The South African retirement landscape is undergoing significant transformation with the introduction of the Two-Pot Retirement System, set to be implemented on 1 September 2024. This system, which is part of the 2023 Revenue Laws Amendment Bill and Pension Laws Amendment Bill, aims to provide individuals with greater flexibility in accessing retirement savings while ensuring long-term preservation for post-retirement income.

Understanding how the system operates, especially with regard to taxation, is essential for retirement fund members to make informed decisions.

How the Two-Pot System Works

The new system is structured around two core components—each with specific rules about access, contributions, and preservation:

1. Vested Pot: All contributions and investment growth accumulated before 31 August 2024 are placed into the vested pot. The rules governing this portion remain unchanged. Members can access these funds according to the conditions that were in place before the new system’s implementation.
2. Savings Pot: From 1 September 2024, seed capital will be transferred from the vested pot into the savings pot. Members will be allowed to withdraw funds from this pot once a year, but the withdrawals are subject to taxation at the member’s marginal tax rate. Importantly, these withdrawals do not require the member to terminate their employment.
3. Retirement Pot: The bulk of retirement contributions will flow into the retirement pot, designated for long-term savings. These funds can only be accessed at retirement and must be used to purchase an annuity if the total is above R165,000.

Key Features of the Two-Pot System

One Withdrawal Per Year: The system allows a single withdrawal from the savings pot each tax year. However, there are limitations. The initial withdrawal, known as seed capital, will be capped at 10% of the member’s retirement savings as of 31 August 2024, with a maximum of R30,000. Annual withdrawals after this will also be subject to a minimum withdrawal limit of R2,000.

Taxation of Withdrawals: Withdrawals from the savings pot will be taxed at the member’s marginal tax rate. This means that the withdrawn amount will be added to the member’s annual income, which could push them into a higher tax bracket, resulting in a greater tax burden. This makes early withdrawals potentially costly and may reduce the member’s long-term retirement savings significantly.

Compulsory Preservation: The retirement pot component is strictly preserved for retirement, with no option for early withdrawals. At retirement, members are required to use their retirement pot to purchase an annuity if the value exceeds R165,000, ensuring a consistent post-retirement income stream.

Tax Implications

One of the most critical aspects of the two-pot system is how withdrawals from the savings pot are taxed. Members will face taxation on the withdrawal amount at their marginal tax rate. The South African Revenue Service (SARS) will treat the withdrawal as part of the member’s taxable income for that year, possibly resulting in an increased tax liability.

Potential Impact on Tax Brackets: Depending on the amount withdrawn, members may find themselves pushed into a higher tax bracket, leading to higher overall tax payments. This can have a lasting effect on a member’s financial situation, as the tax on the savings pot withdrawal will be paid alongside their regular annual tax obligations.

Withholding Tax: When members withdraw from the savings pot, the tax is deducted through a withholding process. This means the Fund will calculate and withhold the necessary taxes before disbursing the remaining balance to the member. However, members should be aware that these withdrawals might increase their total taxable income, leading to a tax shortfall at the end of the financial year.

Preservation of Long-Term Savings

While the two-pot system provides an opportunity to access retirement funds early, it also emphasizes the importance of preserving savings for retirement. Any withdrawal made before retirement will reduce the overall amount available for future income generation, thereby limiting the benefits of compound interest. Additionally, members who withdraw from the savings pot may lose out on the full potential of their retirement fund growth.

Opting In for Certain Members

Members who were 55 years or older on 1 March 2021, and part of a provident fund, were excluded from the automatic implementation of the two-pot system. However, they are given the option to opt in by notifying the Fund before 31 August 2025. If they choose to opt in, they can participate in the savings pot component, allowing access to early withdrawals.

Conclusion

The Two-Pot Retirement System introduces a balance between flexibility and preservation, providing South Africans with access to their retirement savings in times of financial stress, while also safeguarding long-term retirement income. However, the tax implications of early withdrawals should be carefully considered, as they may significantly impact both short-term financial obligations and long-term retirement security.

Members are encouraged to view their retirement savings holistically, ensuring that they are not eroding their future income by accessing funds prematurely.