The two-pot system: Borrowing today, paying in retirement

South Africa’s recently introduced two-pot retirement system has ushered in a new era of financial flexibility, allowing individuals to access a portion of their retirement savings earlier than before. While many facing immediate financial challenges have rejoiced at the possible reprieve, the two-pot system also introduces a set of risks that could jeopardise their long-term financial wellbeing. To mitigate these risks, it is becoming critical to discuss the implications of this system.

Is tapping into your retirement savings to settle today’s debts worth risking your financial future? While the two-pot system offers immediate relief, some may argue that it could be driving consumers towards a cycle of credit dependency that would leave them unprepared for retirement, writes Lerato Thwane, Head of E-Commerce at XDS, a business unit of Mettus. 

Understanding the two-pot system: A double-edged sword

Signed into law under the Revenue Laws Amendment Bill by President Cyril Ramaphosa on 1 September this year, the two-pot system introduces a new structure for retirement savings. It divides contributions into an accessible pot, which can be withdrawn before retirement to cover debts, emergencies, or unforeseen expenses, and a preserved pot, which remains locked until actual retirement to ensure there are funds available for the future.

While this approach provides flexibility, it also opens the door to potential long-term consequences. For individuals struggling with short-term financial difficulties, the accessible pot may seem like an attractive solution. However, using these funds for immediate relief can lead to the depletion of resources that will be needed to maintain a comfortable lifestyle in retirement. This balancing act requires careful planning and foresight.

Balancing short-term relief with long-term consequences with the two-pot system

The ability to tap into retirement savings offers practical benefits, such as avoiding high-interest debt and maintaining good credit profiles. In some cases, it can even help people escape a financial emergency. However, making early withdrawals can unintentionally set a precedent for future financial decisions, potentially leading to increased reliance on credit.

For example, someone who withdraws from their accessible pot to pay off credit card debt may find themselves relying on loans again when new expenses arise. This cycle can result in a continual diminishing of savings as retirement approaches, with fewer and fewer funds available to support living costs or unforeseen healthcare needs. As life expectancy increases and healthcare costs rise, ensuring that retirement savings are sufficient to last through one’s golden years becomes increasingly challenging.

A real-world example

Consider a professional in their mid-40s who decides to withdraw a portion of their accessible pot to settle outstanding medical bills. Although this action provides relief and resolves the immediate debt, it also reduces the total retirement savings available to generate growth over the next 20 years. 

When retirement age arrives, the individual may find that the nest egg they had counted on is much smaller, leading them to seek part-time work or rely on family for financial support. What started as a one-time withdrawal ended up impacting long-term stability.

Suggestions for responsible retirement management

Navigating the two-pot system requires a delicate balance. Here are some key considerations for effectively managing retirement savings under this new structure:

1. Limit withdrawals: Treat early withdrawals as a last resort. Before dipping into the accessible pot, exhaust all other options, for example, make budgeting adjustments, take up a side income, or renegotiate debt terms.
2. Understand the impact: Calculate how a withdrawal will affect the growth of your savings. Early withdrawals not only reduce the amount saved but also the potential compound interest earned over time.
3. Stay informed about credit: Avoid relying on credit to fill gaps created by accessing retirement funds. Instead, focus on building a sustainable financial plan that minimises debt.
4. Plan for long-term expenses: Ensure that even after making a withdrawal, there are sufficient funds in the preserved pot to cover anticipated retirement costs. Consider medical expenses, housing, and lifestyle needs.

Balancing immediate needs with future stability

While there is no denying that the two-pot system offers a practical way to address short-term financial challenges, it is not without its risks, including paving the way for deeper financial difficulties in the future if not managed wisely. Making the most of this flexibility demands a thoughtful approach that prioritises long-term financial wellbeing.

Ultimately, retirement planning should go beyond merely accumulating savings, and requires a comprehensive strategy that includes budgeting, debt management, and disciplined financial habits. In the pursuit of financial security, a cautious and informed approach to managing retirement savings is essential to avoid the pitfalls of borrowing today and paying tomorrow.