National Treasury recently published two papers on retirement reforms for public comment, the first proposes a “two-pot” system to improve accessibility and preservation of retirement savings, and the second to improve governance of umbrella funds
First paper: Encouraging South Africans to save more for retirement
The first paper raises potentially more contentious proposals than the second.
National Treasury (Treasury) recognized that retirement fund members may need to access their savings before retirement, especially due to the economic hardship from Covid-19. However, this relaxation must be balanced with the need to ensure individuals have made sufficient provision for their retirement.
Treasury proposes a "two-pot" system to provide for preservation and flexibility: (i) a retirement pot of which two-thirds of future contributions must be preserved until retirement; and (ii) an accessible pot of which one-third of future contributions can be accessed because of financial hardship without first having to resign from existing employment. Treasury also proposes that the two-pot system should apply to retirement annuity funds and defined benefit funds.
Treasury's main objectives with the "two-pot" system are: (i), to encourage savings through regular contributions to a retirement fund; (ii), to preserve retirement funds as much as possible for retirement; and (iii), to allow partial access to retirement funds during periods of financial distress. The protection of members with vested rights on amounts held in funds at the implementation date is still under consideration.
Under the proposals, the accessible pot would permit a withdrawal at any time, but at most, one withdrawal per year of a minimum of, e.g. ZAR 2 000, without members having to consider resigning. Accessing members would pay the withdrawal costs to prevent non-accessing members from subsidizing their costs, and they would be required to update their details with the fund. They may also be required to undergo retirement benefit or financial awareness counselling.
We explain the two-pot system using a simple example.
Person A is employed and has ZAR 1 000 000 in a provident fund when the two-pot system is implemented (implementation date). From the implementation date onwards, one-third of A's contributions are deposited into the accessible pot and two-thirds into the retirement pot. After some time, there is ZAR 100 000 in the accessible pot; ZAR 200 000 in the retirement pot; and ZAR 1 000 000 plus growth in the vested rights pot. Person A faces financial hardship and is able withdraw the ZAR 100 000 from the accessible pot either as a lump sum withdrawal or partial withdrawal.
If Person A resigns to join a new employer:
- amounts in the accessible pot and the retirement pot would be transferred to a preservation fund or the retirement fund of their new employer – the accessible pot would still be accessible. Person A would be unable to withdraw the retirement pot, which must be preserved until retirement;
- vested rights on implementation date - either (i) transfer the full ZAR 1 000 000 plus growth to a provident preservation fund on a tax neutral basis; or (ii) withdraw the full ZAR 1 000 000 plus growth, which would be subject to tax.
At retirement, Person A may withdraw the remaining accessible pot in cash, but they must purchase an annuity with amounts in the retirement pot. Vested rights can be withdrawn as a lump sum or used to purchase an annuity, depending on the nature of these rights on implementation date.
The main tax question to consider is whether the current treatment of allowing deductions for retirement contributions should apply to both pots. There are also wider policy considerations about the equity and efficacy of the deductions. Treasury has recognized that there could be opportunities for tax arbitrage if the two-pot system is implemented using the current tax rules. Lower income earners could also be penalized relative to higher earners through a higher effective tax rate on withdrawals.
The paper also proposes to implement auto-enrolment or mandatory retirement saving for all employed and self-employed persons, and to consolidate the many funds into a few bigger funds.
Treasury proposes to implement the two-pot system in 2023.
Second paper: Governance of Umbrella Funds
The second paper was prompted by Treasury’s concern that some umbrella retirement funds have poor governance. Umbrella funds serve multiple employers, and include bargaining council or sectoral funds. Governance challenges include a lack of employee representation on the board, over-dependence of board members on product and service providers for advice, and conflicts between loyalties to members and to those who elected or appointed the board members.
The Financial Services Conduct Authority (FSCA) is already taking steps to improve governance of funds exempted from compliance with section 7A(1) of the Pension Funds Act.
Treasury further recommends that, among others, umbrella funds should be subject to specific governance provisions and that there should be standardized information on charges to facilitate comparisons between funds and promote effective competition.
Treasury proposes a consultation process through which the industry is invited to consider measures to improve the governance of umbrella funds on various issues.
Impact of proposals
The proposals in these two papers will affect all retirement funds, employers, sponsors to umbrella funds, members and service providers. The Webber Wentzel Tax and Retirement Funds Team will be closely monitoring developments on these topics.