Luke Fraser
South Africa’s new two-pot retirement system will go live at the beginning of September, but Allan Gray says members should not consider it an emergency fund.
The group recommends that savers avoid touching their long-term investments and instead focus on building an actual emergency fund that they can turn to in times of need – without the risk of running through one-third of their retirement savings.
The new system, which has been established as an answer to the financial difficulties many South Africans hit during the Covid-19 pandemic, will ultimately be set up with a ‘savings’ and ‘retirement’ pot.
The savings pot will hold one-third of all retirement savings from the implementation date and will be accessible once a year before retirement.
The remaining two-thirds will be allocated to a retirement pot, which will be inaccessible before a member retires. The funds at retirement will then be used to purchase a retirement income product.
Existing retirement savings will go into a ‘vested’ pot and will follow existing rules.
“While access to the savings component will be a welcome relief to those in dire need, as a retirement fund member, it is vital to be mindful of the unintended consequence of unnecessary early access, which can prevent you from reaching your long-term investment goals,” said Allan Gray’s Tebogo Marite.
“Your retirement savings are intended for a very specific purpose: funding your income in retirement.”
“Despite getting access to a component for emergencies, it is important to guard against thinking of your savings component as your emergency fund. Depleting your savings component annually will result in you having one-third less on which to retire.”
Although the new system was created with emergencies in mind, such as the Covid-19 pandemic, Marite said that a separate emergency fund should be created. It should aim to hold at least three times one’s monthly salary.
She recommended investing the emergency fund in a low-risk unit trust.
She added that building a healthy emergency fund will take some effort, including lifestyle adjustments, such as paying off an expensive credit card and a monthly budget.
She said that R4,167 should be set aside for 18 months to accumulate R75,000 for those who earn R25,000 after tax.
“Ultimately, you should aim for your emergency fund to be sufficiently sized to buy you enough time to manage and recover from a crisis without the need to dip into your long-term investments,” said Marite.
“It is not prudent to rely on long-term investments – including the soon-to-be accessible savings component of your retirement funds – as they are specifically intended to meet long-term goals and are typically invested accordingly, with relatively high equity exposure.”
Other problems
Allan Gray and several other financial institutions have warned South Africans about the upcoming two-pot system.
When it comes to tax, all withdrawals from the savings pot will be treated as taxable income and subject to tax in line with one’s marginal rate. This means that a portion of the money one withdraws will go to taxes, reducing the payout that they receive.
In addition, consistent contributions and minimal withdrawals ensure that many allow their savings to grow and benefit from compound interest.
Compound interest means that one’s savings earn interest on both the initial and accumulated interest, leading to exponential growth.
The South African Reserve Bank also said the new two-pot system would worsen South Africa’s already dire savings rate.
Despite the central bank stating that the annual net outflow is likely to dwindle and the industry will reach a new steady state under the new two-pot system, it warned that it could worsen things in the near term.
The bank’s high withdrawal scenario sees an additional R100 billion being withdrawn from people’s bank accounts when the system goes live, hurting member’s long-term savings ability.
BusinessTech
