the tax benefit you received when contributing. I once read that some interest groups tried to get penalty structure similar to the old tax tables implemented, but this was ultimately turned down. Good One SARS!
Remember, the 2-pot system is about balancing immediate financial needs with long-term retirement security. Anything the helps achieve better results than the current system, get a vote from me!
What Else?
Other changes that i think will improve the retirement landscape:
Cryptocurrencies - While the world has progressed towards adoption of cryptocurrencies as investments, to the extent that we now have Exchange Traded Products(ETPs) for cryptocurrencies, these are currently excluded from pension funds
Higher Offshore Limits - While these have been recently increased, they can still handicap performance in the long run if the other allocations don't perform well relative to the best performing allocation
How Allocation Limits Are Measured - Limits are measure by "current market values" meaning that if an asset allocation persistently outperforms, you may end up in a situation where you have to sell a performing allocation in exchange for a poor-preforming allocation. I would rather the "allocation values" be used as a measure
Risk Approach of Living Annuities - I am yet to grasp why reg.28 rules do not apply to living annuities. One can have their money in investments with a higher risk profile during the drawdown stage, than when they were in the accumulation stage. Should it not be the other way around? Grow your pension fund aggressively and then protect it when you need it? Instead of the current setup of being conservative at growing the assets, only to take higher risks when it matters most...
Self-Managed Pensions Investments - There are certain countries that allow individuals to manage their own investments. Canada, Australia, Singapore and Switzerland are a few of the countries that allow this. I wouldn't mind having to take and pass an exam to prove competence, if this means greater flexibility and choice within the pension investment space.
I can think of a few more but these changes are main ones that could fundamentally improve the outcomes of pension investments.
What do you feel about the 2pot system? Is there anything that you think can improve future retirement outcomes?
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