Advisers warn of tax risks of early withdrawals under new two-pot retirement system

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Van Zyl stresses the need for advisers to inform customers that accessing funds from the savings pot before retirement can inflate taxable income, leading to higher tax liabilities and potentially jeopardising financial stability in their retirement years.

“Any amount withdrawn annually is added to taxable income for that respective tax year, potentially increasing tax liability significantly, especially if they are in a high-income bracket. If you contribute to a retirement annuity to benefit from a tax-deductible contribution, the full portion taken then from the savings pot is 100% taxable upon withdrawal, negating the initial benefit,” van Zyl says.

This immediate tax burden can erode the funds available for short-term needs, making early withdrawals less cost-effective compared to other liquidity options. “It’s also important to highlight to customers that money withdrawn from the retirement savings pot is no longer invested, which reduces the compounding growth potential of their retirement savings,” says van Zyl.

“Frequent or substantial withdrawals from the savings pot mean that less money is left in the retirement fund to grow over time, diminishing the total amount accumulated by the time they retire.”

Here are five essential tips from van Zyl to help financial advisers navigate these complexities:

• Educate customers on the new two-pot retirement system: Under this system, retirement contributions are divided into two pots: the savings pot, which can be accessed before retirement, and retirement pot, only accessible upon retirement.

  Advisers need to explain the structure and emphasise the purpose of the two-pot retirement system to customers. Clear communication and education about how the system works and its implications will help customers make informed decisions and avoid potential financial pitfalls.

  The savings pot should not be regarded as an annual bonus pot or an emergency fund – it should only be considered for access in case of an exceptionally dire financial emergency.

  Where customers belonged to a retirement fund before 1 September 2024 technically there will be three pots, one would be the vested pot, which is contributions and growth up to end of August 2024, in addition to the two new pots mentioned above. Another important change is the new de minimis amount which is set to be R 165,000 vs the current amount of R247,500.

• Encourage emergency savings: Advisers must encourage customers to establish separate emergency-savings options to avoid the need to tap into the savings pot prematurely.

  “It’s crucial to have liquidity available for immediate expenses without dipping into retirement funds,” he advises. “By setting aside money in a separate account, customers can ensure they can access funds when needed, reducing the risk of incurring unnecessary tax liabilities.”

• Promote long-term planning: Van Zyl says the benefits of long-term planning cannot be overstated.

  “The money in a retirement fund grows with compounding interest and is tax-free within the fund,” van Zyl explains. Advisers should emphasise the advantages of maintaining contributions in the retirement fund to benefit from these compounding returns and avoid the tax penalties associated with early withdrawals. This approach helps customers maximise their retirement savings over time.

• Simulate tax scenarios: Using tax-simulation tools can be an effective way for advisers to help customers understand the potential tax impact of withdrawals from the savings pot.

  “We have various tools to do simulations for customers, which can help them make informed decisions,” van Zyl notes. "These simulations can provide a clear picture of the tax implications in the short term and at retirement, enabling customers to make better-informed financial decisions."

• Consider alternative liquidity options: "Advisers should suggest alternative liquidity options, such as discretionary investments, policy loans, overdraft facilities, credit cards, or home loans, instead of withdrawing from the savings pot. “It could be better to use other liquidity options to avoid increasing your tax liability,” van Zyl advises.

  These alternatives can provide necessary funds without immediate tax consequences, preserving retirement savings. However, he cautions that while using debt responsibly is useful, the Covid-19 pandemic showed how quickly credit can be revoked, highlighting the risk of overreliance on credit.

"Thorough preparation and informed decision-making are key to maximising the benefits of the two-pot retirement system and ensuring long-term financial wellbeing while minimising tax liabilities,” he concludes.