Question

I recently saw a YouTube clip where a financial planner recommended using the two pot system to withdraw funds from retirement savings. This seems to fly in the face of all the advice I’ve received in the past. What are your views?

Answer

I had a look at the video.  The financial planner argues that the JSE has underperformed in dollar terms against foreign stock exchanges. Because retirement funds are constrained by regulation 28 which limits offshore exposure to 45%, the returns on your retirement savings would be a lot better if you were able to invest the funds elsewhere.

The example that she used is that of someone earning R370,000 a year and taking out R25,000 from the retirement funds.  This R25,000 will attract R7,725 in tax, giving you a net investable amount of R17,275.

The planner then says that you should be able to get a return of 15% a year on your investments.  If you achieve this on the R17,275, you will reach the R25,000 mark within 3 years and then after that you will be doing a lot better than you would have done in a retirement fund.

There are a couple of assumptions that need to be tested in this calculation:

Long term returns

A return of 15% a year does seem high for long term investments like retirement savings where you typically have a 30 year time frame.  If we assume an inflation rate of 5%, then a return of CPI +10% is ambitious.

CGT

The new investment will attract capital gains tax – based on current earnings, the client would pay CGT of 6.9% on the growth of this investment.  This number would increase as the client is likely to get salary increases over his or her working life and therefore be paying tax at a higher rate.

Growth within the retirement fund

The regulation 28 investment portfolio that I like to use for retirement savings delivered 10.8% over the past 3 years.  If you take the money out of your retirement funds, and you are indeed able to generate a 15% return, then you should deduct the return that you would have got in the retirement fund.  In this example, the additional return that you could get in the new investment would be 4.2%.

If we want to calculate how long it would take for the R17 275 to grow to R25,000, we will need to use an interest rate of 4.2% and not 15%. Using this number, it would take you 10 years to reach the R25 000 breakeven mark.  When we add in the impact of CGT, the break even period will be longer.

Regulation 28 certainly dampened returns in the past.  However, since 2023, the limit for offshore assets in a retirement fund was increased to 45%.  This is very much in line with the exposure that many of the non-retirement fund had. I have seen several presentations in the past where actuaries recommended having around 45% of your assets offshore to get the ideal mix of risk and return. 

In the light of the changes to regulation 28, a 4% difference in performance between retirement and non-retirement funds is unlikely. I suspect that the difference will be a lot less than that.  This means that the time needed to make up the loss of capital due to the tax of R7 275  that you paid will be even longer.  I calculated that it would take 19 years to break even if there was a 2% difference in performance.

I would certainly recommend that you think carefully before taking money out of your retirement savings.