The two-pot system: Long term tax implications for members

by Subedra Reddy, Thiroshen Naidoo and Aaryikh Rawthee | 29,May,2024 | NBC Holdings, Q2 2024, Special Feature

Herman van Papendorp

Everybody loves tax – not! Unfortunately, in South Africa taxation is unavoidable and very high. It is also very complicated. The two-pot system has introduced a new way to tax our retirement funds. Any withdrawal from your savings pots will be based on income tax tables at your marginal rate of tax. In this article I want to illustrate the impact that this change may have on retirement benefits. I will aim to show this using some illustrative Fund Credit projections. We will be looking at defined contribution funds. At the date of writing, the legislation promulgating the two-pot system is still not final. Please note that contents of this article are meant to provide some insight and understanding. It is not meant to be advice. If you want advice, then please speak to your fund consultant or financial planner. I also needed to make a number of assumptions in order to project the benefits and tax payable. For ease I have not mentioned those assumptions in this article. However, if you are one of the rare individuals the loves to discuss financial projections and assumptions then feel free to contact me.

Tax tables
If you withdraw from a retirement fund the following tax table is applicable:

I will refer to the above table as the withdrawal table.

Now, this table is quite complicated so let’s look at an example

Example 1
Mr Gumede has resigned from employment. His Fund Credit is R50 000.
His first R27 500 is taxed at 0%.
This leaves R50 000 – R27 500 = R22 500
The R22 500 falls into the second line of the table and so will be taxed at 18%.
18% of R22 500 = R4 050

So Mr Gumede pays tax of R4 050.
Thus the net amount he gets is R50 000 – R4 050 = R45 950

 

Under the two-pot system if you withdraw from your savings pots then you will be taxed based on income tax tables:

This is the same table that applies to the salary that you receive every month. I will refer to the above table as the income tax table.

Let’s also look at an example to see how this table will work under the two-pot system:

Example 2
Mr Gumede has had a heart attack. He needs to be admitted to hospital
He has decided to make a withdrawal from his savings pot to pay the hospital.
He has R50 000 in his savings pot. He will withdraw the entire R50 000.
Mr Gumede earns a salary of R300 000 p.a.
The R50 000 withdrawal from his savings pot gets added to his taxable salary.
His new taxable salary is now R300 000 + R50 000 = R350 000
This puts him in the third row of the income tax table.
The marginal rate applicable in the third row is 26%.
His R50 000 withdrawal will thus be taxed at 26%.
Tax paid is 26% of R50 000 = R13 000
So the net amount he gets is R50 000 – R13 000 = R37 000

So you can see that the tax payable is calculated very differently even for the same withdrawal amount of R50 000:
• Under the withdrawal table the tax is dependent only on the size of your withdrawal.
• Under the income tax table the tax is dependent on the size of your withdrawal and the size of your salary.

So, what does this mean? Under which table will you pay more tax? And will you only pay more tax under the two-pot system if you are a high earner?

In the rest of the article, I will give some insight into which table results in more tax being paid across the working lifetime of a member. In order to fully understand the impact of using the income tax tables we will have to look at members across a range of salaries.

Fund credit projections
Let’s look at the impact of the two-pot system on your tax. We will do this with some illustrative examples. We will look at this from the point of view of a new member. We will look each year at how much he has in his savings pot. We will assume he takes out everything from his savings pot each year. We will then look at how much tax he pays under the withdrawal table and how much he pays under the income tax table.

Name: Sipho Gumede
Age: 20
Starting Fund Credit: 0
Retirement Age: 60
Contribution rate: 12% (Net to retirement)

We will do some projections for Mr Gumede looking at a range of annual salaries:

  • R100 000 p.a.
  • R250 000 p.a.
  • R500 000 p.a.
  • R1 000 000 p.a.
  • R2 000 000 p.a.

 

Salary of R100 000 p.a

If Mr Gumede earns R100 000 p.a. then at the end of his first year of working he would have accumulated R4 000 in his savings pot.

Under the withdrawal table he pays R0 in tax as his benefit is below the tax free threshold of R27 500.

Under the income tax table he pays R720 in tax.

At the end of his second year of working he has R 4 280 in his savings pot.

Under the withdrawal table he pays R0 in tax as his benefit is still below the tax free threshold of R27 500.

Under the income tax table he pays R770 in tax.

 

I have done this for Mr Gumede for every year of his working life and calculated each year the difference between the tax paid under both sets of tables.

The following graph shows this:

 

 

 

The above graph shows the difference between the two tax tables for Mr Gumede for each year of his working life. The income tax table results in more tax being paid in every year.

Over his working lifetime Mr Gumede pays about 67% more tax under the income tax tables versus the withdrawal tables. If you were to accumulate this difference (with interest) until his retirement age this difference would amount to about R360 000.

 

Salary of R250 000 p.a.

The following graph does the same projection for Mr Gumede but with a salary of R250 000 p.a.

 

The above graph shows the difference between the two tax tables for Mr Gumede for each year of his working life. The income tax table results in more tax being paid in every year.

Over his working lifetime Mr Gumede pays about 72% more tax under the income tax tables versus the withdrawal tables. If you were to accumulate this difference (with interest) until his retirement age this difference would amount to about R1.3 million.

 

Other salaries

The following graph does the same projection for Mr Gumede but with a salary of 500 000 p.a.; R1 000 000 p.a.; and R2 000 000 p.a.:

 

The income tax table results in more tax being paid in every year under all the salaries used.

 

The following table shows the increase in tax under the income tax tables:

Conclusion

It can be seen that the change from the withdrawal tax table to the income tax table will result in a significantly higher amount of tax being paid by members.

Should National Treasury/SARS be charging such a high rate of tax on withdrawals under the two-pot system? One of the main reasons for allowing access to retirement fund savings during employment is that savings levels outside of retirement funds are extremely low.  Members thus need to take out debt at extremely high rates of interest. In order to prevent this, access to retirement funds has been allowed. But is it fair to members to pay such a high rate of tax for emergency withdrawals? In South Africa, where unemployment is so high and savings so low shouldn’t the tax system encourage savers as much as possible? At the very least shouldn’t the two-pot system come with a tax system that was the same as the previous system?

It is very important that members receive appropriate financial advice and understand the tax implications of making withdrawals under the two-pot system.

Subedra Reddy
Executive Head: Actuarial DC Funds at NBC Holdings | + posts
Thiroshen Naidoo
Actuarial Manager at NBC Holdings | + posts
Aaryikh Rawthee
NBC Holdings | + posts