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Early access to your retirement savings

Early access to your retirement savings

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In December 2021 Treasury released a paper called “Encouraging South Africans Households to Save More for Retirement”. 

As part of its aim to implement retirement reforms, government recognised that they have 3 key remaining problems to address: 

  • Coverage: Whilst the current retirement system covers many workers, there remain significant categories of workers who are not participating in any retirement scheme. 
  • Costs: Whilst the costs applying to retirement funds might be made more transparent, most of the cost structure of retirement funds relates to the size and number of funds, which are not economical. 
  • Preservation: Many members of retirement funds do not preserve their savings, tending to cash out every time they change jobs. Whilst the default regulations do assist with preservation, significant loopholes remain. 

In terms of tackling the issue of coverage, the South African government intends on introducing auto-enrolment or mandatory system of retirement saving for all employed and self-employed persons. The government proposes introducing auto-enrolment to cover all formal employees, thereby ensuring that all formal sector workers will have a nest egg (and possibly risk cover) at retirement. The informal sector poses a bigger threat as seasonal or vulnerable workers don’t earn a steady salary/wage and the retirement system is built around regular contributions. Mandatory cover may be the solution for this as employers would be forced to deduct contributions prior to paying the informal worker and pay that contribution into an occupational fund or any other approved fund. 

In terms of costs, the intention is to reduce the number of “smaller” retirement funds available and consolidate them into a few “bigger” retirement funds. 

Preservation of retirement savings until the member reaches retirement has been an issue for a long time. South Africans are allowed to cash in their entire retirement fund savings when they resign from employment, and we often find that most South Africans exercise that option. Even those who chose to preserve their retirement savings into a preservation fund are allowed one (full) withdrawal from their preservation fund. All of this leads to the often-cited statistic that less than 7% of South Africans can afford to retire at their normal retirement age. 

Tax on withdrawals of retirement funds prior to retirement is punitive in nature and despite this, most South Africans still choose to access their funds prior to retirement. Whilst the government recognise how it important it is to encourage and preserve saving towards retirement, they also acknowledge the difficulties faced by South Africans who face financial distress. This could even encourage resignations to access one’s retirement savings. 

The two-pot retirement system 

For this reason, the government intends to fundamentally change how they govern access to our retirement funds by introducing the two-pot retirement system. The proposal will be for retirement funds to cater for two separate pots made up of one third and two thirds of all retirement fund contributions. Members will be able to access the one third pot (access pot) at any stage prior to retirement as a lump sum however they will not be able to access any portion of the two third pot (retirement pot) as a lump sum (even on resignation). This will only apply to new contributions made after the implementation of the two-pot system. Treatment of the extent of vested rights on amounts accumulated by implementation date is still under consideration. There are some suggestions that members will be allowed to access a small percentage of the vested portion. 

The member will be required to use the two third portion to purchase a compulsory annuity at retirement. The two-pot system will apply to all retirement funds including retail products like retirement annuities (RAs) and preservation funds. Another consideration for government is whether to allow the contribution tax deduction to the access pot. The current system does not allow for much tax arbitrage however if the two-pot system is passed then that allows members to make contributions to a year and claim a tax deduction only to access one third (access pot) immediately after they have invested. This loophole however should not result in penalising those retirement fund members who are legitimately saving towards retirement with the goal of providing an income at retirement, from claiming a full tax deduction (capped at R350 000) on their contributions towards a retirement fund. 

The government indicated in the paper that they are looking at four options on how to deal with the access pot in terms of tax: 
  1. apply marginal rate of tax on any withdrawal of the access pot; or 
  2. no tax contribution deduction on all contributions going into access pot but allowing the withdrawal to be tax-free (similar to a tax-free investment); or 
  3. introduce a flat rate to tax withdrawals; or 
  4. leave the tax system as is. 
Whilst it may not seem ideal to allow retirement fund members to access their retirement savings prior to retirement given the low percentage of South Africans who save adequately for retirement, it is encouraging to note that retirement fund members will not be able to access two thirds of their retirement savings prior to retirement. This should drastically increase the amount retirement fund members are able to access at retirement in order to purchase an income. 

Source: Encouraging South African households to save more for retirement by National Treasury, 14 December 2021