Making early withdrawals from your retirement savings can have significant long-term consequences, potentially reducing the future value of your retirement by up to six times the amount withdrawn.
This was explained by product development actuary at Coronation’s Rael Bloom, who said that it is vital to limit early withdrawals.
Under the new two-pot retirement system, two-thirds of contributions go into a retirement component that cannot be accessed until retirement, while one-third goes into a savings component.
This savings portion allows for one withdrawal per year (of at least R2,000) before retirement if needed.
“After years of regulatory reforms, this change has finally brought compulsory preservation over the line – an essential step toward improving retirement outcomes for millions of South Africans,” Bloom said.
“In addition to compulsory preservation, the two-pot system also allows members to access a portion of their savings for emergencies.”
Since the system’s implementation, early withdrawals have been higher than expected, Bloom noted.
“Within the first 10 days of the system going live in September, SARS received nearly 160,000 tax directive applications for savings pot withdrawals, amounting to R4.1 billion.”
“The country’s largest administrator processed more claims in the first week than in the prior six months combined.”
Recently, the South African Revenue Service (SARS) said that it has received 1.2 million tax-directive applications for withdrawals, of which 1.1 million were approved.
Since the floodgates opened on the 1st of September, pension funds have paid out R21.4 billion.
However, Bloom said that this initial boom is expected to subside in the near future.
“We anticipate that once the dust settles, the two-pot system should function as intended – offering members the flexibility to access a portion of their savings in an emergency while preserving the majority of their savings until retirement.”
“The real value of the system – and the financial security it can provide – depends on how well members understand the long-term consequences of early withdrawals,” Bloom said.
Having the option to make early withdrawals can be incredibly useful for members who may need the money in an emergency, doing so also comes with extreme losses in the long term.
“While the two-pot system offers flexibility for accessing funds during emergencies, early withdrawals come with significant long-term financial consequences that could drastically reduce a member’s standard of living in retirement.”
“The immediate consequence is that withdrawals from the savings pot are taxed at the member’s marginal tax rate, meaning a portion of each withdrawal is lost to taxation.”
“Members who wait until retirement to withdraw benefit from preferential lump sum tax tables. By withdrawing early, they effectively forfeit this valuable tax advantage.”
The losses do not stop at tax benefits, though, Bloom explained.
“More importantly, members disrupt the powerful effects of long-term compounding when they withdraw early. Compounding enables retirement savings to grow exponentially over time, as returns generate further returns.”
For example, he said that “for every R1 withdrawn from a retirement fund 30 years before retirement, the future value of a member’s savings is reduced by around R6 in real terms, due to the opportunity cost of foregoing compounded growth.”
“Even over shorter periods, the impact is still significant – withdrawals made just 10 years before retirement could result in an opportunity cost of R2 (in real terms) for every R1 withdrawn.”
This means that members who make early withdrawals will have a much lower standard of living once they retire than they would have had.
“This serves as a powerful reminder that early withdrawals not only deplete the current balance but can ultimately jeopardise long-term financial security.”
Bloom added that Coronation urges members to stay invested where possible to experience the immense value of long-term compounding.
“For example, our flagship multi-asset Global Houseview strategy has delivered real returns of 9.2% per annum since its inception in 1993.”
“To put this into perspective, R100 000 invested at the strategy’s launch in October 1993 would have grown to R7,6 million today. This showcases the significant growth potential of staying invested.”
While making an early withdrawal does have significant downsides, the two-pot system offers a range of benefits. Not only is this system more flexible, but it is also expected to increase the interactions between retirement providers and their members.
“This shift presents a unique opportunity for the retirement industry to engage with members more meaningfully than ever before,” Bloom said.
“Historically, member interactions with their retirement funds were infrequent, often limited to major life events like job changes or nearing retirement.”
“Now, with more regular transactional touchpoints, funds have the opportunity to continuously educate members on the hidden costs of early withdrawals and the significant benefits of staying invested for the long term.”
Overall, this system has the potential to significantly boost retirement outcomes if members avoid the trap of taking out their savings.
“The message is clear: stay invested, where possible, and let your savings grow for a more secure retirement.”
