As of September 1, 2024, South Africa’s retirement system has evolved with the addition of two new ‘pots.’ This change allows South Africans to access a portion of their retirement funds before they retire, without the need to resign from their jobs and withdraw all their savings, as was previously required.

However, proceed with caution! Tapping into your retirement savings can lead to significant tax implications, both immediately and in the long term. Our audit firm in the Western Cape is here to guide you and your employees through these tax consequences and help explore all available alternatives before making any decisions regarding withdrawals.

According to the National Treasury, “The two-pot system is designed to promote long-term retirement savings while also providing flexibility to assist fund members facing financial difficulties.”

With these two new pots, fund members can now access part of their savings before retirement while still preserving a portion for their future. However, this increased flexibility comes with important tax and financial considerations that should be thoroughly evaluated.

The Structure of the New Three-Pot Retirement System

Before September 1, 2024:

• The VESTED Pot: This pot contains all contributions made to retirement funds before the cut-off date, minus 10% (or up to R30,000) that is transferred to the new Savings pot as seed capital. Existing rules still apply to this pot.

After September 1, 2024:

• The SAVINGS Pot: Starting September 1, one-third of all contributions will be directed into this pot. The funds in the Savings pot can be accessed before retirement, with only one withdrawal permitted per tax year (minimum of R2,000, no maximum). These withdrawals are considered taxable income at your marginal rate.
• The RETIREMENT Pot: The remaining two-thirds of contributions will go into this pot. Funds in the Retirement pot cannot be accessed until retirement, with some exceptions (such as emigration, ceasing SA tax residency, or visa expiry for non-residents). At retirement, the funds in this pot must be used to purchase an annuity.

Tax and Financial Considerations

It is crucial to carefully consider the tax implications and other consequences of withdrawing funds from any of these pots. Early withdrawals before retirement age (typically 55) can be significantly more costly from a tax perspective because the Withdrawal Benefit Tax Table or the Individual’s Tax Table will apply.

Important Tax Points:

• Withdrawals up to R550,000 as a lump sum at retirement are tax-free. However, this R550,000 is a lifetime cumulative benefit, meaning pre-retirement withdrawals can diminish this tax advantage.
• Transfers from the Vested and Savings pots to the Retirement pot are tax-free.
• Employer contributions continue to be treated as taxable fringe benefits.
• Withdrawals from the Savings pot are treated as income and taxed according to a tax directive obtained by the fund manager from SARS. Any outstanding tax debt will be automatically deducted from the withdrawal.
• Pre-retirement withdrawals from the Savings pot, taxed at your marginal rate, could push you into a higher tax bracket, resulting in higher taxes on all your income for the year.

For instance, if you withdraw R80,000 from your Savings pot, your annual taxable income could increase from R300,000 to R380,000, shifting your marginal tax bracket from 26% to 31%. This could increase your annual tax liability by R21,275. By contrast, waiting until retirement to withdraw the same amount could result in no tax at all.

The Hidden Costs of Early Withdrawals

While contributions to your retirement fund are still tax-deductible (up to 27.5% of your annual income, with a maximum of R350,000 per tax year), the benefits of this deduction can be negated by the taxes on early withdrawals. Additionally, early withdrawals also lead to the loss of potential tax-free growth on your savings.

For example, if you choose not to withdraw R80,000 and instead allow it to grow at an average annual rate of 10% over 25 years, the potential returns could be R866,776. This means that by withdrawing R80,000 early, you could lose out on R121,958 in tax-free growth.

Expert Guidance is Available!

Understanding the tax and financial implications of early withdrawals from your retirement fund is essential for making well-informed decisions. Often, early withdrawals are more costly in terms of taxes and lost investment growth compared to other financial options, such as overdraft facilities, credit cards, or home loans.

If you or your employees are contemplating withdrawing funds from a retirement account, our tax specialists in our audit firm in the Western Cape are ready to assist. We specialize in financial services, including personalized SARS tips, to help you navigate these complex decisions with confidence.