What the proposed “Two-Pot” system means for your Retirement Fund Savings
What the new “Two-Pot” system means for your Retirement Fund Savings
What is the Two-Pot system?
National Treasury has proposed the Two-Pot system which allows you to save one-third of your retirement contributions in a “pot” that you can access over a 12- month cycle, two-thirds will then remain in your preservation “pot” until retirement.
How is this different to the current system?
Currently, fund members cannot access their retirement savings while still working for their employer. Only upon withdrawal, including retrenchment, the entire retirement savings is accessible, leading to low preservation.
Why has this been proposed?
We have a poor savings culture in SA. This can be attributed to a lack of knowledge of investments including discretionary and retirement savings. In addition, discretionary savings are low due to savings platforms having high costs, high minimums, and daunting platform rules. Household savings average just above 2 percent of GDP per annum, most of which is contractual savings for retirement funds. As such households don’t have access to emergency funds during periods of crisis, such as the COVID-19 pandemic.
Members of funds therefore find themselves cash strapped and thus it is not unusual for members to resign to access their retirement savings. The proposed Two-Pot system can alleviate cash-strapped households, during times of need, such as the COVID-19 pandemic, which could lead to a reduction in resignations.
In addition, the two- thirds portion that needs to be preserved till retirement will greatly improve retirement outcomes.
The proposed amendments represent the best of both worlds.
How does the Two-Pot system impact Members Retirement Outcomes?
Initial mathematical modelling performed by the Actuarial Society of South Africa (ASSA) suggest more than a 100% improvement in retirement outcomes, under a specific set of assumptions. The below graphic illustrates ASSA findings:
How does this affect my Income Replacement Ratios (IRRs)?
Current Structure VS Two-Pot system
The downfall is the temptation created for members who would have preserved their benefit over their full working life, to now being able to access the one-third portion. This will result in a worse retirement outcome for these members as opposed to the current system. This is illustrated below by Mike:
Source: Actuarial Society media release: 7 October 2021
Implementing the Two-Pot system
How does it work:
What are the practical challenges with implementing the system?
· Adaptation of administration systems and processes, given the complexity of the changes.
· Tax treatment of one-third withdrawal pot.
· Redesign of Pension Fund investment strategy.
· Communication and education to members
What would the changes to the investment strategy for Pension/Provident Funds be?
We envisage a split investment strategy.
The one-third pot which is fully accessible over 12-month cycles would require a much more conservative investment strategy, to manage volatility using lower tenure and more liquid instruments which tend to have lower yields.
The two-thirds pot will be preserved till retirement. Given the inherently longer investment horizon, the investment strategy can be more aggressive, targeting higher returns, higher exposure to riskier asset classes like equity and private equity, which tend to have higher expected investment returns, which could encourage further retirement savings.
What is the expected timeline to implement the Two-Pot system?
We expect at least 2-3 years to fully implement the Two-Pot system, given the complexity of the changes. The industry is currently expecting the draft legislation (mid-2022) that will execute the changes.