How will the Two Pot System affect my pay-out at retrenchment?
By Brett Ladouce
The current economic environment is putting a lot of pressure on the cash flow of employers. The electricity crisis, the high inflation rate and the low economic growth rate are forcing companies to cut costs by reducing staff numbers through a retrenchment process.
When your contract of employment is terminated as part of a retrenchment process, you will no longer be able to be an active member of the fund in which your previous employer participates. You will no longer be able to make contributions to the fund or to receive life cover in terms of the fund rules.
Many people wrongfully see their retirement fund retrenchment benefit as “free money” that can be spent on lifestyle items. Unfortunately, there is no such thing as “free money”. The decision to spend your retirement fund money today on lifestyle items will negatively affect your financial position in the future. Before you fall into this trap, please think hard about what you want to do to replace the income stream that you have lost, get sound financial advice, and then decide what the best financial decision is for you to take in regard to your retirement savings.
As with almost all things in life, the taxman must be taken into account before you make a financial decision. The bad news is that your lump sum cash retrenchment benefit will be taxed. The good news is that it will be taxed on the lump sum retirement benefit tax scale and not on the lump sum withdrawal benefit tax scale. As a result, the first R550 000, and not only the first R27 500, of your retrenchment benefit will be tax-free.
Currently, you can take your full retrenchment withdrawal benefit from the fund in a lump sum cash benefit. As of 1 March 2024, you will be able to take the money in your savings pot and vested pot (if you have one) as a lump sum cash benefit but not the money in the retirement pot. As two-thirds of all new contributions will be paid to the retirement pot, the lump sum retrenchment benefit will be significantly less than the benefit that is currently available, as per the example below:
Example: Peter and Joan both worked at the same company for 10 years and accumulated R1 000 000 in their retirement fund before they were retrenched. Peter started to work at the company on 1 March 2014 until 28 February 2024 (before the implementation of the Two Pot System), and Joan started working at the company from 1 March 2024 and worked until 28 February 2034.
It is clear that Peter will have access to a significantly higher lump sum retrenchment benefit in the current system than Joan will have after the implementation of the Two Pot System. On the other hand, Joan will have a retirement nest egg of R666 667 to access when she retires in future, and Peter will have to start from scratch to accumulate enough money to retire comfortably, if he decides to take all his retirement savings in cash when he is retrenched.
Before deciding what to do with your retirement savings when you are retrenched, you should first determine what your future plans are:
- Will you immediately start working for a new employer and earn a salary without there being a period where you are without an income?
- Are you going to start your own business or upskill by studying or obtaining a new skill that can provide an income to you in future?
- Do you want to become debt free?
After setting your goals, the decision on what to do with your retirement savings becomes easier. It might make little sense to take all your retirement savings as a lump sum withdrawal benefit if you will start working for another employer immediately and you do not have high-interest loans that you want to pay off. When you start a position at a new employer immediately after being retrenched, it will, in most cases, be in your best interest to preserve your retirement savings by either transferring it to the retirement fund of your new employer or by transferring it to a preservation fund.
If you intend to start your own business or are to obtain a qualification or to acquire a new skill, for example, plumbing or programming, you will need money to set up your business, to pay for your qualification or vocational training programme and to sustain you and your family until the business or the new skill you have acquired can provide an income stream for you going forward. In these cases, a lump sum retrenchment benefit can provide the capital required to go in this new direction and to sustain your family until your new venture generates a sustainable income stream.
Only take the amount of money you will need for your short-term needs as a cash lump sum benefit when you are retrenched and, if possible, try to preserve the rest of your retirement savings for the day that you retire. Seek advice from a financial advisor and tax advisor who can help you to strike the right balance between making provision for your short-term needs after retrenchment and your long-term retirement provision.
* Ladouce is a pension funds lawyer and the author of Pension Funds for Palookas
PERSONAL FINANCE