Danger of rushing implementation of two-pot retirement system

The danger of rushing the implementation of the two-pot retirement system puts South Africa’s retirement fund system at a critical juncture. While a successful implementation promises to address key long-standing deficiencies in the current retirement framework, an unsuccessful or rushed implementation runs the risk of destabilising or undermining confidence in a crucial sector of the economy.

The two-pot retirement system divides retirement fund contributions into a retirement pot and a savings pot. The retirement pot will hold two-thirds of contributions and will be strictly preserved for retirement, while the savings pot, holding the remaining one-third, can be accessed before retirement to use for financial emergencies.

However, Rael Bloom, product development actuary at Coronation, says while this six-month reprieve provides additional time for industry stakeholders to prepare for the change, the deadline remains challenging due to several key issues that must be resolved, including:

• A raft of regulatory changes are required to give legal effect to this new system and provide clarity about the changes required. This includes changes to the Income Tax Act and Pension Fund Act that must still be finalised and promulgated.
• Sars must adjust its systems and processes to accommodate the tax requirements.
• The Financial Services Conduct Authority (FSCA) must approve enabling rule amendments for all retirement funds affected.
• Administrators must make necessary system upgrades and adjustments to meet the requirements of the new system.
• Funds must make necessary preparations, such as ensuring that they have the correct bank details for all members.
• Member education about the new system must be conducted to help members understand how the new two-pot system works, dispel any myths about it, and clarify what will happen to the accumulated savings pots.

He says if the system is not implemented properly, there is a risk of member discontent, which could undermine confidence in the retirement industry. There are three key risks that need to be carefully managed: execution risk, risks related to the initial seed capital payment, and risks to retirement savings stability.

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#1: Execution risk in two-pot retirement system

The two-pot system is the largest reform of the South African retirement system in its history. Bloom says the aggressive timeline introduces the risk of delays, errors, and a lack of member understanding about the benefits they are entitled under the new system.

“The practical challenges of implementing a reform as substantial as this means that the revised deadline of 1 September 2024 will still be tight but much more manageable than the initial 1 March 2024 target.

“To ensure a smooth transition to the new system, clear and effective communication with members about the upcoming changes is vital, alongside operational changes that are required for industry stakeholders to be able to deliver on their respective obligations under the new system.”

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#2: Risks regarding the initial seed capital payment

There is a very real risk of significant member unhappiness regarding an initial “seed capital” lump sum that will be available to members when the two-pot system is introduced, Bloom says.

“The first area of possible discontent is around how much members will receive when the new system is implemented. Throughout the two-pot deliberations, there has been a strong push for an initial lump-sum payment to be made to members at inception of the system in the form of a seed capital payment.

“While this is technically classified as a seed transfer from their vested pots (existing savings) into the new savings pot (which can then be accessed immediately), it will practically be seen as an initial once-off lump sum withdrawal that members will be allowed to take from their current retirement savings.”

According to Bloom, advocates for the payment of seed capital emphasise the urgent need for members to access a portion of their capital, highlighting the financial hardships many consumers face in the aftermath of Covid-19 and the ongoing economic challenges in South Africa.

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Amount of seed capital in two-pot retirement system

He says the amount of seed capital is expected to be set at 10% of a member’s retirement balance, subject to a maximum of R30 000. This is a gross amount and the actual amount that members will receive will be lower because it will be reduced by tax and administration costs.

“There is a risk that some members may not have a full understanding of the actual amount that they will receive when their seed capital is paid out.”

Secondly, some members are likely to expect that they will receive their initial seed payments on, or shortly after, the implementation date of 1 September 2024, but there is a risk that it may take longer for all stakeholders to have the necessary processes in place so that funds can make these payments to all their members, Bloom points out.

In the current system, most funds only pay a small percentage of their member base for life events such as retirement or resignation. In contrast, all members of retirement funds will be entitled to a seed capital withdrawal at inception, putting a huge administrative burden on funds, their administrators and other industry stakeholders such as Sars and the FSCA, he says.

“This risk of the seed capital payouts not meeting member expectations is compounded by the significant financial difficulties many South Africans face, coupled with the fact that funds have limited time to educate members about the new system.”

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#3: Retirement savings sustainability risk

While the immediate focus is understandably on meeting the September deadline, Bloom points out that a more significant long-term risk relates to the expectations that may be created following the payout of the initial seed capital lump sums.

“It is critical for the long-term sustainability of the retirement system that this initial seed payment is only allowed once and that additional lump sum withdrawals from members’ retirement pots and vested pots are not allowed.

“After the seeding, the only amounts that should be accessible to members should be the balances available in their savings pots.”

Bloom warns that South Africa must be careful that it does not end up in a situation that is similar to what happened in Chile during the Covid-19 pandemic. Before the pandemic, Chile’s pension system was generally well regarded, but the retirement system was decimated following a series of Covid-19-related withdrawals, with over $50 billion flowing out of the system.

Australia also allowed emergency withdrawals from Superannuation funds during Covid, but only under very specific and limited means-tested conditions. This protected the integrity of the Australian system, allowing it to recover once the immediate needs of the pandemic had passed.

Therefore, Bloom says, it is essential for South Africa to clearly establish that no further rounds of seeding will be permitted. “Such discipline is crucial to protect the industry and avert severe harm to retirement savers and to the broader economy over the long term.”