The two-pot system – a game changer?
By Freddy Mwabi, Consulting Actuary
Introduction
It is an undisputed fact that the Covid-19 pandemic and ensuing lockdowns have left a mark on the economic health of many South African households. The SA SMME Covid-19 impact report published by Finfind in November 2020 states, “According to the National Income Dynamics Study (Coronavirus Rapid Mobile Survey), a consumer study, South Africa has lost a decade’s worth of jobs in less than half a year of lockdown and the economy slowed by 16.4% in the second quarter of 2020 compared with the first quarter of 2020.” What the pandemic highlighted was individuals’ needs for more flexibility and access to savings during times of unforeseen financial pressures.
On 29 July 2022, National Treasury published the Draft Revenue Laws Amendment Bill for comment. The Draft Bill includes proposals regarding the implementation of a two-pot retirement system to address the short-term needs of some retirement fund members to access their savings in times of emergency or need, as well as Government’s goal of promoting preservation of retirement savings until retirement.
In further developments, National Treasury proposed on 20 September 2022 to parliament that the two-pot system be postponed until March 2024.
The two-pot system
The proposed two-pot system will consist of the following with effect from the implementation date:
- A “savings pot”, which will receive up to one-third of future contributions for retirement with interest added. Members will have access to this pot once a year.
- A “retirement pot”, which will accumulate the remainder of the contributions plus interest. Contributions to this pot will be preserved until retirement.
The two-pot system will in effect be a three-pot system for existing members, who will have a “vested pot” that will house the accumulated contributions prior to the implementation date. The “vested pot” will be governed in accordance with the conditions in existence prior to the implementation date but will not receive any further contributions going forward. However, it will receive interest.
The main features of the proposed system can be summarised as follows:
| Vested pot: pension fund | Vested pot: provident fund | Savings/Access pot | Retirement pot | |
| Contributions | All contributions before the implementation date | All contributions before the implementation date | Up to one-third of contributions from the implementation date | Two-thirds or more of contributions from the implementation date |
| Access | Can be accessed in full in the future when changing jobs | Can be accessed in full in the future when changing jobs | Can be accessed once during any 12-month period, subject to a minimum of R2 000 | Must be preserved until retirement |
| Retirement | Must annuitise two-thirds subject to a de minimis amount of R165 000 | May be taken in cash at retirement (subject to annuitisation of contributions after 1 March 2021) | Balance (if any) may be taken in cash at retirement | Must annuitise in full, subject to a de minimis amount of R165 000 |
An example
Consider a 30-year-old member who earns a pensionable salary of R20 000 a month and has accumulated contributions of R200 000 in their retirement fund on the implementation date. Under the proposed system, this amount would go into the “vested pot”. The member makes a net contribution of 18.5% of pensionable salary to a pension fund. Furthermore, we assume no initial amount in the “savings pot” but one-third of the contribution would go into the “savings pot” and the remainder into the “retirement pot”.
Using the information and a few simple assumptions, we project the fund value at normal retirement age depending on whether the member makes no withdrawal from their savings or withdraws an amount equal to 5%, 25%, 50% or 100% of the value available in the “savings pot” each year.
As expected, regular withdrawals from the savings pot will result in a lower amount available at retirement. The reduction in fund value relative to the no-withdrawal scenario, depending on the amount withdrawn from the savings pot, is as follows:
| Withdrawal amount p.a. | Reduction in total fund value |
| 5% of savings pot | 15% |
| 25% of savings pot | 25% |
| 50% of savings pot | 26% |
| 100% of savings pot | 27% |
We have also observed that the larger the amount withdrawn, the smaller the marginal reduction in total fund value at retirement. In the case above, there is only a marginal difference of two percentage points in the total fund value reduction between the choice of withdrawing 25% or 100% of the “savings pot”. This suggests that the very act of withdrawing from the accumulated savings has a more telling effect than the extent of the withdrawals.
The progression of the member’s projected fund value in the above examples can be illustrated graphically as follows:
Graph: Total fund value at retirement
Effect of compulsory preservation
The compulsory preservation of the retirement pot will have a significant impact on the retirement outcome for members in the long term, especially for those who will start contributing after the implementation date. At least two-thirds of all future contributions plus investment returns will be available at retirement to purchase a pension whereas, under the current dispensation, a member may be tempted to cash in a substantial portion of retirement savings when changing jobs.
The chart below shows the effect if the member in our example elects to take a withdrawal benefit in cash after 15 years, which again illustrates to what extent preservation is a key lever in improving the retirement outcome for members.
Graph: No preservation vs two-pot system
Note: In the chart above, the member has taken 100% of the “savings pot” each year.
Is the two-pot system a game changer?
The built-in preservation feature of the two-pot system has the potential to produce better retirement outcomes than the current regime. As the chart above shows, if a member took their entire savings in cash half-way through the period to retirement as the current system allows, they would accumulate less than half the amount which could be saved in the two-pot system even if the entire “savings pot” is accessed. This is a radical change to the approach to retirement funding, especially for members who start contributing after the implementation date.
A welcome change in behaviour could be that employees are no longer tempted to resign from work to access the retirement savings in times of distress. Knowing that they will have access to some funds in times of need, may also encourage employees to increase their contributions to retirement funds, which are a virtual tax haven.
Our calculations show that the outcome at retirement is not significantly sensitive to large withdrawals from the “savings pot”, which provides members with a great deal of flexibility in their financial planning. However, effective communication is essential to instil in members the notion that the primary purpose of a retirement fund is to provide for retirement, and that it is in their best interest to limit access to the “savings pot” as far as possible.
The State may also benefit, as an improved retirement outcome for members will decrease the reliance of the state old-age pension, thus making some funds available to Government to provide for other social services.
The two-pot system is certainly a major disruption but also an opportunity to address a number of things as far as our retirement provision system is concerned.