Retirement savings play a critical role in ensuring financial stability and security in one’s later years. As individuals transition from active employment to retirement, having a well-structured savings plan becomes essential for maintaining their standard of living and covering unforeseen expenses. Without enough retirement savings, people will face financial stress, limited access to necessary resources, and reduced quality of life.

The introduction of the two-pot system on 1 September 2024 emphasises the importance of managing retirement funds more effectively. This new system aims to address existing challenges and promote better financial health by offering a structured approach to saving and accessing retirement funds.

Understanding and adapting to these changes is vital for individuals looking to secure their financial future and ensure they are well-prepared for the transition into retirement.

Let’s take a closer look:

The two-pot system

Effective 1 September this year, South Africa will introduce a new retirement savings framework known as the two-pot system. This system is designed to address major issues with the current retirement fund structure and enhance individuals’ financial security.

The current retirement fund system has had to deal with many challenges. One major issue is the ability for employees to access their retirement savings fully upon leaving employment, except for retirement purposes. This access has created an incentive for individuals to resign prematurely to access their funds, leading to inadequate preservation of savings earmarked for retirement.

Additionally, during periods of financial distress, such as those exacerbated by the Covid-19 pandemic, many people found their retirement savings – typically inaccessible – could not be used to alleviate immediate financial burdens.

To address these concerns, the two-pot system offers a restructured approach to managing retirement savings, dividing them into three distinct pots: the vested pot, the savings pot and the retirement pot. The new system features two main components for retirement savings.

Unpacking the pots

The first component, the savings component, results in one-third of the total contributions (excluding risk premiums and administrative charges) from employees. Funds in this pot will be accessible without requiring the employee to leave their job, providing liquidity for financial emergencies. Employees can make withdrawals from this component once per tax year, with a minimum amount of R2 000.

These withdrawals will be taxed and must be included in the employee’s gross income. Additionally, when the system kicks in, a one-time seeding capital of 10% of the total value of the vested component as of 31 August 2024 (up to R30 000) will be transferred to the savings pot.

The second component, the retirement component, results in two-thirds of the total contributions (excluding risk premiums and charges). Unlike the savings pot, funds in this component must be preserved until retirement. Withdrawals from this component are not permitted before retirement, and upon retirement, the full value must be paid out in the form of an annuity. Annuities from this component will be included in gross income and taxed according to progressive personal income tax brackets.

In addition to these new components, there will be a vested component, which refers to all contributions and growth accumulated up to 31 August 2024. This element remains unaffected by the new system. No further contributions can be made to the vested component after 1 September 2024, except for members of provident funds or retirement annuities who were 55 years or older on 1 March, 2021. Individuals will still be able to access their vested funds upon resignation, with withdrawals taxed according to existing rules.

Changes to payroll and reporting

The new system also introduces changes to payroll and reporting. Withdrawals from the savings component will need to be reported for tax purposes, including them in the employee’s remuneration. The retirement fund will need to obtain a tax directive from the South African Revenue Service to determine the PAYE to be withheld and report the withdrawal using IRP5 code 3926.

Employers are not required to calculate or report the split between savings and retirement contributions separately; this will be managed by the retirement fund. No new reporting requirements regarding the split in contributions are expected from either the retirement funds or Sars.

In a nutshell, the two-pot system intends to improve the management and accessibility of retirement savings, dealing with the issues of premature withdrawals and the need for accessible funds during financial distress. While employers do not need to modify their payroll systems, it is important to educate employees about the new system and its implications for their retirement savings.

This dramatic shift in retirement fund management is intended to create a more balanced approach to savings and accessibility, helping people better plan for their financial futures.