How to nav­i­gate tax-free sav­ings ac­counts

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For the past three years, the an­swer to the ques­tion, “how do I start in­vest­ing?” has been easy: open a tax-free sav­ings ac­count (TFSA).

But this comes with the caveat that there are broadly four types of TFSA — and most peo­ple, mis­led by banks and in­surance com­pa­nies, open the wrong ones. This is dis­as­trous be­cause the ex­ist­ing reg­u­la­tions do not make it easy to switch ac­counts.

A handy re­source to start re­search­ing TFSAs is­, cre­ated by Stu­art Theobald, of In­tel­lidex. The fi­nan­cial ser­vices re­search house also con­ducts an an­nual sur­vey. It’s hoped the 2017 poll of TFSAs will show peo­ple have wo­ken up and are not sim­ply go­ing to their banks to sign up for the com­pletely point­less money mar­ket ac­counts on of­fer.

The 2016 sur­vey showed 59% of the R2.6bn sav­ings TFSAs at­tracted went to banks. This is sad if you con­sider that, un­der ex­ist­ing laws, the first R23,800 in­ter­est you earn if you are un­der 65 is tax free. This rises to R34,500 if you are older.

As­sum­ing a bank’s in­ter­est pay­ment to savers matches the cen­tral bank’s 7% repo rate (in re­al­ity, they aren’t that gen­er­ous), it would re­quire sav­ings of R340,000 be­fore the ex­ist­ing tax-free thresh­old was breached. As the high­est amount of sav­ings that could have been placed in a TFSA in its three-year ex­is­tence is R93,000 — the an­nual limit was raised to R33,000 this tax year from R30,000 in the prior two years — peo­ple who have opened TFSAs with banks are not get­ting any tax ad­van­tage they would not have en­joyed in any case.

In­surance prod­uct flog­gers have led peo­ple to be­lieve bank TFSAs are the only type avail­able. They use the ar­gu­ment above to con­vince peo­ple to rather put what­ever they can af­ford into re­tire­ment an­nu­ities. Peo­ple who fall for this are ba­si­cally vol­un­teer­ing for dou­ble tax­a­tion: if you are a wage slave al­ready con­tribut­ing to a com­pany pen­sion fund, money you put into a re­tire­ment an­nu­ity comes from your af­ter-tax salary. And when you draw it later as your pen­sion, it gets taxed again as in­come.

In­tel­lidex’s sur­vey found the life in­surance in­dus­try has man­aged to grab the next big­gest slice of the TFSA pie (15%). This leaves stock­bro­kers and unit trust traders (com­monly called Lisps — an acro­nym for linked in­vest­ment ser­vice providers) tied in third place, with 13% each.

My bias is to­wards the TFSAs of­fered by stock­bro­kers. The fees are far lower than those for full-fea­tured stock­broking ac­counts, but TFSA stock­broking ac­counts are lim­ited to a se­lec­tion of ex­change traded funds (ETFs).

Us­ing my Absa Stock­broking TFSA as a ref­er­ence, the choice of ETFs that can be traded via the ac­count is 39. Stock­bro­ker TFSAs ex­clude eight ETFs from the JSE’s full menu. The ex­cluded ETFs are those fo­cused on sin­gle com-

A big ad­van­tage TFSAs have over pen­sion prod­ucts is that they are not con­strained by rules lim­it­ing for­eign shares

modi­ties rather than of­fer­ing di­verse port­fo­lios of shares or bonds.

To make things even more con­fus­ing, there are 28 ex­change traded notes (ETNs) avail­able to trade in full-fea­ture stock­broking ac­counts that are ex­cluded from TFSA stock­broking ac­counts.

A key dif­fer­ence be­tween ETFs and ETNs is that the for­mer are po­liced by SA’s col­lec­tive in­vest­ment laws. Whereas a gold ETF has to phys­i­cally own the bul­lion it rep­re­sents, a gold ETN could syn­thet­i­cally track the price of gold through rolling over fu­tures con­tracts. Since ETNs do not nec­es­sar­ily own what they claim to, they are re­garded as too risky to be al­lowed in TFSAs.

A big ad­van­tage TFSAs have over pen­sion prod­ucts is that they are not con­strained by rules lim­it­ing for­eign shares and so forth. Your en­tire TFSA port­fo­lio could be Deutsche Bank’s MSCI World In­dex tracker — a good choice, as it

of­fers the big­gest di­ver­sity in terms of ge­og­ra­phy and the num­ber of com­pa­nies out of the avail­able range of JSE-listed ex­change traded prod­ucts.

Again us­ing Absa Stock­bro­kers as a ref­er­ence, an ad­van­tage TFSAs have over full broking ac­counts is 0.2% bro­ker­age, with no min­i­mum or monthly fees. You do not have to pay div­i­dend with­hold­ing tax, which now stands at a whop­ping 20%, or cap­i­tal gains tax when you even­tu­ally sell.

The full-fledged ac­count has 0.4% bro­ker­age, with a min­i­mum fee of R120 (ex­clud­ing Vat), mak­ing trans­ac­tions of a few hun­dred rand un­vi­able.

Though my bias is to­wards ETFs, the se­lec­tion of unit trusts avail­able via Lisps is big­ger, and I can­not claim to have re­searched all the Lisps out there to see if any of­fer lower fees than the big stock­bro­kers.

The war be­tween ETFs and unit trusts has not been as heated in SA as in the US be­cause there is a lot of over- lap be­tween the play­ers. The first ETF man­ager in SA, Sa­trix, was orig­i­nally a sub­sidiary of the JSE. Prod­ded by other mar­ket en­trants’ crit­i­cism that there was a con­flict of in­ter­est, the JSE sold Sa­trix as a joint ven­ture to San­lam and Deutsche Bank. Nowa­days, Sa­trix is wholly owned by San­lam, which uses it as a brand for both ETFs and unit trusts.

His­tor­i­cally, ETFs were closely as­so­ci­ated with in­dex track­ers — funds that build their port­fo­lios by me­chan­i­cally fol­low­ing stock mar­ket in­dices rather than hav­ing ac­tive man­agers se­lect shares. The lines be­tween ETFs and unit trusts have also be­come blurred, with most pop­u­lar in­dices of­fered as unit trusts and a grow­ing num­ber of “smart beta” ETFs com­pet­ing against ac­tively man­aged unit trusts.

Syg­nia CEO Magda Wierzy­cka pre­vi­ously ar­gued that in­dex track­ers sold via Lisps of­fered a bet­ter deal than ETFs sold via stock­bro­kers. But now that Syg­nia has en­tered the ETF mar­ket by ac­quir­ing Deutsche Bank’s range of JSE-listed for­eign blue-chip track­ers, she may switch al­le­giance.

A famous ex­am­ple of some­one who switched from hero of ac­tive man­agers to ar­dent be­liever in in­dex track­ing is in­vest­ment guru War­ren Buf­fett.

“If a statue is ever erected to hon­our the per­son who has done the most for Amer­i­can in­vestors, the hands-down choice should be Jack Bogle,” Buf­fett wrote in his most re­cent let­ter to Berk­shire Hath­away share­hold­ers. Bogle, the founder and for­mer CEO of in­vest­ment giant Van­guard, is con­sid­ered the fa­ther of in­dex track­ing.

Buf­fett’s let­ter marked the conclusion of a bet that no hedge fund man­ager could beat Van­guard’s S&P 500 over 10 years. One hedge fund man­ager ac­cepted Buf­fett’s chal­lenge — and got soundly thrashed.

A com­mon rea­son peo­ple mis­trust in­dex track­ers is they of­fer av­er­age re­turns, and there is a pop­u­lar mis­con­cep­tion — even among peo­ple who have done univer­sity cour­ses in sta­tis­tics — that you have a 50% chance of beat­ing the av­er­age.

To see why that is a fal­lacy, con­sider the av­er­age num­ber of fin­gers of peo­ple in a largee­nough crowd. Some un­for­tu­nate per­son is bound to have lost at least one fin­ger. (This seems par­tic­u­larly com­mon among famous gui­tarists — think of jazz leg­end Django Rein­hardt, Black Sab­bath’s Tony Iommi and the Grate­ful Dead’s Jerry Gar­cia.) Just as nearly ev­ery­one is likely to be above av­er­age mea­sured by how many fin­gers they have, nearly all ac­tive fund man­agers are found to be be­low av­er­age mea­sured by stan­dard mar­ket cap-weighted in­dices over time. And the few ac­tive fund man­agers who do beat the av­er­age achieve this through blind luck rather than skill — some­thing many peo­ple still refuse to be­lieve, de­spite the over­whelm­ing ev­i­dence.

TFSAs stand out as a good govern­ment ini­tia­tive in ed­u­cat­ing peo­ple about in­vest­ing and di­rect­ing them to sen­si­ble prod­ucts in the form of ETFs. But this as­sumes that peo­ple ed­u­cate them­selves enough to avoid the banks and in­surance com­pa­nies.

If you can af­ford to save more than R33,000 a year, Absa Stock­bro­kers (and I as­sume its com­peti­tors, too) let you link your TFSA to a fullfea­tured broking ac­count.

Some peo­ple see the R500,000 life­time limit on TFSAs as an ar­gu­ment against open­ing such ac­counts, but I sus­pect that will be a mov­ing hori­zon, with the limit lifted in fu­ture bud­gets.

In­surance prod­uct flog­gers have led peo­ple to be­lieve bank TFSAs are the only type avail­able

Pic­tures: iSTOCK

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