Retirement funds and the Two-Pot system
This concern is compounded by the high levels of consumer debt and stagnant salary increases that have not kept pace with inflation. The system aims to help cash-strapped consumers while encouraging them to save more diligently for retirement. However, it also presents challenges that investors and retirees should be aware of when managing their retirement funds.
Overview of the Two-Pot System
Since its inception on September 1, funds saved for retirement prior to this date were referred to as the “vested pot.” On September 1, the vested pot was divided into two parts: the savings pot and the retirement pot.
The Savings Pot
At the start of the two-pot system, 10% of your vested pot is transferred to your savings pot, up to a maximum of R30,000. For example, if you had R2 million in your vested pot, only R30,000 would be transferred to your savings pot, as it was capped at this amount from the onset. The remaining funds would go into your retirement pot and can only be accessed upon retirement.
As of September 1, you would have access to only R30,000 in your savings pot. If you withdraw this amount, it will be taxed at your current marginal tax rate, which could potentially place you in a higher tax bracket.
Additionally, any funds contributed to the savings pot after September 1 can be withdrawn. For example, if you accumulate R150,000 in your savings account during the 2024/25 tax year, you can withdraw either a minimum of R2,000 or the full R150,000, but you will be taxed at your marginal rate, which may also affect your tax bracket. To encourage retirement savings, the government allows the first R550,000 withdrawn from the savings pot at retirement to be tax-free, with reduced tax rates on amounts exceeding this limit.
The Retirement Pot
The retirement pot contains two-thirds of your retirement funds and can only be accessed at retirement. Funds contributed before September 1 fall under the “old” rules, while those contributed after that date are subject to the “new” rules. With the “old rules” funds contributed to retirement prior to the 1st of September can be accessed, drawn or moved upon retirement.
Under the new rules, retirees can choose to receive their retirement funds as:
- A Living Annuity, or
- A Life Annuity.
A) Living Annuity
With a living annuity, retirees decide what percentage of their funds to withdraw, with a minimum of 2.5% and a maximum of 17.5%. This option requires the retiree and their financial advisor to actively manage the retirement fund annually. However, there is a risk that funds may not grow adequately or may underperform, leading to financial hardship. In the event of the retiree’s death, any remaining funds in the living annuity will be paid to a spouse or nominated individual.
B) Life Annuity
With a life annuity, retirees receive a guaranteed annual amount, adjusted by a specified escalation percentage for a predetermined number of years. For example, if a retiree has R2 million in the retirement pot and chooses a life annuity of R10,000 for 20 years with an annual escalation of 5%, they will receive this amount, adjusted for inflation, each year.
If the retiree outlives the specified period, they will continue to receive the monthly income until death. If the retiree dies before the term expires, the nominated beneficiary has the option to take the remaining funds as a lump sum or continue receiving monthly payments for the duration of the agreement.
Important Considerations
It is essential to note that while retirees can transition from a living annuity to a life annuity, they cannot move funds in the opposite direction. Therefore, it is crucial for retirees to consult with a knowledgeable financial advisor to determine the optimal combination of living and life annuities, as navigating these new rules can be challenging.
