The Two-Pot Retirement System in South Africa offers flexibility and ensures that retirement savings are protected, but it also comes with certain challenges. Here’s an overview of its Pros and Cons:
Advantages
- The system allows for withdrawals from the savings pot before retirement, giving individuals access to funds in case of financial emergencies. This can provide much-needed relief without the need to tap into other long-term assets.
- With the retirement pot locked until retirement, individuals are still encouraged to save for their future. This ensures that the majority of contributions remain invested, growing through compounding interest.
- By separating the savings into two distinct pots, the system helps individuals to better manage their retirement savings. Access to only a portion of the funds discourages unnecessary withdrawals that might compromise long-term financial security.Contributions to the retirement pot continue to provide tax benefits, encouraging more consistent savings while allowing some flexibility with the savings pot.
Disadvantages - Withdrawals from the savings pot are added to the individual’s taxable income for the year, potentially pushing them into a higher tax bracket. This could lead to higher tax liabilities, especially for those in higher income groups.
- Accessing funds from the savings pot reduces the total amount left to compound over time. This can have a significant impact on the long-term growth of retirement savings, potentially leaving individuals with less money when they eventually retire.
- While intended for emergencies, the availability of the savings pot may tempt individuals to withdraw funds for non-essential needs, thus eroding their retirement savings over time.
- For those with contributions before 1 September 2024, managing the vested pot alongside the two new pots adds complexity. Each pot is subject to different rules, and individuals will need to stay informed to make optimal decisions.
On 1 September 2024, South Africa introduced the Two-Pot Retirement System, designed to offer greater flexibility in managing retirement funds. While this system allows earlier access to retirement savings, it also comes with significant tax considerations that individuals must understand before withdrawing funds.
Under South Africa’s Two-Pot Retirement System, contributions to your retirement fund are divided between the retirement pot and the savings pot:
One-third (33.3%) of future retirement contributions goes into the savings pot, which can be accessed before retirement.
Two-thirds (66.6%) of the contributions go into the retirement pot, which is locked until you retire and ensures that long-term savings are preserved.
These proportions apply to all retirement fund contributions made after 1 September 2024. Importantly, the system does not apply retrospectively to contributions made before that date; these funds will be placed in a separate vested pot, which is governed by the old rules.
Under the Two-Pot Retirement System, the amount you can withdraw from the savings pot is limited to certain conditions, but there are no annual caps on withdrawals. However, it’s essential to note that these withdrawals are subject to tax implications based on your income, which can affect the overall benefit of the withdrawal.
Withdrawal Rules
- You can withdraw 100% of the funds in the savings pot at any time before retirement, subject to taxation.
- There is no limit on the frequency of withdrawals from the savings pot, but each withdrawal is taxed as part of your annual taxable income.
- However, the savings pot will only accumulate contributions from 1 September 2024 onward, meaning the savings available for withdrawal might be limited in the initial years.
- The retirement pot remains untouchable until retirement.
Comparison Based on Income
Here’s how much tax an individual would pay on withdrawals from the savings pot under the Two-Pot System, based on their income and the marginal tax rates in South Africa. The tax liability depends on the individual’s total income, as withdrawals from the savings pot are added to their annual taxable income.
South Africa’s Marginal Tax Brackets for 2024/2025:
- 18% for income up to R237,100
- 26% for income between R237,101 and R370,500
- 31% for income between R370,501 and R512,800
- 36% for income between R512,801 and R673,000
- 39% for income between R673,001 and R857,900
- 41% for income between R857,901 and R1,817,000
- 45% for income over R1,817,000
Example 1: Lower-Income Earner (R150,000/year salary)
- Annual Contribution to Savings Pot: R5,000
- Current Taxable Income: R150,000 (taxed at 18%)
- Tax Impact of Withdrawal: If the individual withdraws R5,000 from the savings pot, this is added to their taxable income, making the total taxable income R155,000.
- Tax Liability: Since the individual remains within the 18% tax bracket, they would pay R900 (18% of R5,000) in tax on the withdrawal.
Example 2: Middle-Income Earner (R500,000/year salary)
- Annual Contribution to Savings Pot: R16,650
- Current Taxable Income: R500,000 (taxed at 31%)
- Tax Impact of Withdrawal: If they withdraw R16,650 from the savings pot, their taxable income increases to R516,650.
- Tax Liability: Since they move slightly into the 36% tax bracket, the tax on the first R12,800 of the withdrawal will be at 31%, and the remaining R3,850 will be taxed at 36%.
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- Tax on R12,800 at 31%: R3,968
- Tax on R3,850 at 36%: R1,386
- Total Tax: R5,354
Example 3: High-Income Earner (R1,200,000/year salary)
- Annual Contribution to Savings Pot: R39,960
- Current Taxable Income: R1,200,000 (taxed at 41%)
- Tax Impact of Withdrawal: If the individual withdraws R39,960, their taxable income increases to R1,239,960.
- Tax Liability: At the 41% tax bracket, the entire R39,960 will be taxed at 41%.
- Tax on R39,960 at 41%: R16,384
Summary of Taxes on Withdrawals
- Lower-income earners face lower tax liabilities due to the lower marginal rate.
- Middle-income and high-income earners face steeper tax penalties on withdrawals, especially if the withdrawal pushes them into a higher tax bracket.
It’s important to consider that withdrawing from the savings pot not only affects your short-term finances (via taxes) but also impacts your long-term retirement savings growth.
The two-pot system does not seem to be a beneficial option for individuals but even so, a lot of south African taxpayers have opted to take it resulting in the government collecting R6.7m to the fiscus after just one day from the withdrawals.
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