Two-pot system: Three questions to ask your financial advisor

Managing money effectively has never been more crucial, especially in light of the recent reforms to South Africa’s retirement savings framework. Despite the importance of financial planning, most South Africans find themselves unprepared for retirement. A 2022 survey by the National Treasury revealed that only 6% of South Africans are financially equipped to retire comfortably. This alarming statistic demonstrates the urgent need for effective financial strategies, particularly with the emergence of the new two-pot system.

Here are three main questions you need to ask your financial advisor:

1. Are there any tax implications or penalties for accessing funds from the savings pot before retirement?

With the implementation of the two-pot system on 01 September 2024, South Africans now have more flexibility in managing their retirement savings. One of the most significant features is the ability to access funds from the savings pot before retirement. However, it’s essential to understand the tax implications and potential penalties associated with early withdrawals. 

Withdrawals from the savings pot are subject to taxation, with the amount withdrawn added to your taxable income for the year, which could push you into a higher tax bracket. While there are no additional penalties beyond the applicable taxes, frequent or large withdrawals could significantly reduce the amount available for your retirement, impacting your long-term financial security.

2. What are the benefits and risks associated with the savings pot?

The savings pot within the two-pot system offers both advantages and potential drawbacks that must be carefully considered. The primary benefits include liquidity and flexibility. Immediate access to funds provides a financial safety net for emergencies, reducing the need to incur debt. Moreover, funds can be used for various purposes such as medical expenses, home repairs, or education costs, offering significant financial freedom. 

However, there are also risks. Frequent withdrawals from the savings pot can reduce the total amount available for retirement, potentially compromising your financial security in later years. Additionally, without disciplined financial planning, there is a risk of spending the funds on non-essential items, depleting savings meant for crucial needs. 

To mitigate these risks, consider setting clear goals for withdrawals, establishing a detailed budget that accounts for both immediate and long-term needs, and planning to use the savings pot in a strict manner, prioritising genuine emergencies or significant financial obligations.

3. What alternative savings options or emergency funds should I consider to avoid over-reliance on the savings pot?

To ensure the sustainability of your retirement savings, it’s important to explore alternative savings options and establish robust emergency funds. This approach can prevent over-reliance on the savings pot and help maintain your financial stability. Consider high-interest savings accounts, which offer higher returns than regular savings accounts while remaining accessible. 

Fixed deposits are another option, providing better returns over a set period and encouraging disciplined savings due to limited access. Additionally, investment accounts that allow for regular contributions to stocks, bonds, or mutual funds can offer long-term growth. Establishing a dedicated emergency fund with enough to cover 3-6 months of living expenses is also crucial. This fund should be easily accessible and used exclusively for urgent financial needs. Investing in comprehensive insurance policies, including health, home, and car insurance, can cover unexpected expenses without dipping into your savings.

Essentially, the two-pot system introduces significant changes to how South Africans manage their retirement savings. By understanding the tax implications, benefits, and risks of the savings pot, and exploring alternative savings options, you can make informed decisions that enhance your financial security. Engage with your financial advisor to develop a comprehensive strategy that aligns with your goals, ensuring a stable and prosperous future amidst these new reforms.

Written by  Jacques Erasmus, Senior Executive Manager at Assupol