Two retirement pots

Is the proposed two-pot retirement system ‘stirring the pot’ in the retirement fund industry?

THE DRAFT tax legislation released by National Treasury on 29 July 2022 contains details of the much anticipated two-pot retirement system.  The proposed changes are quite far-reaching although there will also be criticism that the changes do not go far enough.

The intention is for the changes to address the following two concerns:

• The inability of households in financial distress to access their retirement savings prior to withdrawal or retirement; and
• The failure to preserve funds for retirement, in those instances where members withdraw from their pension or provident funds on termination of employment.

In terms of the current rules applicable to pension and provident funds, members may only access their retirement savings upon withdrawal or retirement.  As a result, in times of financial distress, members of pension or provident funds sometimes terminate their employment to withdraw from their pension or provident funds.

Members of preservation funds and retirement annuity funds, on the other hand, may only access their funds upon retirement (other than preservation fund members funds being entitled to a once-off opportunity to withdraw an amount from such fund before retirement).

Although the COVID-19 pandemic intensified the calls of members to have im-mediate access to their accumulated retirement savings to alleviate financial pressure, it is clear from the proposed amendments that members will not be allowed pre-retirement access to their current accumulated savings—only to a portion of future savings.

According to the media statement that was published by National Treasury, the two-pot system “will present a better balance between ensuring preservation of retirement savings and allowing some withdrawals through a savings vehicle incorporated into the retirement funds”.

So what is new?

The following, in a nutshell, are the main features of the proposals:

• With effect from 1 March 2023, all pension, provident, preservation, and retirement annuity funds will be obliged to allocate contributions paid to them to a new ‘Retirement pot’ and a ‘Savings pot’. Retirement savings up to 28 February 2023 will be ‘grandfathered’ by way of a ‘Vested pot’ and will not be impacted by the new rules.
• Members will be able to withdraw funds from the ‘Savings pot’, which amounts will be subject to the normal tax rates.
• The amounts in the ‘Retirement pot’ will only be accessible on retirement. It appears that it will not be possible to withdraw funds from this pot on termination of employment prior to retirement.

Two pots or three pots?

With effect from 1 March 2023, up to one-third of the contributions paid to a retirement fund may be allocated to the ‘Savings pot’ while the balance of such contributions must be allocated to the ‘Retirement pot’.

Retirement fund contributions will still be tax-deductible up to the current caps (27.5% of taxable income or R350 000 per annum).  However, contributions in excess of these caps must be allocated to the ‘Retirement pot’.

If the proposed amendments are promulgated in their current form, members of retirement funds will be entitled, post 1 March 2023, to withdraw an amount of not less than R2 000 from their ‘Savings pots’ once a year without having to resign / withdraw from service or retire (referred to as a Savings withdrawal benefit).

In this way, National Treasury will be assisting those who may be in financial distress to access a portion of their retirement savings while they remain a member of the retirement fund.

A member does not need to provide any reasons to the retirement fund as to why they wish to make an annual withdrawal from the ‘Savings pot’.

Should there be any funds available in the ‘Savings pot’ when a member reaches retirement age, the member may choose to either transfer the funds to the ‘Retirement pot’ or withdraw the available balance in cash.

Amounts allocated to the ‘Retirement pot’ cannot be accessed before a member reaches retirement age.  On retirement, the total value in the Retirement pot must be paid in the form of an annuity (monthly pension).  However, if the value of the Retirement pot is less than the proposed minimum amount of R167 500, then the value may also be taken as a cash withdrawal.

Despite the references to this as a two-pot system, there is also a third pot that will hold the current accumulated retirement savings, referred to as the ‘Vested pot’.

All contributions (member and employer, where applicable) and retirement interest that accumulated in the funds before 1 March 2023 must be valued as at 28 February 2023 to determine the Vested pot.  The Vested pot will remain subject to the current conditions, which means that members of a pension or provident fund will not be able to withdraw savings from the Vested pot before resignation or retirement.

Since preservation funds and retirement annuity funds must also provide for a ‘Savings pot’ and a ‘Retirement pot’, members should also be able to with-draw savings from a preservation fund and a retirement annuity fund.

As is the case for pension and provident funds, the ‘Savings pot’ and ‘Retirement pot’ will only apply in respect of contributions received from 1 March 2023 onwards.

Tax considerations in respect of the two-pot system

Any amounts withdrawn from the ‘Savings pot’ will be included in the member’s normal taxable income, and will not be subject to the Withdrawal Tax Table.  This differs from the tax treatment of a lump sum paid by a retirement fund upon the termination of employment prior to retirement age—for example, upon resignation.

Although the Withdrawal Tax Table is substantially more onerous than the Retirement Tax Table, National Treasury was concerned that applying the Withdrawal Tax Table to a Savings withdrawal benefit would provide some form of tax arbitrage.

The 36% marginal tax rate in terms of the Withdrawal Tax Table is still 9% lower than the marginal tax rate in terms of the normal tax tables (45%).  High-income earners who benefit from a 45% tax benefit when claiming their contributions as a deduction would thus have a 9% tax ‘saving’ if taxed at 36% on a Savings withdrawal benefit.

However, the application of normal tax tables will not necessarily result in the ‘Savings withdrawal benefit’ being taxed at a higher effective rate.  In those instances where a member’s normal marginal tax rate is 36% or less, and if the member is accessing funds from the Savings pot in order to replace lost income (i.e. if they are withdrawing savings in order to replace remuneration), the application of the normal tax tables will not necessarily result in a higher tax liability than if the Withdrawal Tax Table was applied.

The fact that National Treasury has not made any changes in respect of the tax treatment of contributions (i.e. members are still entitled to the same tax benefit) while taxing the Savings withdrawal benefit at the normal tax rate, clearly demonstrates the policy intention of encouraging members to save for retirement while not encouraging members to access the Savings pot.

Furthermore, the fact that provision is made for amounts to be transferred tax-free from a Savings pot to a Retirement pot, or between similar pots in different funds, again demonstrates this policy intention.

Next steps

A lot of work would need to be done by, amongst others, retirement funds, the Financial Sector Conduct Authority (FSCA), fund administrators, and SARS before 1 March 2023 to ensure the implementation of the two-pot system.

For example, retirement fund rules would need to be amended to accommodate the two-pot systems; transfer between funds and ensuring vested rights.  Retirement funds would also need to reconsider their investment strategies, and whether assets would need to be invested in more liquid portfolios.

The FSCA will have its hands full in approving rule amendments and dealing with fund queries, and administrators may need to update their systems to accommodate the split among the three pots. The amended rules must also be approved by SARS.

Whether the two-pot system will be implemented in its current proposed form by 1 March 2023 is to be seen.  Some may say that the proposed implementation date is a bit ambitious.

National Treasury advised that it will consider the feedback received from the public on the draft Bill.  The Standing Committee on Finance and the Selected Committee on Finance in Parliament are expected to also call for public comment, and will convene public hearings on the draft Bill before their formal introduction in Parliament.

National Treasury had invited comments and queries on the proposed two-pot system up to the close of business on 29 August 2022.  However, considering the amount of work to be done and some stakeholder feedback already received on the proposed amendments, it is likely that a second draft Bill will be published for public comment.

WRITTEN BY DEIRDRE PHILLIPS and ANERIA BOUWER