An excellent tax-free retirement vehicle

START SAVING EARLY AND DON’T CASH IN

On a tax-free savings account (TFSA) there is no capital gains tax and you won’t be taxed on interest, income or dividends.

However, you aren’t allowed to contribute more than R33 000 a year to your TFSA or more than R500 000 in your lifetime. If you contribute the maximum yearly amount, you’ll put in R2 750 monthly and reach your lifetime limit in 15 years and two months.

But what kind of future investment value could you be looking at, and would it be enough to retire on? Since a TFSA should be a long-term investment, I’ll assume a 100% equity allocation, which, historically over the long term, would have returned a little over 15%. I calculate that after the 15-and-a-bit years of contributing R2 750 monthly to a TFSA, you’ll have a nice nest egg worth just over R1.7 million.

After adjusting for inflation (historically 6% per annum), you’ll have about R726 000 in today’s money. This calculation is for the case where one contributed a lifetime limit, then immediately stopped and cashed out.

But youngsters have a lot of time on their side. Let’s take a 21-year-old and assume they make a R2 750 monthly contribution to their TFSA until they reach the lifetime contribution limit, then leave the investment untouched until they’re 55. With this extra time, the power of compound interest kicks in. At 55, they’ll have R3.3 million in today’s money, tax free. (Assuming you draw 4% of the overall capital as an income yearly, that’s enough to draw a monthly income of R11 000).

Now, let’s assume this person found their soulmate, who also started contributing to their TFSA at 21. If we combine their TFSA values at 55, they’d have R6.6 million. If they followed the 4% rule, that would allow them to draw a monthly R22 000 inflation-adjusted income until they die. While they won’t be jet-setting across the world, R22 000 a month is probably enough for a modest-to comfortable retirement.

Instead of stopping at 55, let’s assume they retire at 60. The couple’s combined TFSA balances would be worth over R10 million in today’s money. That would be enough for a monthly, tax-free income of R33 000. Despite investing for a little over 15 of their 39-year working careers, a couple, maxing out their TFSAs from an early age, without contributing to anything else (retirement annuities, company pension plans, discretionary investments, etc) would have more than enough for retirement.

So, a pretty solid retirement plan would be:

Age 21 to 36: Contribute R2 750/ month to a TFSA Marry someone doing the same Age 36 to 60: Stop investing, blow all your cash on cars, houses and travelling

Age 60: Retire with enough money (in excess of R10 million)

The key takeaways are to start early; don’t cash out money earmarked for retirement; and ignore all the media noise, perennial pessimists and continuous warnings of impending doom.

Originally published on www. stealthywealth.co.za