Two-pot system: The role of financial advisers

South Africans have long faced challenges in meeting their everyday needs and are grasping at any opportunity for new sources of income. With high inflation, rising interest rates and slow economic growth, the cost of living continues to climb. If you add high debt levels, the disposable income has shrunk, leaving many with little to save, especially for retirement.

Our savings culture and low preservation rates have made it difficult for South Africans to retire comfortably. To tackle this issue, South Africa is reforming its retirement industry with the two-pot system.

What is the two-pot system?

Starting 1 September 2024, the two-pot system will transform how retirement funds are managed. All retirement fund members will have three retirement pots: a vested pot, a savings pot and a retirement pot. Contributions will be split, with one-third of contributions going into the savings pot and two-thirds to the retirement pot.

Here is a breakdown:

• Pot 1 (vested pot): that contains all your retirement savings prior to 1 September 2024,
• Pot 2 (savings pot): accessible once per tax year; and
• Pot 3 (a retirement pot): not accessible (even when resigning) and has to be preserved until retirement.

Why financial advisers are critical

The introduction of the two-pot system brings new opportunities, but also complexities. Financial advisers play a role in ensuring that members are not making irrational choices with their retirement savings. Here are key areas where advisers can make a difference:

1.Understanding long term effects

How will the change to the two-pot system may affect your clients’ financial decision-making? Are members maximising the benefits of the new system without jeopardising their retirement savings?

Advisers need to explain the short-term and long-term implications of the two-pot system with their clients. Advisers should remind their clients of the reasons for investing in a retirement fund: it is a tax-effective way to guarantee sufficient capital for income at retirement. This is important to ensure clients do not jeopardise their long-term savings, especially with the savings withdrawal option.

Just because there is an option to withdraw from their retirement savings, doesn’t mean that people should. There are tax implications associated with the withdrawals, therefore each withdrawal comes with an opportunity cost. Because of compounding rates, fund members should aim to preserve their retirement savings and limit withdrawals to maximise their savings at retirement.

2. Providing tailored advice 

Each client has unique financial needs and circumstances. Advisers should leverage their understanding of their clients’ emotional approach and offer personalised advice. By doing so, they can ensure clients manage their retirement savings more effectively, maintain healthy net replacement ratios and secure a stable future income.

3. Educating members 

For the two-pot system to be truly beneficial, members need to understand it fully. The role of an adviser is pivotal to educate members to help them better understand their options and guide them to their long-term goals while maximising tax benefits. A well-informed client is more likely to make sound decisions aligned to their retirement objectives.

4. Highlighting the importance of compound interest 

Regarded as the eighth wonder of the world, compound interest ensures your interest is earning interest. The longer retirement savings remain untouched, the more interest it accrues and the larger the amount grows. The importance of compound interest needs to be emphasised to clients to ensure they are not missing its benefits by withdrawing early.

The path forward

Financial advisers have a significant role to play in the successful implementation of the two-pot system. By providing clear, understandable advice, they can simplify and ease the transition to the two-pot system for clients. The role of advisers in the process, is not just to manage funds, but to empower South Africans on their way forward in their retirement journey.