What’s the p(l)ot: the two-pot retirement system and what it means for investors

Annual income twenty pounds, annual expenditure nineteen six, result happiness.Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery. --- Charles Dickens, David Copperfield

?South Africa’s household savings rate is amongst the lowest in the world at only 0,5%; and stands far below that of many emerging market peers like India and Brazil. The household savings rate is an important indicator of a country’s financial and economic health because savings fund investment which, in turn, leads to economic growth, job creations, and rising incomes. The two-component system which is being put in place in South Africa – or colloquially the “two pot system”– aims to make important improvements to repair the country’s weak state of saving. And these changes have important implications for people planning for retirement.

First a brief recap. The changes to the Pension Fund Act, were implemented on 1 September 2024, and this introduced two components to an individual’s retirement savings:

1. A retirement or preservation component – comprising 2/3 of contributions: This component is designed to preserve a portion of the retirement fund for retirement purposes. Under the new regulations, this portion of a person's retirement savings must be retained in this “pot”, and withdrawals are disallowed until retirement age. This is intended to ensure that individuals will have sufficient funds to support themselves in retirement.
2. A savings component – comprising 1/3 of contributions: This component allows for the early withdrawal of some of a person’s retirement fund before retirement age, providing flexibility in meeting unexpected financial needs. A minimum of R2,000 can be withdrawn, and there is no maximum limit, although only one withdrawal may be made per year. Withdrawals from this component will be taxed at the member’s marginal tax rate and will likely incur additional administration fees.

There is no doubt that South Africa is a country of immense disparity between those who are financially stable and those who are financially fragile and, for the latter group, the need to access those funds can be very real. With a Gini coefficient of 63.0, South Africa’s income distribution ranks as the most unequal in the world. For this reason, the proposals have been made to give individuals the opportunity to access a portion of their retirement funds in the case of dire need. It would be trite not to recognise that South African consumers do not have a buffer in the form of savings that they can dip into during periods of high inflation and recession.?

However, the tragic irony is that those who need to get hold of their funds ahead of time are exactly the people who should not: they will need every cent of their retirement savings to provide for themselves in their retirement years.

Given this, what does the two-component system mean for retirees and investors ahead of retirement?

?The future belongs to those who prepare for it today. --- Malcolm X

Once in place, the retirement component can never be touched or spent. This is a huge advantage over the current system in which, if a person leaves his or her employment, they can take the full amount in cash and spend it. This has resulted in less than 5% of people being financially able to retire. In future, more and more people will have at least two thirds of their retirement assets preserved. This will benefit individuals by ensuring a permanent savings pool, and it will also be good for the country as, over time, this growing pool will place less reliance on the state. National Treasury could also see the benefit of higher tax revenue: whatever is withdrawn from the savings component will be taxed at the member’s marginal rate.

While there might be some short-term difficulties and confusion regarding the implementation of this legislation, it is unlikely to negatively impact retirement outcomes. People who access their retirement funds under the new legislation would most likely have cashed in their retirement savings anyway. The temptation to do so when changing employment will ultimately be removed, guaranteeing better retirement outcomes in the long run.

Despite these overarching positives, I would like to sound two notes of caution:

1. Impact of withdrawal of retirement assets: Any early withdrawal of capital will take wealth away from your future self. This aspect, if anything, is underappreciated because the single most important thing you’ve got in investing is time. If you take anything out of an investment early, compounding is gone. By giving people access to these assets, we have to step away just for a moment from the financial fragility and the strain on household balance sheets and recognise that the purpose of a retirement system is to look after your future self. By giving people access to retirement assets early or along the way, you are permanently removing their capacity to look after their future selves. So, at a philosophical level, there's a very real problem with the way that this is designed.
2. Impact in terms of use of assets: We also need to view this against the backdrop of South Africa, which is a savings-starved country. Most people retire with insufficient assets, retiring into effective bankruptcy, implying that there will be a huge temptation to dip into this pool of capital. Worse, a key reason for finding ourselves in this situation is that South Africans have a bias towards consumption. I fear that a disproportionate amount of the money that comes out of the system will be pointed towards consumption rather than looking after the balance sheet.

To me, that’s as worrying as the compounding that’s taken away. It’s going to feed more consumption in the country rather than savings and investments, and that is the critical ingredient which is missing from South Africa’s growth structure.

If anything, the most effective application of those assets would be to pay down debt, pay down a mortgage, pay down loans on other assets, or use them to acquire capital assets, such as property or an investment. In other words, people should use the cash to bolster their balance sheets, not to spend on consumption, as if it was a windfall. But mostly, if you can possibly avoid it, don’t cash out your retirement savings at all.

While the proposed structure of the new system will see some limits in terms of access to funds, it could have been better structured, given that other models exist. In Singapore, we see a model with much more appeal. First it is compulsory for all Singaporean and permanent resident workers earning a monthly wage of at least SG$50 (equivalent to roughly R650) to contribute to the Central Provident Fund (CPF) , which is a defined contribution scheme. Then, employers are required to match employees’ CPF contributions. This discipline ensures that individuals build up a substantial retirement fund. While the CPF encourages long-term savings for retirement, it also offers flexibility in withdrawals for certain purposes only, such as housing, healthcare, and education, providing a safety net for unexpected expenses, but not for wanton consumption.

The Chilean pension system, introduced in 1981, has been widely regarded as a successful model that involved shifting from a pay-as-you-go system to individual retirement accounts. It has significantly increased national savings and provided better financial stability for retirees. Under this system, workers are mandated to contribute a percentage of their income to individual retirement accounts managed by private pension funds known as Administradoras de Fondos de Pensiones (AFP) . However, despite its success in many areas, the system has faced criticism for not adequately addressing income inequality and for the low pensions received by some contributors. Also, there have been concerns about high administrative fees charged by AFPs, and disparities in retirement outcomes.

This leads me to the impact that the changes proposed under the two-component system are expected to have on the administration and compliance of retirement funds. This system will add costs to an already compliance-heavy industry, with the additional management and monitoring requirements. New administration systems have had to be developed and there is a new level of monthly reporting required. Funds have had to undertake extensive education programmes and engagement has become more intense, which is time consuming and costly. Note that a mere 1,5% difference in annual returns over a 35-year period can lead to a 30% to 40% reduction in pension pay-outs.

Do whatever it takes to keep your funds invested

The habit of saving is itself an education; it fosters every virtue, teaches self-denial, cultivates the sense of order, trains to forethought, and so broadens the mind. --- Theodore T. Munger (1830-1910)

Notwithstanding the challenges, the two-component system represents a positive move for the country in terms of strengthening the retirement system and growing long-term savings. We are in an environment in which consumers have been stranded, the economy has been growth-less for a decade or more, unemployment rates are elevated, and grossly skewed inequality is deeply entrenched. It also doesn’t look like interest rates are not going to fall as fast or as far as had been anticipated at the start of the year. Under the new system, the temptation to withdraw funds, and the need to withdraw funds, will be high. Fully respecting that financial circumstances might leave a person with few options; I would point to a few guidelines that could help people in their decision making when it comes to retirement fund assets under the two-component system.

First keep withdrawals to an absolute minimum and only extract whatever is essential – you are robbing your future self by making an early withdrawal. Second, if possible, consider transferring funds from your savings component to your retirement component if it has a more aggressive investment allocation and therefore ought to grow at a better rate over time, thereby providing greater capital for your retirement. (This may depend on your fund rules and options.) Third, if you do withdraw funds, use those funds to pay down debt, and first pay down debt that carries the highest interest rate. Don’t use withdrawals to fund consumption. Also, be aware that you will be taxed on the withdrawal at your marginal tax rate and, depending on what you earn and how much you intend to withdraw, you could nudge yourself into a higher tax bracket. Fourth, if you are in debt, speak to your bank about renegotiating your loan conditions or look around among different banks. We’ve seen one of the of the banks recently announcing that there is mis-pricing in terms of long-term loans – and even modest reductions in interest rates on debt can have material impacts on your long-term financial welfare.

While, in theory, we are introducing a system that will offer relief to cash-strapped consumers and put agility into South Africa’s already-sophisticated pension system, the reality is that this comes with challenges. Studies suggest that a 15 percent to 17 percent contribution is necessary to achieve an acceptable pension. South Africa already falls woefully short on this measure, and while the two-component system takes us in the right direction, there is more to be done.

Saving creates a critical path to prosperity – and retirement saving is a fundamental component of this vital pillar. There are further ways for the state and the private sector to step in to advance the current iteration of the new system. We could learn from Chile, Singapore, Australia, and others who have Ingrained the impact and power of disciplined saving through efficient financial systems as a platform for prosperity. Australia’s compulsory fund was introduced in 1992, and the system now ranks as the fourth largest in the world, with $3.7tn in assets and 13,3mn Australians – or half the population – have at least one account. Further, countries as diverse as India (10,8%) and Brazil (16,9%) have achieved savings rate that challenge the supposition that households in low-income countries cannot save. In fact, experiences across countries that have escaped the poverty trap make a nonsense of this belief. ?Auto enrollment (compulsory savings) is expected to be the “next big thing” to happen in the retirement industry, which would have enormous benefits for individuals, the retirement sector, and the country.

This article is produced as part of a series for the Tennant Group , a South African financial services provider that has been in business for over 30 years. Founded by Steve Tennant , the group offers a comprehensive, fully integrated employee benefits solution with a single touch-point experience.

Versions of this article were published by The Conversation Africa in two parts:

• South Africa has changed its retirement rules to help boost country savings: how it will?work
• Saving for retirement in South Africa? Four tips to navigate the new pension?rules