Taking stock of two-pot: A trustee’s perspective

All South African retirement funds have been impacted by the recent introduction of the two-pot retirement system. While implementing this has taken the focus of government, regulators and industry representatives for some time, you may be wondering who is thinking about the long-term implications for individuals.

As an Allan Gray retirement fund member, there are various mechanisms in place to protect you. The trustees of your retirement fund play an important role in ensuring that your fund is well governed and that your interests are protected. They also work with the investment, operational and client-servicing teams to deliver great outcomes for you.

In his capacity as a trustee of the Allan Gray retirement funds, Richard Carter takes stock of Allan Gray’s two-pot implementation and discusses some of the questions and issues trustees are considering in their bid to make sure members get the best results. Richard has been a trustee since May 2011 and is a member of the Allan Gray Retirement Annuity Fund and the Allan Gray Umbrella Pension Fund.

Allan Gray, as your retirement funds’ administrator, has written at length about the new two-pot retirement system, with most of the information accessible in the two-pot retirement system info hub on the website. As a reminder, going forward, contributions to your retirement fund, and growth thereon, will be divided into two components. The larger, two-thirds portion, is designed to provide you with an income in retirement, while one-third is designed to provide cash at retirement, or before retirement in cases of financial distress, when you have no other option.

Importantly, your existing retirement investment at 31 August is now housed in a “vested” component, less a small portion (10% of your retirement investment, to a maximum of R30 000), which was used to “seed” your savings component to get the system going and give you an opening balance to withdraw in case of emergencies.

Notwithstanding the significant amount of work Allan Gray undertook to adapt systems and processes ahead of go-live, as trustees, we were nervous. It was very difficult to predict the extent of the demand for withdrawals in the first few days, and whether the systems and teams would cope. While we were assured that Allan Gray itself was well prepared, we had no clear view of other providers and industry players critical to the smooth running of the process end to end, including the South African Revenue Service (SARS). Any upheaval in the industry would have a knock-on impact and affect members’ overall experience.

Reviewing the Allan Gray business’s operational performance since 1 September, the two-pot implementation has gone smoothly.

Over and above the practicalities around withdrawals, we were concerned and continue to worry about members taking out money that they don’t desperately need, undermining their long-term retirement savings goals. Looking forward, we wonder if people will keep taking whatever they can out of their savings component, and, if they do, if they plan to make up for these withdrawals with higher contribution rates.

We have many unanswered questions. Only time will reveal the answers.

Performance review

Reviewing the Allan Gray business’s operational performance since 1 September, the two-pot implementation has gone smoothly. The system itself and the various administrative teams have coped with the significant volume of calls, emails and transactions. Withdrawals have been actioned efficiently and online transactions have been mostly seamless.

In the first six weeks after the implementation of the two-pot system, just over 5% of Allan Gray retirement fund members requested a withdrawal – although this varied greatly by fund. The amounts requested totalled 1.6% of the assets in the five retirement funds. While this is a significant proportion of members and a meaningful amount of money, it appears to be lower than what we believe the average experience of pension funds in the market has been.

Looking at the largest fund, the Allan Gray Retirement Annuity, where no early access to funds was possible before the two-pot implementation, we are reasonably pleased that only 5% of members have accessed their funds, as this is lower than what we feared the number would be.

From a tax perspective, the average tax rate applied to these withdrawals was just over 25%. Of more concern were the penalties levied, with several members receiving no net withdrawal at all as the entire amount was taken by SARS to settle outstanding penalties. For more insight into two-pot withdrawals and tax, see Carla Rossouw’s piece.

Looking ahead

Helping members understand how to get the best outcomes is one aspect of the role of the trustees, as explained in the text box at the bottom of this article. While the implementation of two-pot was a once-off event, understanding the long-term implications is an ongoing activity. There have been three recurring themes in the questions coming through so far:

1. Should two-pot affect one’s investment strategy? Should members be more or less conservative in the investment portfolios they choose?

These questions are coming up in the context of whether one should invest one’s savings component more conservatively to create a safety net in case a withdrawal is needed. This overlaps with a common question about whether to take advantage of “life-staging” offered by some retirement funds.

Life-staging is a popular approach, whereby members reduce risk in their portfolios as they approach retirement – typically by switching from portfolios with higher equity allocations to more cautious portfolios. This is to protect against big drawdowns in the final years before retirement. This conservatism is amplified by a focus on the cash lump sum available at retirement – members de-risk to have more certainty about this cash lump sum.

There is no such thing as a free lunch in investing. In de-risking for potential pre-retirement withdrawals or to protect the cash amount at retirement, a reduction in risk may also mean a reduction in expected return. Over time, this can have a real cost in terms of lower income in retirement.

In a two-pot world, if members withdraw their full savings component ahead of retirement and need to use the remaining assets to buy a retirement income product, does this make life-staging less appropriate? Perhaps these members should remain more focused on long-term growth, while still protecting their capital, to give themselves an opportunity to build a long-term, sustainable income.

2. What should members do about their vested portion?

For many members, especially those who have been saving diligently for several years, keeping a lid on the vested component is even more important than not dipping into the savings component. As a reminder, the vested component is treated in the same way as the whole account was treated before 1 September 2024, except that no further contributions can be allocated to it.

… increasing your contributions could be a responsible way to make the new two-pot system work for you.

As an example, for a 55-year-old who has been saving in a retirement fund since they were 25 and intends to retire at 65, the vested component plus growth thereon could be expected to make up as much as 90% of the amount available at retirement. If this describes you, the most important thing you can do is to make sure that your vested component remains invested appropriately and resist the urge to take this money out (if your fund’s pre-1 September 2024 rules allow a once-off withdrawal).

3. Should members use their savings component as an emergency fund?

Common advice is to set up an emergency fund equivalent to three to six months of your salary to cope with unexpected expenditure or reduction in income. This could be invested in a low-risk unit trust, such as a money market or interest fund, which will preserve your capital over the short term and offer easy access when needed. An emergency fund should be prioritised ahead of other discretionary investments to avoid you having to rely on long-term investments for short-term needs (and potentially having to withdraw at inopportune moments).

Some members and their advisers have asked if it could make sense to use the savings component of their retirement fund for emergency fund purposes. The answer is, this could make sense – if you are willing to direct emergency fund contributions into your retirement fund, over and above what you are currently contributing to your retirement fund.

For example, if you were previously saving 12% of your salary for retirement, and that was enough, dipping into the one-third of your contributions that now go into a savings component for emergencies will leave you with a shortfall: To the extent that you use this one-third for emergencies, you will be eating into your retirement savings, and all else being equal, you will not have enough at retirement.

However, using the example above, if you want your retirement vehicle to double as an emergency fund, you could increase your pre-tax contribution to 18%. If you don’t need it for emergencies, or even if you use some of it, but not the full amount, it could enhance your retirement investment. Even if you end up needing all of it for a rainy day, you would not worsen your retirement outcome.

It is worth considering, though, that your retirement fund is managed according to specific investment limits as prescribed by regulations and may be subject to restrictions by your fund’s administrator (such as investment restrictions or withdrawal timelines); this would not apply to a separate emergency investment account.

As trustees, our focus is on making sure that the Allan Gray retirement funds continue to do a great job for members in an ever-changing environment.

But what about the tax? If you consider that you receive a tax break at your marginal tax rate when you invest the money, then when you take it out, you will pay tax at your marginal rate (your highest tax bracket). Provided your tax rate has not changed significantly between when you contributed and when you withdraw, you could still be better off than using after-tax money to build your emergency fund and paying tax on the investment return as you go.

It is important to check if you are currently contributing less than the allowed maximum to your retirement funds, in which case increasing your contributions could be a responsible way to make the new two-pot system work for you.

A member-focused approach

As trustees, our focus is on making sure that the Allan Gray retirement funds continue to do a great job for members in an ever-changing environment. While the new two-pot system is one of the biggest changes we have dealt with in my time as a trustee, I don’t think it will be the last. Whatever changes come along, the trustees will continue to oversee the funds with your best interests at heart.