While the country is abuzz with the new two-pot system legislation, which came into effect on 1 September 2024, members are still pondering the pros and cons of the new legislation. The two-pot system aims to preserve two-thirds of members’ future contributions for retirement and in the event of a member changing employment. The legislation now also allows members to partially access their retirement savings should they encounter emergency financial situations while they are still employed. The flexibility in accessing some of the retirement money while working could assist in leveraging debts, but it would also reduce members’ future retirement savings.

Growing your retirement savings with the help of compound interest

Retirement planning is a long-term commitment, and the earlier you start saving, the better the impact of compound interest will be. Compound interest is defined as interest that is paid both on the original amount of money saved and on the interest that has been added to it. Simply referred to “interest earned on interest”. This means that over time, members’ investment savings can grow at an accelerating rate when invested.

Let’s look at an example to explain the concept:

A member invests an amount of R1,000 for a period of three years and earns 5% interest per year (assuming that all other factors are constant).

In year one, the return would be R50, which would start to compound in the following year. After the first year, the member would have made R1,050. By adding the same 5% interest in the second year, the member would get a R52.50 return, and the total amount would be R1,102.50. In the third year, the total growth would be R1,157.63 (R1,102.50 x 5%). The extra returns over and above the initial R50 interest gained are relatively small initially, but they grow steadily as time goes on. This concept is guaranteed to work in a long-term investment despite volatile markets, provided that the member refrains from withdrawing their money before their retirement date.

Accessing part of the retirement money now or annually is at an opportunity cost of earning more returns for the future. To illustrate this opportunity cost, most fund administrators have built two pot calculators showing members their potential loss of growth over time and explaining the present cost of withdrawing part of their retirement savings.

Below are factors that will enhance the concept of compound interest to work in your favour:

• A return rate that beats the inflation rate – These factors may be out of members’ control as they are dealt with more within the fund’s Investment Policy Statements (IPS) by the trustees of the funds. The risk factors can be mitigated with proper investment strategies and investment advice.
• Preserved retirement savings and continuous contributions – Keeping your money invested and ensuring monthly contributions will harness the effect of compound interest.
• Time horizon – This is a crucial factor; some members may start saving earlier than others, but investing longer allows the money in the fund to grow over time, enhancing the final amount available at retirement.

Our daily lives are evidence enough that we are living in a rapidly changing world, with instant gratification and consumption impacting us daily. The current generation is predicted to have longer life spans due to advanced technologies, wider access to wellness programs, and improved medical inventions. With such environmental effects, we are bound to develop cognitive and mental behavioural biases that influence our decision-making regarding investing.

It is imperative to have a retirement planning strategy (with constant review measures) in place. Members are to ensure that they get guidance from accredited financial planners when creating their plans, and it’s also critical to acquire benefit counselling when changing employment or at any life-changing event.

Making your money work for you

Apart from “eating into your future” money today and not allowing compound interest to work its magic, there are other disadvantages to consider when withdrawing your retirement savings before retiring, which include the taxation cost (marginal tax rate charged at withdrawal) and transactional administration costs.

Here are some ways members can improve their future retirement savings:

• Additional Voluntary Contributions (AVC) – Contributing extra to your retirement savings is a no-brainer; however, members struggle to either start or keep such contributions continuous due to affordability. The best trick is to align your AVC with your salary increment date or use a portion of your bonus incentive as a once-off AVC. Not only will you increase your retirement value but there is a tax deductibility benefit when putting extra into your retirement funds.
• Avoid withdrawing from the saving pot – Members should investigate utilising constructive budgeting tools to cater for monthly expenditures and creating emergency funds outside of their retirement vehicle (e.g. Bank Savings Account) for liquidity in times of need.

As per Albert Eistein’s infamous quote, “Compound interest is the eighth wonder of the world. He who understands it earns it …he who doesn’t … pays it.” Keep in mind that the key is to grow as much wealth now and retire comfortably later.