During the recent Budget speech, the Minister of Finance confirmed the intended launch date of 1 March 2024 for the two-pot retirement system. With 12 months to go, it is important to understand the regulatory aspects and potential challenges.
One of the biggest issues we face is that the legislation still has not been finalised. The Budget review referred to forthcoming draft legislation and the issues that this will address. Without this draft legislation, there is considerable uncertainty regarding implementation.
We understand the broad strokes of the expected changes, but the devil is always in the detail: Administrators need to amend systems based on precise requirements, funds need to process rule amendments based on finalised legislation, and the FSCA needs to process all those amendments prior to implementation. Members and their advisers also need to receive clear and accurate communication about how the changes will affect them. None of this can be done until the uncertainty is resolved. The industry has repeatedly said that the expected length of time it will need to implement the changes once legislation is promulgated is 12 to 18 months.
It is not surprising that it is taking a while to get the legislation right – the reforms involve major changes to a system with serious issues that need to be addressed. The intention is that the new two-pot system will allow access to those who desperately need it, while at the same time improving the preservation of retirement savings. Offering partial access will, over time, see the amount of money in the system grow, and lead to better retirement outcomes for most savers.
Under the new system, it will be compulsory for all retirement funds to split contributions received between two notional portions – one-third will be allocated to a “savings portion” that will allow early access to funds, while the remaining two-thirds will be allocated to a “retirement portion”. At retirement, whatever is left in the savings portion will be available as a cash lump sum. The retirement portion will have to be used to purchase an annuity. Any money saved up before implementation of the new system will remain in a “vested portion”, subject to the treatment that currently applies, meaning it will have “vested rights”.
What is still to be finalised?
In the Budget review, the National Treasury set out four areas that require additional work following the extensive public consultation on the reforms.
One of the more contentious issues relates to “seeding”. Given that changes will only apply to contributions made from the implementation date, the vested portion will represent the biggest portion of retirement savings for many members for some time. Seeding would involve allowing members to transfer some of the funds that have accumulated in their vested portion (prior to the new system being implemented) to the new two-pot system, thereby allowing some immediate access to historic funds. While there could be merit in allowing this, if the seeding is too generous, the cost in terms of leakage from what has been saved to date could be material.
The next area relates to the legislative mechanisms to include defined benefit funds in an equitable manner. There seems to be agreement that defined benefit funds should be included in the new system, but that is easier said than done. Defined benefit funds work differently – it is not a simple matter to split contributions into two portions, given that the rights and benefits of members are not defined in terms of contributions, but rather in terms of a formula often based on factors such as salary and years of service. These benefits must be adjusted fairly whenever a withdrawal is paid out.
The third area is that of legacy retirement annuity funds. While these funds might not make up the lion’s share of retirement savings, there are technical challenges to incorporating them in the new system. Again, there is broad agreement that they should fall within the new system, but this needs to be done with care given that the product design and supporting systems do not easily lend themselves to the flexibility envisaged with the new savings portion.
The final area is the treatment of the retirement portion on retrenchment. One of the concerns that were raised during the public consultation process is that members who are retrenched with no alternative source of income, and who have depleted their savings, might need some access to the funds in their retirement portion. This is a contested area. The point of the savings portion is to provide some relief when members fall on hardship, and to pay out funds from the retirement portion before retirement will undermine the secondary aim of improving outcomes at retirement.
The first three of these areas will be addressed in the draft legislation that we are waiting for, while the last one will be deferred until the two-pot system is operational. It is important to remember that in the early years post implementation, the vast majority of savings (and hence benefits) will sit in the vested portion, all of which will be available on retrenchment in an occupational fund.
A full analysis of the regulatory aspects and challenges of the two-pot system can only be properly undertaken once the final legislative amendments have been published. There is still considerable uncertainty regarding what has to be implemented by the retirement funding industry at large and we eagerly await the revised draft legislation.
For more information, listen to our recent podcast on this subject.