As final legislative amendments for South Africa’s new two-pot retirement system are yet to be published, Richard Carter, head of Assurance at Allan Gray, looks at the challenges ahead.

During February’s Budget speech, finance minister Enoch Godongwana confirmed that the two-pot retirement system would be launched on March 1st, 2024. But with just 12 months to go, it is important to understand the regulatory aspects of how this will happen, and the potential challenges.

One of the biggest issues we face is that the legislation still hasn’t been finalised. The Budget review referred only to forthcoming draft legislation. Yet in the absence of this draft, there is considerable uncertainty regarding implementation.

We understand the broad strokes of the expected changes, but the devil is always in the detail. This is because administrators need to amend systems based on precise requirements, funds need to process rule amendments based on the final legislation, and the Financial Sector Conduct Authority (FSCA) needs to process all those amendments before it is implemented. Retirement fund members and their advisers also need to be given clear communication about how the changes will affect them.

Yet none of this can be done until the uncertainty is resolved. The industry has repeatedly said that the expected length of time it will need to implement the changes once legislation is promulgated is 12 to 18 months.

It’s no surprise that it takes a while to get the legislation right – the reforms involve major changes to a system with serious issues. The intention is that the new two-pot system will allow access to those who desperately need cash, while at the same time improving the preservation of retirement savings. Offering partial access will, over time, see the amount of money in the system grow, and lead to better retirement outcomes for most savers.

Under the new system, it will be compulsory for all retirement funds to split contributions received between two notional portions – one-third will be allocated to a “savings portion” that will allow early access to funds, while the remaining two-thirds will be allocated to a “retirement portion”. At retirement, whatever is left in the savings portion will be available as a cash lump sum. The retirement portion will have to be used to purchase an annuity. Any money saved up before implementation of the new system will remain in a “vested portion”, subject to the treatment that currently applies, meaning it will have “vested rights”.

Four outstanding matters to be finalised

In the Budget review, National Treasury set out four areas that require additional work following the extensive public consultation on the reforms.

The first is “seeding”. Given that changes will only apply to contributions made from the implementation date, the vested portion will represent the biggest portion of retirement savings for many members for some time. Seeding would involve allowing members to transfer some of the funds that have accumulated in their vested portion (prior to the new system being implemented) to the new two-pot system, thereby allowing some immediate access to historic funds. While there could be merit in allowing this, if the seeding is too generous, the cost in terms of leakage from what has been saved to date could be material.

The second area is the legislative mechanisms needed to include defined benefit funds in an equitable manner. There seems to be agreement that defined benefit funds should be included in the new system, but that is easier said than done. Defined benefit funds work differently – it is not a simple matter of splitting contributions into two portions, given that the rights and benefits of members are not defined in terms of contributions, but rather in terms of a formula often based on factors such as salary and years of service. These benefits must be adjusted fairly whenever a withdrawal is paid out.

The third area is that of legacy retirement annuity funds. While these funds might not make up the lion’s share of retirement savings, there are technical challenges to incorporating them in the new system. Again, there is broad agreement that they should fall within the new system, but this needs to be done with care, since the product design and supporting systems do not easily lend themselves to the flexibility envisaged with the new savings portion.

The fourth area is the treatment of the retirement portion on retrenchment. One of the concerns that was raised in the public consultation is that members who are retrenched with no alternative source of income, and who have depleted their savings, might need some access to the funds in their retirement portion. This is a contested area. The point of the savings portion is to provide some relief when members fall on hard times, and to pay out funds from the retirement portion before retirement will undermine the secondary aim of improving outcomes at retirement.

These are all tricky issues. The first three will be addressed in the draft legislation that we are waiting for, while the last will be deferred until the two-pot system is operational.

But it is important to remember that in the early years after the new system is implemented, the vast majority of savings (and hence benefits) will sit in the vested portion, all of which will be available on retrenchment in an occupational fund.

In the end, a full analysis of the regulatory aspects and challenges of the two-pot system can only be properly undertaken once the final legislative amendments have been published. Yet we’re still waiting to see what this looks like.

For more information, listen to Allan Gray’s recent podcast on this subject.

* Carter joined Allan Gray in 2007. He is head of Assurance and is responsible for Compliance, Risk, Internal Audit and Group Legal. He is also a director of Allan Gray Life and Allan Gray Investment Services. He is a qualified actuary.