The two-pot retirement system represents a significant change in retirement planning, providing financial advisers and their clients with a valuable opportunity for transformation. It is expected that replacement ratios will improve from the current dismal average of 25%-35% to around 50% or more.
In an ideal world, the prudent advice to members would be to preserve their savings pot to ensure a comfortable retirement. However, the reality is that low to middle-income households struggle financially, facing a constant juggling act with monthly expenses. It is estimated that a middle-income earner with a bond of R1.5 million, a car loan of R300,000 and a personal loan of R50,000 is now paying around R5,400 more per month on loan repayments compared to November 2021. This financial strain is compounded by unexpected expenses such as medical bills not covered by medical aid, or car breakdowns, leading to a downward spiral into debt.
Research conducted by Alexforbes, which included approximately 900,000 members revealed a total debt-to-income ratio (secured and unsecured) of 77%, highlighting the challenges households face. Continuing dire situations like these result in high stress levels, deteriorating health, depression, reduced productivity and absenteeism, directly impacting both the employer and our economy. It is estimated that the South African economy loses up to R33 billion annually due to absenteeism. Given these realities, expecting members not to access their savings pot is unrealistic. Instead, retirement funds and advisers should assist members in balancing the pros and cons based on their circumstances, aligning short and long-term goals. This was the overarching purpose of the newly created system.
Linking savings pot to specific goals
The question arises: how do we encourage members to view the savings pot as a means to an end, rather than easily accessible money? With the new retirement dispensation, financial advice will be vital to improve members’ short and long-term financial outcomes by linking savings pots to specific goals or ‘Thinking outside the Savings Pot.’
Based on Alexforbes’ calculations, we believe that the savings pot could, in some circumstances, be used to help members achieve short, medium, and long-term financial goals, such as paying off or reducing unsecured debt, saving for their child’s education, and accumulating adequate savings for a lump sum at retirement.
For example, let’s consider a 25-year-old member with an annual income of R350,000 and an unsecured debt ratio of 35% of annual income, with a debt interest rate of 18%. The member’s goals are to settle their unsecured debt as soon as possible and then save for their child’s tertiary education. To achieve this, they increased their contributions from 15% to 16% of salary.
- As shown, at retirement, the member still has sufficient savings in their pot to access as a lump sum if desired. Their total retirement benefit (retirement and savings pot) is estimated to achieve a replacement ratio of 70%, compared to 54% if they had accessed their savings pot annually.
- The impact of debt repayment: The additional disposable income available to the member in less than three years is R3,052, providing welcome relief and acting as a buffer against further unsecured debt. Depending on the situation, this solution can also be combined with debt counselling, which Alexforbes offers.
- As a financially constrained member, an education policy with a monthly premium of R1,200 is simply not affordable, whereas a 1% increase in monthly contributions to the fund (R292) would enable the member to afford tertiary education for the child. Although Alexforbes considers a tax-free savings account a better option, it is important not to lose sight of the fact that many members do not have disposable income to provide for additional savings to the extent required.
- Pension fund contributions of up to 27.5% of remuneration (maximum R350,000) are tax deductible. The member contributes an additional 1% to the fund (R292), but their take-home pay only reduces by R216 due to the favourable tax dispensation.
- Tax on amounts withdrawn from the savings pot: While members will be taxed at marginal rates on any withdrawals, calculations show that the impact does not differ substantially compared to after-tax money allocated to a tax-free savings account.
As illustrated above, by attaching specific goals to their savings pot, the member improved their short-term financial outcomes, planned for medium-term expenses, and continued to protect their replacement ratio. Compared to the expected replacement ratio of around 57% for a similar member who accessed their savings annually, goals-based savings requires consideration.
The pivotal role of an adviser
The scenarios presented are merely illustrations of how the savings pot can be used to improve a member’s short-term outcome. The challenges and goals for each member must be assessed individually, including the relevant tax and long-term implications, emphasising the crucial role of financial advisers or retirement counsellors.
With short term needs being better managed, the focus on long-term retirement planning will become more acceptable to members. While the above scenarios are feasible for younger members and those joining from 1 September 2024 onwards, members closer to retirement who did not preserve their benefits in the past requires a different discussion.
It is also important not to lose sight of the importance of making adequate contributions to not only achieve the required replacement ratio but also protect it when accessing the savings pot. Calculations show that with contribution levels below 12%, prudent advice would be to preserve or access only in genuine financial emergencies.
Regardless of the different scenarios, it is evident that the two-pot retirement system creates an opportunity to improve the lives of low to middle-income earners, with the financial advisory industry playing a fundamental role. In fact, the success of the two-pot retirement system depends on members receiving proper financial counselling and advice, not only at resignation or retirement but also on an ongoing basis. By walking the journey with members, providing guidance on improving their current financial situation, and building trust, advisers can offer long-term and other financial solutions as well.
