Launched on September 1, South Africa's two-pot retirement system is designed to offer greater flexibility in managing retirement savings. It allows individuals to access a portion of their retirement funds before retirement through a “savings pot”, while a “retirement pot” remains inaccessible until retirement.
As of October 11, R21.4bn in withdrawals have been applied for through the system, reflecting considerable early engagement with this new access to savings. Withdrawals from the savings pot are subject to tax at the saver's marginal tax rate. This approach provides immediate access to savings but introduces a tax liability at the point of withdrawal, which differs from the traditional method of deferring taxation until retirement. While the system offers flexibility, it raises questions about the long-term impact on retirement savings and how tax policy may influence individual decisions.
Financial experts caution that this added flexibility comes with risks. While early access to funds offers a lifeline during financial emergencies, it can leave some individuals with insufficient funds later in life. Projections show that frequent withdrawals from the savings pot could reduce total lifetime retirement savings from nine times the saver's average annual salary to just two or three times.
There are concerns that the savings pot could jeopardise future financial security, particularly for lower-income earners. To address these challenges, strategic tax policy reforms might be made to further incentivise smart retirement decisions. We discuss several of these in a Southern Africa Towards Inclusive Economic Development (SA-TIED) programme working paper.
A challenge in South Africa’s retirement savings landscape is the disparity in tax benefits for different income levels. Currently, higher-income earners get more tax savings from tax deductions than lower-income earners due to their higher marginal tax rates. They also often contribute more to retirement savings to further increase the size of their deduction. This creates an unequal benefit distribution, with lower-income earners not receiving equivalent incentives from the current system.
This disparity means that the existing system of tax deductions disproportionately benefits higher earners. Introducing tax credits alongside the two-pot system could create a more equitable retirement savings structure. We found that reform options that replace deductions on retirement contributions with a tax credit system could reduce inequality in South Africa.
In the 2019/20 tax year, the average retirement contribution was R39,121, while top earners — with annual earnings above R1.5m — averaged R175,193. While minimum contributions to employer-provided retirement funds are often automatically deducted from payrolls, higher-income earners tend to make additional voluntary contributions. Because retirement contributions are tax-deductible, the current system provides a bigger incentive to high earners to save, which may entrench existing inequalities.
In contrast, a tax credit system for retirement contributions would provide the same rate of tax savings for all income levels. This means that the percentage of a saver’s retirement contribution returned as a tax credit will remain the same for all income levels. Those who contribute more will receive a larger tax credit, so the incentive to save is not skewed towards the top of the distribution.
Overall, a transition to tax credits would be a positive step towards a more equitable retirement savings system
We used the personal income tax microsimulation model (Pitmod) to estimate how such a reform would impact government revenues and inequality levels. Pitmod simulates tax policy reforms, allowing us to see how a transition to a tax credit system might impact outcomes for various income groups. We also compared different conversion rates, the rate at which contributions are converted to tax credits. For example, a 26% conversion rate means that 26% of the annual contribution is returned as a tax credit.
Our findings suggest that a 26% conversion rate is a viable option. This reform option would increase tax liability for the highest income groups while reducing it for lower earners, making the system more progressive.
In the 2019/20 tax year, the tax credit with a 26% rate would have also generated R22.7bn in additional tax revenue, a 4.2% increase compared to the current tax deduction. This additional revenue could fund, for example, a monthly increase of R518 to recipients of the old-age grant.
South Africa has a comprehensive social welfare system that provides grants to vulnerable groups, including the elderly. The old-age grant is a vital lifeline for millions of South Africans who rely on it for their basic needs. However, the government faces significant fiscal constraints, and there is growing concern that the current system may not be fiscally sustainable in the long term.
Overall, a transition to tax credits would be a positive step towards a more equitable retirement savings system. While the new two-pot system has its benefits, it also carries the risk of undermining long-term financial security. Our proposal attempts to mitigate these risks by encouraging long-term savings equally across income groups.
• Jansen is a professor in economics at Stellenbosch University, South Africa. Steyn retired from the South African Revenue Service, where she worked as an economist in the Macroeconomic Research Unit. Ngobeni is an economist in the Macroeconomic Research Unit at Sars
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.