Two-pot retirement system — Be careful before making withdrawals from your funds

Question: I recently saw a YouTube clip in which a financial planner recommended using the two-pot system to withdraw funds from retirement savings. This seems to fly in the face of all the advice I’ve re­ceived in the past. What are your views?

Answer: I had a look at the video. The financial planner argues that the JSE has underperformed in dollar terms against foreign stock exchanges. Because retirement funds are constrained by regulation 28, which limits offshore exposure to 45%, the returns on your savings would be a lot better if you were able to invest the funds elsewhere.

The example that she uses is that of someone earning R370,000 a year and taking out R25,000 from the retirement funds. This R25,000 will attract R7,725 in tax, giving you a net investable amount of R17,275.

She says you should be able to get a return of 15% a year on your investments. If you achieve this on the R17,275, you will reach the R25,000 mark within three years and after that you will be doing a lot better than you would have done in a retirement fund.

There are a couple of assumptions that need to be tested in this calculation:

Long-term returns

A return of 15% a year does seem high for long-term investments such as retirement savings, where you typically have a 30-year timeframe. If we assume an inflation rate of 5%, then a return of CPI +10% is ambitious.

Capital gains tax

The new investment will attract capital gains tax (CGT) – based on current earnings, the client would pay CGT of 6.9% on the growth of this investment. This number would increase, as the client is likely to get salary increases over his or her working life and will therefore pay tax at a higher rate.

Growth within the retirement fund

The regulation 28 investment portfolio that I like to use for retirement savings delivered 10.8% over the past three years. If you take the money out of your retirement funds, and you are indeed able to generate a 15% return, then you should deduct the return that you would have got in the retirement fund.

In this example, the additional return you could get in the new investment would be 4.2%. If we want to calculate how long it would take for the R17,275 to grow to R25,000, we will need to use an interest rate of 4.2% and not 15%. Using this number, it would take you 10 years to reach the R25,000 break­-even mark. When we add in the impact of CGT, the break-even period will be longer.

Regulation 28 dampened returns in the past, but in 2023, the limit for offshore assets in a retirement fund was increased to 45%. This is very much in line with the exposure that many of the non-retirement funds had. I have seen several presentations in the past where actuaries recommended having around 45% of your assets offshore to get the ideal mix of risk and return.

In light of the changes to regulation 28, a 4% difference in performance between retirement and non-retirement funds is unlikely. I suspect it will be a lot less than that. This means the time needed to make up the loss of capital through the tax of R7,275 that you paid will be even longer. I calculated it would take 19 years to break even if there was a 2% difference in performance.

I would certainly recommend that you think carefully before taking money out of your retirement savings. DM

Kenny Meiring is an independent financial adviser. Contact him on 082 856 0348 or at financialwellnesscoach.co.za. Send your questions to [email protected].

This story first appeared in our weekly Daily Maverick 168 newspaper, which is available countrywide for R35.

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