Divorce and the two-pot pension system

This article on the two-pot pension system is the second in our three-part series on divorce in later life.

What do changes to the Pension Act mean for couples divorcing in later life?

If you have an occupational pension or pay contributions to a retirement annuity (RA), you will be aware of the changes in pension law that came into effect last year, called the “two-pot system”. If you are a member of a scheme or a private investor, you will have received communication from your pension provider on what this means. But here’s a brief refresher:

The historical problem

Historically, if you saved toward retirement via deduction from your salary in a plan provided by your employer, on termination of that employment you were permitted to withdraw the entire amount as cash. Such a withdrawal was subject to tax and you forfeited the tax benefits associated with retirement savings, but you had access to your money. This option was particularly attractive to young people (for whom retirement is years away and almost impossible to imagine) and was often seen as a windfall when changing jobs. However, it caused a problem. This design meant that South Africans had low levels of retirement savings due to taking pre-retirement withdrawals from company pensions rather than transferring to a preservation fund. At the same time, people often had limited if any access to benefits in times of financial need. This need for emergency funds was a major contributor to pre-retirement withdrawals.

The government’s solution – the “two-pot pension system”

To resolve this problem, government revised the Pensions Act and introduced the two-pot pension system. This gives investors two “pots”, or components. In fact, for existing scheme members there are three. Contributions and their investment returns earned before 1 September 2024 are in the “vested component”. But all contributions made after that date will be divided between a retirement component and a savings component, in a 2/3 – 1/3 split. You can’t access the retirement pot until you retire. But you can make one withdrawal per year from the savings pot, subject to certain conditions. These withdrawals will be taxed. In this way the government hopes to ensure people have sufficient retirement savings while having access to emergency funds. But unlike money in a retail savings account, if the savings pot is not used, it continues to grow tax-free towards retirement.

What happens now in the event of divorce?

These changes have caused some confusion over how pension interest will be calculated on divorce. This will have a greater impact on older couples whose retirement savings are more substantial than a younger couple’s. Pension interest in the context of divorce is a theoretical amount based on the benefit accumulated at the date of divorce by the spouse who is a retirement fund member. In a marriage in community of property, the non-member spouse is entitled to an equal share of the benefit the member spouse would have received if they were to resign from the fund on the date of divorce. As part of the “clean break” principle, this amount is awarded to the non-member spouse in a lump sum as part of the divorce settlement.

In divorce proceedings, pension savings will now be treated in the following way, according to one provider’s website: “Deductions as contained in the Pension Funds Act will be made proportionally from all three components – Vested, Savings, and Retirement Components. This will apply to deductions such as maintenance orders and divorce awards.” However, there is a discrepancy between the wording of the Pension Funds Act and the Divorce Act in terms of pension interest. According to the Divorce Act, pension interest refers to a fictional asset – fictional in the sense that the member has no access to it at the time of divorce, provided that divorce is pre-retirement. Clearly that is not the case with the savings pot, as the member does have access to it. This raises the question of whether or not pension interest will only be calculated on the retirement pot. 

Pension Funds Amendment Act

Industry bodies spotted this anomaly when legislation was in draft form, and the Pensions Funds Amendment Act was developed to address the conflict. It contains a clause that states that the PFA will take precedence if the definitions clash. In other words, pension interest should be calculated on the total amount held, whichever pot it sits in. However, this won’t stop someone from taking the maximum withdrawals permitted prior to divorce, in an effort to reduce the amount used for calculating pension interest. Divorce lawyers will need to be vigilant. This is highly likely to be tested in court: if a spouse takes a maximum withdrawal from the savings pot just before commencing divorce proceedings, and spends it or transfers it to a third party, the courts may view this in the same vein as alter ego trusts – a less than ethical means of protecting or hiding assets and keeping them out of the joint estate.

Why it matters in later-life divorce

The risks inherent in the two-pot pension system relative to divorce are more serious for older couples for several reasons. Firstly, the value of a pension, either in an occupational scheme or an RA, is likely to be much higher than one held by a young couple. Therefore the value of the savings pot will also be considerable. The couple may have been prudent and avoided “raiding” the savings pot, thus ensuring the maximum potential retirement income. If the member spouse then takes a withdrawal from the savings pot, the amount available for retirement is reduced for both spouses. Secondly, an older couple may have a wider discrepancy in their incomes or one spouse (usually the wife) may be financially dependent on the other; therefore the division of pension interest will have a major impact on quality of life in retirement, particularly for the lower earner. Any attempt to influence the amount used for the pension interest calculation could have serious consequences. 

Cape Town family lawyers can help

At SD Law, we follow court proceedings closely. As these legislative changes are challenged in court, we will keep abreast of what it means for you, our clients. We are not afraid to raise a legal challenge ourselves if relevant. If you are considering divorce in later life and are concerned about your pension entitlement, we can help. Simon Dippenaar & Associates Inc. is a law firm in Cape Town, Johannesburg and Durban with specialised divorce attorneys and family lawyers. Call Simon on 087 550 2740 or email info@sdlaw.co.za for a confidential discussion.

Further reading:

• Divorce in later life
• Protecting high-value assets during divorce
• Dealing with hidden assets in divorce
• Calculating the pension interest on divorce
• Two-Pot doesn’t mean you can hide money during a divorce

Divorce Attorney Cape Town

http://divorceattorneycapetown.co.za/

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