Balancing the unintended consequences of the two-pot system

Liquidity and tax are growing concerns for retirement fund managers as access by members to the new savings pot looms ever nearer.

By Jaco Visser

There seems no getting away from it: the two-pot system will open the door to a flood of withdrawal claims as the savings pot is split from the retirement pot.

Make no mistake, this is a big concern, as it’ll weigh on both the investment allocation decisions, and the liquidity management of pension fund members. But how bad will this be really?

“We expect a 90% to 100% increase in withdrawal claims,” says Jonathan Sierra, corporate product specialist at 10X Investments. This will put pressure on fund managers’ claims processing administration, as well as SARS’ ability to issue tax directives to funds.

In a move to appease labour unions – which are unhappy with the fact that government wants to see more retirement savings preserved for the long haul – National Treasury proposed that the savings pot of members be seeded with 10% of current members’ fund credit, up to a maximum of R25 000.

In practice, this will mean that fund members will have immediate access to up to R25 000 from March, 2024. Given the state of South Africa today — high food prices, stagnant wages and elevated unemployment — experts expect a rush on retirement fund savings.

This means pension funds will need to have access to liquid investments, such as money market and income assets, before the implementation date.

“There is a lot of work to be done on liquidity,” Johan Gouws, head of advice at Sasfin Wealth tells Today’s Trustee. “I don’t think March 1, 2024 is going to happen.”

There is also concern that future changes to the liquidity management, or rather, asset allocation of retirement funds will incentivise members to periodically withdraw funds from their savings pot.

The basic structure is that a third of a retirement fund member’s contribution will be allocated to the savings pot, with the balance held in the retirement pot. Members will be allowed to make a single withdrawal of at least R2000 a year. That means funds will need to keep some of their investments in liquid assets, such as cash, to ensure they can meet requests for early withdrawals.

The draft legislation also caters for members who resign during the year.

As Treasury put it in an explanatory memorandum: “In the event that a member resigns from employment and such member has already made use of their single withdrawal, an additional withdrawal will be allowed provided the member’s gross interest in their ‘savings component’ is less than R2000.”

But Sierra is worried that the readjustment of funds’ investments will lead to members opting to withdraw their savings pot regularly, when they’re allowed to.

“How will funds’ investments be structured?” he asked at the recent conference of the Council of Retirement Funds for SA (Batseta). “Will a third be in income assets and two-thirds in growth assets?”
There are potentially undesirable consequences too, including the possibility of younger members withdrawing their savings pot annually, and investing it in growth assets to obtain a higher investment return over time.

And this sort of churn may impact a member’s long-term returns on their savings.

As it stands, younger members typically have the bulk of their retirement savings invested in higher-yielding risk assets, such as equities. On the other hand, members close to retirement typically have their savings invested in more income-type investments, such as cash and bonds, to preserve as much capital as possible.

Beware the tax

Still, not everyone is worried about the liquidity issues; some even welcome the certainty on how much seed capital will be allowed in the savings pot.

“The industry has eagerly awaited the inclusion of the seeding element, which is now addressed in the draft legislation,” says Blessing Utete, managing executive at Old Mutual Corporate Consultants.

The withdrawal conditions (subject to a 10% limit, capped at R25 000) mean that funds can navigate any liquidity issues that arise. “We are confident that the manageable seeding will have minimal impact on the liquidity requirements of retirement funds.”

Members opting to withdraw from their savings pot will, however, face a nasty tax bill.
According to Treasury, withdrawals “from the ‘savings component’ will be added to the individual’s taxable income and will be taxed at their marginal rate”.

Right now, a member who withdraws his or her fund credit is exempt from paying tax on the first R27 500 withdrawn, pays 18% on the value between R27 501 and R726 000, 27% on the value between R726 001 and R1.089m and 36% of the value above R1.089m.

But Claire Sherwood, head of employee benefits at 27four Asset Management, is worried about how this will all play out.

“I’m scared about the tax treatment,” she said at the Batseta conference. “Members won’t be taxed at the time of withdrawal [from their savings pot]. They will only know [about their tax obligations] after the tax year is done.”

This means those members who earn a taxable income of just south of the government’s R95 750 tax threshold, and opt to withdraw funds from their savings pot, will likely not know about their tax obligations at the time of cashing out their savings.

Practically, if a member earns a taxable income of up to R7979 a month (equal to one-twelfth of R95 750), their payslips will most likely not include a deduction for PAYE tax. If the member then withdraws R2000 from their savings pot, he/she would be liable for R360 in income tax, which will only be assessed once the member files their tax return in July.

But, as Sierra says, fund managers need to drive home the message about the savings pot – sooner rather than later.

“Trustees and fund management companies should educate members that it is only a last resort to cash out your retirement savings. It should not cover expenses.”

Given the state of South Africa’s economy, this is a hard message to deliver to financially struggling members.

Visser was a guest of Batseta at its recent winter conference.

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