By: Henri Le Grange, Old Mutual Personal Finance Certified Financial Planner®

South Africa's move to implement the Two-Pot Retirement System in September 2024 places financial advisers at the forefront of significant regulatory changes. Amid a backdrop of escalating debt challenges and a rising cost of living, the reform promises to balance short-term financial relief with long-term financial security.

Last week, "Responsible Debt Management Week" highlighted the importance of this balance, underscoring the critical role of financial advice. This is according to Henri Le Grange, Old Mutual Personal Finance Certified Financial Planner®, who emphasises the system's potential but urges caution. "Leveraging retirement savings for debt repayment, especially against high-interest liabilities, requires very careful deliberation of its future impact," he says.

The Two-Pot Retirement System divides retirement savings into ‘two pots’, allocating funds into a readily accessible savings pot for pre-retirement emergencies and a locked retirement pot for post-retirement income.

Le Grange cautions against the opportunity cost of tapping into retirement savings to pay off debt. A study in Chile using Monte Carlo simulations shows that a 10% early withdrawal from your pension fund can lead to a loss of 1.59 dollars in future retirement savings for every 1 dollar withdrawn, reducing monthly pension benefits by 7.26%.

“The allure of tapping into retirement funds to alleviate debt should be a measure of last resort,” he argues. “Advisers must help customers weigh the costs, including potential taxes and fees, against the benefits of clearing debt,” he advises.

Le Grange rather champions an advisory-driven approach to debt management, suggesting that personalised, comprehensive financial strategies are essential. "Financial planning should not be a one-size-fits-all affair. It's about encompassing the entire financial picture of an individual," says Le Grange.

“Advisers should only recommend using retirement savings to pay off debt in cases of really no alternatives, severe financial hardship, life-threatening medical emergencies, or during periods of unemployment.” He advises exploring alternative debt management strategies such as consolidation, home equity leveraging, and budget optimisation before dipping into retirement savings.

Le Grange offers financial advisers six practical ways to help customers manage debt in the context of the Two-Pot Retirement System:

1.      Explaining the Two-Pot Retirement System: Advisers can clarify the concept of dividing retirement savings into two pots: a savings pot that is somewhat accessible before retirement for emergencies and a retirement pot that is strictly for retirement income and cannot be accessed early. This system encourages balancing immediate financial security with long-term retirement planning.

2.       Educating Customers on Debt Types: Advisers can help customers understand the differences between secured and unsecured debts, as well as revolving and installment debts, including the interest rates associated with each. This knowledge allows customers to make informed decisions about which debts to prioritize for repayment.

3.       Developing Comprehensive Financial Strategies: Financial advisers can assist customers in creating balanced financial plans that include both debt repayment and the establishment of an emergency fund. This dual approach helps mitigate the risk of falling back into debt due to unforeseen financial emergencies.

4.       Prioritising High-Interest Debts: Advisers should emphasise the importance of targeting high-interest debts first, such as credit card debts, using the avalanche method. This approach focuses on paying off debts with the highest interest rates first, which can lead to significant interest savings over time.

5.       Cautioning Against Premature Retirement Fund Withdrawal: Advisers should explain the long-term consequences of using retirement savings for debt repayment, such as reduced retirement funds due to early withdrawal penalties and taxes, and the potential for compromised financial security in retirement.

6.       Exploring All Alternatives: Before resorting to using retirement savings, advisers should guide customers through other debt repayment options, such as debt consolidation, negotiating for lower interest rates, and budget adjustments to allocate more towards debt repayment.

"Preserving retirement savings for their intended purpose is crucial," concludes Le Grange. "These funds are meant to secure financial stability and comfort for consumers when they no longer earn a regular income. Using them for purposes other than retirement could compromise their ability to maintain a desired standard of living in later years."