By Sanan Pillay
South Africa's innovative two-pot system, blending immediate access with long-term retirement savings, is inspired by global best practices. There’s comfort in knowing we’re not the first; we’re following a long tradition of similar systems, taking poignant learnings from each.
Here are some of the key lessons taken for two-pot from countries worldwide:
Learnings on early access from Chile
In response to the pandemic, Chile introduced multiple one-off withdrawal windows, allowing individuals to access up to 10% of their retirement savings in each window. Those with smaller balances could withdraw even more. This approach led to 66% of eligible people making withdrawals during each window, with a third of them depleting their accounts entirely due to the higher limits for smaller balances.
The funds withdrawn were primarily used for consumption, emergency expenses, and repaying debts. The forced sale of assets to meet withdrawal demands had several market repercussions:
Increased asset supply: The substantial withdrawals led to a flood of assets being sold, causing a significant drop in asset values across the board.
Rising interest rates: The reduction in available capital for purchasing government bonds resulted in higher yields, as the government had to offer better rates to attract buyers.
Steeper yield curve: The forced selling of bonds pushed yields higher, especially for longer-term bonds, creating a steeper yield curve and reflecting increased future borrowing costs and reduced investor confidence.
Reduced liquidity: The sudden influx of assets for sale, coupled with fewer buyers, decreased market liquidity. Sellers had to accept lower prices due to the reduced depth of the market.
Central bank intervention: To stabilise the market, the Central Bank of Chile intervened by purchasing bonds, aiming to lower interest rates and manage the bond market volatility.
Currency depreciation: The decreased local funding capacity, due to the shrinking of the savings pool, led to a depreciation of the Chilean peso as investor confidence waned.
Inflationary pressure: Increased consumer spending from the withdrawals contributed to higher inflation rates as demand surged.
Credit rating downgrade: The reduction in pension fund assets impacted the government's ability to manage its finances, resulting in a credit rating downgrade.
The experience in Chile highlights several critical issues. The repeated withdrawal windows created a sense of urgency among individuals, leading many to withdraw as much as possible out of fear that future opportunities might be limited. This was exacerbated by the economic crisis, which increased the demand for accessible funds. Consequently, members would need to contribute for an additional five to six years to restore their retirement savings to pre-withdrawal levels.
Learnings for South Africa: South Africa has learned from Chile's experience and has implemented a more structured approach. The two-pot system is designed to prevent the problems associated with repeated large outflows by limiting withdrawals to once per year and focusing on a deeper, long-term solution. This system also seeks to balance mandatory contributions with the flexibility of early access, addressing current issues with resignation-based withdrawals. Research within Sanlam has suggested that almost half of people who resign, choose to cash out their assets instead of preserving them.
Effective member counselling and financial advice will be crucial in helping individuals make informed decisions and in avoiding the negative outcomes seen in Chile.
Dual-accounts: The US, UK and NZ
In the US, early access provisions in their 401(k) system (workplace retirement plans) result in an estimated 40 cents flowing out for every dollar being contributed into the system. Despite this significant outflow, the availability of early access is considered beneficial compared to a scenario with no access, where fewer people might participate in retirement savings. Additionally, allowing early access may prevent individuals from resorting to high-interest debt, offering a potentially less destructive financial alternative.
Several countries, including the US, UK, and New Zealand, have either considered or piloted ‘dual-account’ fund structures akin to South Africa’s new system. These structures divide funds into two types of accounts: a liquid savings account and a less liquid retirement account. The rationale behind this approach is to ensure that retirement funds can maintain investments in less liquid assets, which often offer higher returns but are harder to sell quickly.
Learnings for South Africa: By having a separate, more liquid savings account, the system can manage regular withdrawals without forcing the entire portfolio into more li, potentially lower-return investments. This separation helps preserve overall portfolio performance and aligns to provide both immediate access to funds and long-term retirement savings.
Singapore and Malaysia
In Singapore and Malaysia, provident funds include separate sub-accounts ringfenced for specific needs like housing and medical expenses. These countries have struggled with the issue of people not saving enough for retirement, highlighting the difficulty of balancing immediate access with long-term savings. Singapore’s approach essentially forces people to save, which may be similar to the effect South Africa’s National Treasury is aiming for.
Learnings for South Africa: Allowing early access to retirement funds can reduce the amount saved for retirement, and there's no perfect solution for ensuring adequate savings. However, permitting early withdrawals might encourage more people to join and stay in retirement savings schemes they might otherwise avoid. The aim is to manage the negative effects of early access while still promoting overall savings.
Essential trade-off: poverty now vs. poverty later
The core trade-off in implementing early access to retirement funds involves balancing immediate financial relief against long-term retirement security. This trade-off is particularly significant in South Africa, where the need for emergency liquidity can conflict to ensure adequate retirement savings. The effectiveness of early access provisions largely depends on a country’s overall social support and safety-net environment.
Countries with robust social security systems for the elderly can afford more liberal early access rules, as these systems provide a safety net for retirees. Conversely, in regions like many African countries, where formal financial systems are less prevalent, early access to retirement funds can offer crucial emergency liquidity. Thus, the design of early access systems must be carefully aligned with the broader financial and social security context of the country. South Africa’s National Treasury appears to have taken these factors into account in its approach to balancing immediate needs with long-term savings goals.
Other key learnings:
Initial challenges and long-term benefits: The first year of implementing a dual-pot system might be challenging, but it's expected to yield long-term benefits by encouraging more people to opt into and remain in the retirement system and increasing overall assets in the industry.
Impact of early withdrawals: Early access to retirement savings is common in developed markets. It is crucial to manage early withdrawals carefully to avoid negative impacts on long-term retirement outcomes.
The worry of withdrawals at inopportune times: South Africa is in high inflation, a high-interest cycle that has many people feeling financially stretched. Withdrawals at inopportune times in the market can have a negative, long-term impact on people’s savings as they struggle to make up their losses and later, may not be able to retire with comfort. As ever, there’s a major opportunity cost to consider when making any withdrawal, which can compromise people’s retirement later. Time in the market is critical for compounding returns.
Positively, South Africa seems to be taking a measured approach, aligned with some of the best-run countries in the world. No one knows for sure how the two-pot retirement system will play out, but the structured system in place should go some way to mitigating major market risks.
* Source: Early access to pension savings: International experience and lessons learnt. World Bank. 2019.
** Pillay is a portfolio manager at Sanlam Investments Multi-Manager.
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