A major change to SA’s pension system, known as the Two-Pot Pension System, will come into force on 1 March 2024 and will affect all pension fund members.
On March 1, 2024, there will be a radical change that will affect everyone who is a member of the pension fund. This is known as the Two-Tier Retirement System and applies to all members of the employer pension/health fund, retirement income or conservation fund.
In partnership with Liberty, we are running a four-part educational series to help you understand what the Two-Pot Retirement System means for you.
In our final article in this series, we focus on those paying pension contributions for the first time.
READ: Personal Finance | How will the Two-Pot system affect a mid-career person?
For those joining the pension fund for the first time after March 1, 2024, the Two-Pot Pension System will have the biggest impact.
There will be no funds available in Vested Components as they will not accumulate any funds before March 1, 2024. They will accumulate funds in only two components (Savings Component and Retirement Component).
To summarize, from 1 March 2024 all pension contributions, whether to the employer fund or pension income, will be split between the Savings Component and the Pension Component.
. Savings Component: One third of the member’s contributions will be paid into the Savings Component. Contributions and all growth in the fund will be accessible before retirement. Withdrawals can only be made once per calendar tax year and only if the value of the Savings Component is at least R2 000 or more. Any withdrawals made prior to retirement will incur a fee and will be fully taxable at marginal tax rates. At retirement, funds in the Savings Component may be received as a cash lump sum and taxed according to the lump sum retirement tax tables.
. Pension Component: Two-thirds of the member’s contribution will be paid to the Pension Component. Contributions and growth will be maintained until retirement. In case of retirement, the funds will be used to purchase an annuity.
READ: Personal Finance | Why are there really three ‘pots’ in the Two-Pot Retirement System?
Analysis shows that overall the Two-Pot Pension System will deliver a better outcome for pension fund members than is currently experienced. This is because a portion of retirement savings (Pension Component) must be retained until retirement, unlike the current system in employer pension and benefit funds where all funds can be withdrawn only in case of resignation.
Although members will continue to have access to the Savings Component, if members continually withdraw their savings year after year, they may find themselves underfunded in retirement.
THE POWER OF PROTECTION
Let’s take the example of a 35-year-old who contributes R6 000 a month to his retirement fund. An amount of R4 000 will be paid into the Pension Component and R2 000 into the Savings Component.
Based on an average annual return of 10%, he will have around R13.5 million at age 65, assuming he never withdraws from the Savings Component.
READ: Making Money | When your retirement fund is not enough
At age 65, R4.5 million will be available as a lump sum payment in the Savings Component. The cash lump sum pension benefit will be taxed according to the lump sum pension tax table, with the first R550 000 being tax-free. There would be R9 million in the Pension Component which should be used to purchase annuity income.
If he had withdrawn all his funds from the Savings Component before age 65, the withdrawals would have been taxed entirely at his marginal tax rate and he would not have R4.5 million in the Savings Component which would provide a lump sum payment at retirement.
At age 65 he would have R9 million in his Pension Component, which he would only need to use to purchase annuity income.
PLAN FOR FINANCIAL EVENTS
Instead of relying on your retirement fund for emergencies or other life events like your children’s education, make sure you have other investments as well. You can put money in a notice account for emergencies, buy unit trusts, or invest in a tax-free savings account for other medium-term goals.
These should be included in your financial plan, even if it means a slightly lower contribution to retirement investments. The Savings Component should only be accessed as a last resort before retirement.
PROS AND CONS OF TRANSFERRING TO WITHDRAWAL COMPONENT
The draft legislation currently allows members to transfer funds from certain components to other components within the same pension fund. Although a member may never transfer funds from the Pension Component to the Savings Component, he or she may transfer funds from the Savings Component to the Pension Component.
Depending on the retirement fund, it may be possible to invest the funds in the Savings Component into different investment portfolios than the Retirement Component.
Members who never intend to withdraw from the Savings Component may wish to transfer funds from their Savings Component to the Retirement Component, especially if they invest in a higher-yielding investment portfolio.
Before making this decision, remember that funds cannot be transferred back once transferred to another component. Additionally, any funds in the Pension Component must be used to purchase annuity income and will not be available as a cash lump sum benefit at retirement.
It’s best to seek financial advice to ensure that when you retire you have the option of receiving both a reasonable, tax-efficient cash lump sum and funds to purchase an annuity to cover your living expenses.