A lot of articles have been written about the two-pot retirement system, which will be implemented on 1 March 2024. Most pension fund members have focused more on how the two-pot system will affect them when they withdraw from the fund before retirement by limiting their access to retirement savings at that stage of their life and, not on how these new restrictions might benefit their overall retirement plan.
To be a successful gourmet chef (achieving the best retirement outcomes) in the two-pot system, you need to know and apply the following:
- The success of the dish is determined by the quality of the recipe. The recipe for achieving the best possible retirement outcome is to save as much money as possible for as long as possible and as tax efficiently as possible to achieve the highest possible risk adjusted return on investment over time. Withdrawals from your retirement fund every time you change jobs is detrimental to achieving the best possible retirement outcome. It is like eating all the ingredients before you even start to cook the dish and then having to start all over again, looking for the right ingredients and never cooking the dish. The two-pot system reinforces the recipe of saving, retaining, and growing as much money as possible in your fund in a tax-effective manner until your date of retirement.
- The savings pot is not a pantry. The savings pot should be used to accumulate funds that can be taken as a tax-free lump sum amount at retirement that can provide an additional income stream in addition to the annuity that you must buy with the savings in your retirement pot. It is not there to function as a storeroom or an ATM for an annual withdrawal when you want to spend money that you do not have to buy what you cannot afford. If you withdraw all the money in your savings pot on an annual basis (after paying income tax at your marginal rate on each withdrawal), that pot will be almost empty by the time you get to retirement, as you will only have the contributions that you made the year prior to retirement in that pot. It is unlikely that you will be able to get the full tax benefit of the (current) R550 000 tax-free lump sum retirement benefit if you keep on withdrawing the money in the savings pot before retirement. Every time you take money out of your savings pot, you will forever give up the tax benefit that you received in previous years, and you will reduce the potential tax-free investment income you would have received on that money until your date of retirement.
- Stirring the vested pot too much might spoil the dish. When you leave one employer to join another, do not access the money in your vested pot, if possible. It might be better from both a saving and tax perspective to transfer your vested pot to the fund of your new employer or to a preservation fund to retain the income tax advantages that you have built up over the years. The money in the vested pot should be used to ensure that you can take the maximum tax-free lump sum retirement benefit and buy an annuity that will take care of your income needs after retirement. The money in the vested pot should be untouchable before retirement as spending the money in this pot before retirement will not be to your disadvantage from a tax and savings perspective.
- A pinch of salt can add flavour to the dish. The proposed seeding of R25 000 from your vested pot to your savings pot on 1 March 2024 can be a gift or a curse. It is unlikely that most fund members who withdraw the R25 000 in their savings pot that is seeded from their vested pot will use it to solve short-term financial problems that they might have. There is the risk that fund members might view this as immediate "free cash" without taking income tax and the long-term consequences of their decisions into account. The money might be spent on non-essential purchases or expenses rather than settling high-interest short-term debt or for the payment of emergency expenses. If your marginal tax rate is 30%, you will only receive an after-tax payment of R17 500 if you withdraw the full R25 000 before retirement. If you, however, keep that R25 000 invested in the fund for the next ten years until your date of retirement and it grows by 10% per year, the R25 000 will grow to an amount of R64 843 at retirement. If you keep the R25 000 invested for twenty years until retirement, that money will grow to an amount of R168 187 at retirement. It makes more sense to keep that R25 000 (pinch of salt) invested in your savings pot until you retire and to then take that money as part of your tax-free lump sum retirement benefit. The long-term gain on retaining the R25 000 in your savings pot until retirement outweighs the short-term satisfaction of spending it on something you do not need.
- Good food takes time, effort, and discipline. Saving for retirement is a three-course meal and not a Vienna Gatsby. The retirement pot will be the slow cooker that you will use to cook the three-course gourmet meal that you will enjoy at retirement. You will have to sacrifice a few fast-food meals along the way to have the right ingredients in your retirement pot. The limit on access to your retirement savings ensures that you keep your savings for as long as possible in a tax-efficient investment pool to safeguard that you accumulate enough resources to attain the highest possible monthly income after retirement.
As the cook in your kitchen, you have the choice of which pots and pans to use and how to use them to create the prefect meal. As the chef of your retirement outcome gourmet meal, you can decide to use the two-pot system as a gift that will assist you to ensure the best possible retirement outcome or as a curse that prevents you from accessing all your retirement savings before your date of retirement.
* Ladouce is a pension lawyer and author of the book, “Pensions for Palookas.”
PERSONAL FINANCE