Warning over ‘hidden’ two-pot tax pain in South Africa
South Africans who withdraw from the new two-pot retirement system risk pushing themselves into a higher tax bracket and being taxed at a higher rate, experts warn.
While a lot of noise has been made about the direct tax implications of making withdrawals from the system, Paul Menge, an actuarial specialist at Momentum Investo has warned of the ‘hidden’ tax implications.
From 1 September 2024, members of pension funds, provident funds, pension preservation funds, provident preservation funds, and retirement annuity funds have been able to access a portion of their retirement savings in the member’s retirement fund as a cash payment while still a member of that fund.
Under the new system, one-third of the member’s retirement fund contributions are allocated to a Savings Component (i.e., savings pot), which can be accessed once a year, while two-thirds are allocated to the Retirement Component (retirement pot), which cannot be accessed.
At the launch, 10% of the total value of the member’s interest as of 31 August 2024, capped at R30,000, was allocated to the savings component as seed capital and available for withdrawal.
This saw a huge amount of money being taken out of retirement savings (well over R4 billion) in a short few weeks.
While this provided many members with a much-needed cash injection to see them through hard times in the near term, it came with the caveat that SARS would take its slice.
Menge said that SARS itself has been very vocal about the tax implications of withdrawing from the system, with many funds characterising it as a penalty—a way to disincentivise members from taking out money they will better serve them in their later years.
“The reason for the penalty is that the government encourages us to save for our retirement by giving us tax rebates when we do. In a way they’re ‘taking back’ the rebate when we withdraw from the savings,” he said.
The size of the rebate—and penalty—is equal to the tax rate you normally pay on your salary or income at the time of the contribution or withdrawal.
“At the moment, your financial services company asks for a tax directive as soon as you request a two-pot withdrawal. SARS then tells them what percentage of the amount to pay over to them, and on top of that, to take off any money you owe SARS,” Menga said.
However, there is another tax surprise regarding two-pots that investors may be unaware of.
“This has to do with your income bracket. The tax rate we normally pay, the so-called marginal rate, is based on an income bracket or range. If your current income is close to the top level of the bracket, your investment income from your two-pot withdrawal can push you over that level into a higher tax bracket,” he said.
“You can also be pushed into a higher bracket if you get a salary increase at any time during the tax year. Or another windfall. Sometimes, it will be the combination of a two-pot withdrawal plus your increase that can push you to a higher bracket.”
The specialist noted that, when it’s time for a yearly tax assessment towards July, SARS will look at a taxpayer’s total yearly income, determine your tax bracket, and claim tax based on the full picture.
“The best is to realise that you may have to pay more tax on the amount in the higher bracket based on your “sins” for withdrawing from two-pot and receiving a higher income,” he said.
The concern regarding this is that if you didn’t pay the higher tax when the withdrawal was made, you will have to repay this when you submit your annual tax assessment.
“If you cannot afford it at the time and have to make another two-pot withdrawal to pay SARS, it perpetuates that you keep paying the emperor more than what you had anticipated,” he said.
Menge said that Investo has noted a trend where clients fill in “nil” when asked for their yearly taxable income when they do their two-pot withdrawal.
“The same principle may bite them when SARS does its yearly assessment. If you earn a taxable income, SARS will demand its pound of flesh comes assessment time. You are only postponing the pain or making it worse,” he said.
Momentum Investo provided an example for how this works:
“That’s why financial advisers will say it’s not worth it to withdraw. And, if you are in trouble and absolutely need to use your retirement savings, maybe the painful payment to SARS will encourage you to start building an emergency kitty.
“We know it’s tough out there, but debt, or borrowing from your future self, is not worth it. Drawing up a long-term financial plan, and sticking to it, beats wasting hard-earned money on paying tax that could have been avoided,” Menge said.+
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