With the recent implementation of South Africa’s two-pot system for retirement savings, financial advisors play a crucial role in guiding clients through this significant retirement change. This article explores the details of the system and highlights how financial advisors can best support their clients in making informed decisions for their future financial security.
As of 1 September 2024, South Africa’s two-pot system has introduced a major shift in retirement planning, providing both flexibility and long-term security for retirement fund members. In the past, individuals could cash out their entire retirement savings when changing jobs, often leaving themselves with insufficient funds for a financially stable retirement.
Recognising this issue, the government implemented the two-pot system, which allows members to access a portion of their retirement savings in emergencies while ensuring that most of their funds are preserved for the future.
At Masthead’s recent Cape Town MasterClass, Lizl Budhram, Head of Advice at Old Mutual Personal Finance, discussed the importance of this change. “For years, we’ve spoken about the fact that only 6% of South Africans can retire with financial stability,” she explained. “It’s been 25 years, and that number hasn’t improved. Despite our best efforts, we’ve struggled to make a significant difference. Now, with the introduction of the two-pot system, the legislation itself will help drive better outcomes.
While the two-pot system offers immediate access to funds, its primary purpose is to improve retirement outcomes over the long term. The system is designed with a view toward future financial security. Lizl explains: “While we anticipate a lot of withdrawals in the short term, the Reserve Bank projects that in nine to 10 years, we’ll start seeing the benefits of the system. People will have accumulated more in their retirement funds, ensuring better outcomes for retirees.”
Previously, retirement funds could only be accessed when you resigned, were dismissed or retrenched, but the new system is designed to address both immediate financial needs and long-term retirement goals, and financial advisors will play a key role in helping their clients navigate these changes effectively.
How Does the Two-Pot System Work?
The two-pot system will impact your client’s rights as a member of various retirement funds, including pension funds, pension preservation funds, provident funds, provident preservation funds and retirement annuities. Under this system, all affected retirement funds are required to create two distinct “pots”, which together make up one unified fund. The system also includes a vested pot, which we describe in more detail below:
1. The savings pot: This pot, also known as the “access pot”, receives one-third of the member’s retirement contributions. Starting from 1 September 2024, members are allowed to withdraw from this pot once every tax year, provided the minimum withdrawal is R2 000 (subject to deductions such as tax and other administration fees). The pot was seeded with either 10% or R30 000 – whichever was lower of the member’s accumulated benefits as of 31 August 2024. This pot is intended to provide members with financial flexibility in emergencies.
2. The retirement pot: This pot, also known as the “preservation pot”, receives the remaining two-thirds of your retirement contributions. This pot needs to be preserved and cannot be accessed until retirement, ensuring that the majority of the member’s savings are preserved for their future.
3. The vested pot: This is your fund value before the two-pot system was introduced. No further contributions can be made to this pot apart from arrears contributions, and it remains subject to the rules in place before the system’s implementation, meaning it’s accessible according to the previous withdrawal terms. Starting from 1 September 2024, up to 10% of your vested pot (capped at R30 000) will be transferred to your savings pot as seed capital, making it accessible if needed.
Here is a practical example of how the two-pot system works: If you contribute R6 000 per month to your retirement fund, R2 000 (one-third) will go into the savings pot; R4 000 (two-thirds) will go into the retirement pot.
Together, these pots strike a balance between allowing members access to funds when necessary and preserving long-term financial security. This dual-purpose structure is aimed at improving retirement outcomes across the board.
The Role of Financial Advisors in the Two-Pot System
The immediate engagement with the two-pot system has been significant. The South African Revenue Service (SARS) reported that within the first month of its implementation, R4.1 billion was withdrawn from the savings pots of retirement funds. In addition, Discovery’s Employee Benefits team found that 22% of eligible retirement fund members opted to withdraw from their savings pots in September.
These figures underline the crucial role that financial advisors must play in helping clients understand the implications of their decisions. Withdrawing funds can provide short-term relief but may have long-term consequences if not carefully considered.
As a financial advisor, here’s how you can guide your clients through the two-pot system:
1. Training: Ensure you and your team have undergone comprehensive training on the two-pot system. Document this training in your FSP’s competence register and establish a clear operational process for handling client withdrawal requests. This will ensure compliance and consistency when assisting or advising clients.
2. Communication and compliance: Be upfront with clients about potential delays in processing withdrawals due to the high volume of requests. Ensure that your team follows proper FICA and due diligence protocols to verify the identity of clients requesting withdrawals.
3. Key client considerations: Once a client decides to withdraw from their savings pot, it is crucial for the financial advisor to inform them of the following:
- Tax implications: Withdrawals from the savings pot are taxed as income and are considered with all other taxable income. Clients need to be fully informed about how this will affect their overall tax liability. For example, a withdrawal may push a client into a higher tax bracket than usual, resulting in an escalation of personal income taxes, an impact which may reduce the immediate withdrawal amount or may only become apparent in the period after a withdrawal was made.
- Withdrawal fees: Retirement fund administrators may charge processing fees for withdrawals, which should be clearly communicated to clients.
- Withdrawal limits and rules: Clients must understand that there are specific rules and caps that apply to the amount they can withdraw. In addition, it is important to know how the rules and limits will impact their ability to “resave” or “replace” what has been withdrawn from the fund. In practical terms, withdrawal decisions are not decisions that can simply be fixed by “repaying” the amount taken. The same rules that apply to retirement (monthly) contributions will apply to all future contributions. Therefore, if a client withdraws R9 000 from their savings pot now, they will have to contribute an amount of R27 000 to the fund to ensure that R9000 is reallocated to the savings pot (one-third or R9 000 to the savings pot and two-thirds or R18 000 to the retirement pot).
- Impact on long-term goals: While the savings pot offers flexibility, withdrawing too much can deplete the funds needed for future needs due to the significant impact of compounded interest over longer periods. It’s vital that clients are educated on the importance of balancing immediate financial needs with their long-term retirement objectives.
- Effect on investment growth: Early withdrawals reduce the amount available for investment, which can limit growth opportunities. Clients need to understand how this could affect the overall value of their retirement fund at retirement date. Additionally, these withdrawals may impact the projected retirement age and income outlined in their financial plan, potentially altering long-term retirement goals.
- Be clear on alternatives: Encourage smart saving by advising clients to maintain separate emergency funds which do not attach fees or tax obligations. This can reduce the temptation to withdraw from the savings pot for unexpected expenses.
- Behaviour and customised services: Advisors play a critical role in terms of being the first contact point for customised and tailored financial services. Advisors know their clients and their behaviours and should apply this knowledge to guide them to make considered choices, guarding against reactive or impulsive behaviour which may negatively impact their financial position and financial planning objectives.
- Guard your clients and their financial plan against myths and misconceptions: Over the past few months, it has become clear that several myths and misconceptions have been fuelled by a lack of understanding of the two-pot system and rules. As a financial advisor, clients trust and rely on your input and advice. A lack of communication on important aspects or rules, and failure to provide correct and clear information on impacts or facilities may present an unnecessary opportunity for clients to be caught up in misinformation. Manage your client communications effectively to ensure that they have access to correct and verified information and are made aware of important information like administration channels, calculators or other information points. To ensure your client is fully informed, you could provide written communication outlining the potential effects on their investment.
- Taking advantage of annual reviews: Conducting a review is a legislative requirement but could be an ideal opportunity to update information regarding the client’s savings circumstances and behaviour. It presents an opportunity to discuss what has been implemented, but also plan for future needs, including cash flow requirements, possible emergencies, or general enhancements, changes or additions. It is recommended that the annual review process be updated to include a standard check on clients’ retirement savings status and needs, in particular, whether the client expects or foresee that they will have to access their savings pot in the near future. Where this is recorded as a discussion point, the advisor can use this information to adjust the financial plan accordingly. It will also serve as a protection for financial advisors, should any queries arise at a later stage where a pattern of unplanned withdrawals may have negatively impacted the client’s retirement outcome. Review is necessary when there are changes in the client’s financial situation or when a new financial product is taken up or changes are made to an existing one. Where advice is provided, you must follow the standard advice process, which includes preparing a record of advice. This document serves as proof that a review was conducted, provides details on ongoing fees, commissions and product benefits and demonstrates your commitment to treating customers fairly.
These are just some of the factors that a financial advisor should consider when engaging with and advising clients on how the two-pot system can impact their retirement investment.
Helping Clients Navigate the New Retirement Landscape
At the heart of financial planning is the responsibility not only to help clients prepare for the future but also to educate them on how to make informed decisions today. The two-pot system presents new opportunities and challenges for both financial advisors and their clients.
By ensuring that clients fully understand the implications of their decisions – whether to withdraw from the savings pot or preserve their funds – advisors can help them strike a balance between short-term needs and long-term retirement goals.
As a financial advisor, your role in this new system is critical. With proper guidance and informed advice, you can help clients navigate the complexities of the two-pot system and secure their financial future for years to come.