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In July of this year, the National Treasury announced that the retirement industry is aiming to move to the so-called “two pot system” by 2023. So, what does that mean for you and why are they changing things?
How retirement products currently work
Firstly, let us understand how retirement products currently work and why there is a need for change. Remember that there are two types of retirement products that individuals can contribute towards before retirement – occupational funds which are owned and contributed towards via an employer (also known as pension and provident funds). We can also own and contribute towards non-occupational retirement funds via a retirement annuity. Members of occupational funds can only withdraw from an occupational fund, either in full or partially, when they resign from their employer while no withdrawal can be made from non-occupational retirement funds before retirement.
Withdrawals made from retirement funds are currently taxed at what we informally call “the lump sum tax tables” and there are two different tables – one for withdrawals made before retirement, with only the first R25,000 being taxed at 0%, and one for withdrawals made at retirement where the first R500,000 withdrawn are taxed at 0%. All previous withdrawals are however considered to determine how much tax is paid on your current withdrawal and therefore you will be penalised for taking withdrawals before retirement, which will lower the amount of the withdrawal that is subject to 0% tax at retirement.
It is important to not confuse how withdrawals work before retirement and how they will work at retirement. The two-pot system is specifically going to impact withdrawals made before retirement, but to ensure there is not any confusion on the topic of withdrawals let us briefly consider how they work when a member retires. Before March 2021 members of provident funds were allowed to withdraw the full amount of their benefits when they retire and there wasn’t any obligation on them to use any of their provident fund value to buy an annuity. Pension funds and retirement annuities, on the other hand, limit the amount that can be withdrawn from the fund at retirement to one third of the value of the fund. The remaining funds have to be used to buy an annuity that provides the member with an income throughout retirement. From the 1st of March 2021 all contributions towards provident funds will however be treated in the same way as pension and retirement annuity funds in that only a maximum of one third can be withdrawn from the fund at retirement. All contributions made to a provident fund, as well as the growth accumulated on such contributions, can still be withdrawn in full by the member at retirement should they choose to do so.
What is the problem with the current system
It became well known that people resigned just to allow them to get access to their retirement funds. This became especially apparent during Covid when people were suffering financially due to salary cuts and retrenchments and had no other choice during a financial emergency. With this as the backdrop, it became clear that changes were required to how members can get access to their retirement products during emergencies and as such the National Treasury has proposed the “two-pot” system which is currently open for commentary from the industry.
How will the two-pot system work
The idea is to allocate all contributions made to a person’s retirement products, whether in occupational or non-occupational funds, towards two pots. Two thirds of all contributions will be allocated towards a “savings pot” or, as it will also be known, the “retirement pot”, which can’t be withdrawn before retirement, but will be left in the product until the member retires. The remaining one third will be allocated towards the accessible pot (“the access pot”) which a member can withdraw from once a year. The proposal currently states that this annual withdrawal can either be a partial or a full withdrawal from the access pot, but that the member is only allowed one such withdrawal per annum. It also currently proposes that while there is no upper limit to the amount that can be withdrawn, other than what is available in your access pot, the minimum withdrawal must be R2000.
Withdrawal will also be taxed slightly differently. It is proposed that withdrawals made from the access pot will be included in the member’s taxable income and taxed according to their marginal income tax rate. The benefit is that members will no longer be penalised for withdrawals made before retirement, but the drawback is that there is a risk that the withdrawal pushes someone into a higher tax bracket.
Two alternatives are also being considered regarding the tax treatment of the two-pot system. Firstly, tax deduction in respect of contributions to the access pot can be removed and all withdrawals can be made tax-free. In effect, this would create a tax-free savings account within a retirement fund. Secondly, a flat deduction percentage for contributions is considered. Members could, for example, receive a 30 percent deduction on their contributions, which is unrelated to income. Tax on withdrawals could either be at the same flat rate or could be added to the member’s taxable income for that year.
There might be a third pot
The current proposal states that comments and suggestions are welcome for how the “vested pot”, which are all savings accumulated up until the implementation date of the two-pot system, will be dealt with. Although trade unions are pushing for this vested pot to form part of the access pot, it is unlikely that it will. It is currently proposed that withdrawals from the vested pot will be dealt with in the same way withdrawals are currently being dealt with.
It is clear that there are still many grey areas regarding the new two-pot system, but one thing we know is that the government and regulators are committed to changing access to your retirement funds for when times are tough.