SA’s two-pot retirement system is a positive, but should always be used as a last resort

By Caroline Naylor-Renn, COO of 10X Investments

South Africa’s new “two-pot” retirement system came into effect as of 1 September 2024. The system is designed to ensure that South African workers can deal with emergencies, such as the sudden loss of a job, while preserving at least some of their retirement savings.

It’s a fairly unique system and is designed specifically for a South African context where traditional saving rates are incredibly low and where, according to our own 10X Retirement Reality Report, 56% of working people changing jobs admitted to cashing in their retirement savings. There’s also an unfortunate tendency for people to resign from jobs just so they can access their retirement savings.

The two-pot system changes that. Rather than being able to withdraw the entirety of their savings, people contributing to retirement funds will only be allowed to withdraw a set portion. More specifically, every monthly contribution that you pay into your pension from the 1st of September will be split in two. One-third will go into the savings pot and two-thirds will be in a retirement pot that you can’t touch until you reach retirement age.

As innovative as the system is, however, it’s critical that South Africans don’t withdraw from their savings pot at the first possible opportunity. Instead, they should view it as an option only to be used in emergencies.

Missing out on the magic of compound interest

There are several reasons why people should think twice before making a two-pot withdrawal, but missing out on the magic of compound interest is high up on the list. Remember, compound interest works best over time.

As an illustration of how powerful compound interest over time is, consider a principal investment of R5 000 invested over 20 years and one of R15 000 invested over five years, both at eight percent annually. At the end of 20 years, the R5 000 investment will be worth R23 304.79. By comparison, at the end of five years, the R15 000 will be worth R22 039.92.

But the properties of compound interest also mean that every extra rand you put in early on will result in exponential gains in the long run. Withdrawing a large portion of those savings at any point in your career means handicapping compound interest’s effects.

Even in the unlikely event that you’re able to make back the money and put it back into your retirement savings, you’ll still have lost valuable time. Of course, it is possible to catch up, but you’ll have to increase your contributions by a considerable amount every month.

Beware the tax implications

Another reason why people should think twice before taking advantage of the two-pot system is the tax implications. SARS has already announced that it will be adding significant tax penalties for those looking to withdraw from their retirement. Not only will people be taxed on the amount they withdraw, but that amount will be added to their total income for the year.

Depending on how big the withdrawal is, people could even find themselves pushed into a higher tax bracket. Anyone wanting to make a withdrawal should also ensure that they’re in good standing with SARS. The revenue service has confirmed that it will “instruct the retirement fund to deduct outstanding tax debt from the two-pot withdrawal and pay it over to SARS to set it off against a tax debt”.

Building a South African savings culture

Given how much people have to lose by taking advantage of the two-pot system, it’s clear that it should always be an option of last resort. But for far too many South Africans, the distance between “first choice” and “last resort” is incredibly small. If we want to avoid people using the two-pot system at the first sign of trouble or even for seemingly frivolous expenses, we must inculcate a culture of savings.

Ideally, everyone should have various savings funds, covering emergencies, travel and their children’s education. Everyone should also contribute to those funds monthly. That is, of course, easier said than done, particularly in the face of rampant inflation over the past few years. This is, remember, a country where at least 40% of adults, per the Finmark Trust’s Annual FinScope Consumer South Africa 2023 Survey have to go into debt to buy food every month.

That does not, however, mean that the situation is insurmountable. While economic growth and jobs are important to make saving easier, education can play a critical role too.

This moment in time represents an ideal opportunity to ramp up those education efforts. While we’re educating people on the implications of withdrawing from the two-pot system, stakeholders within the financial sector should build on their existing initiatives and play as big a role in building a culture of savings and investments as possible.