Managing tax-free accounts wisely
WHETHER in big or small amounts, there are meaningful benefits to putting money away for something important. Our government continues to encourage savings including the introduction of Tax-free Savings Accounts (TFSA) in 2015. All proceeds, which include interest income, capital gains and dividends from these accounts, are tax-free.
TFSAs help maximise on personal tax relief; it is recommended to invest the maximum amount permissible every year for 15 years and allow your money to grow, while earning attractive compound interest.
Financial planning professionals recommend that we all save up to six months’ salary, as part of our emergency funds. We all need that safety net should we lose our jobs or need to fix that leaking roof or pay for our children’s major school excursion.
The recent increase of investment into tax-free savings from R30 000 to R33 000 per annum, is likely to increase consumer interest positively, particularly as year-end bonuses arrive but individuals need to pay careful attention to possible SARS penalties for over contribution.
Each individual is allowed to contribute from 1 March to the last day of February to save towards his or her non-retirement savings and to enjoy the proceeds of those savings, tax-free.
“The total lifetime limit that any individual may contribute towards the tax-free savings still remains at R500 000. However, it is expected that this too may be adjusted according to inflation and that updates on these limits will be announced in the future budget speeches,” explains Dave McCall: Executive Head: Investments, Nedbank Limited.
“Of importance to investors are the legislated limits on how much you are allowed to invest.
Investors may choose to invest a lump sum of R33 000 at any point or they may choose to make deposits into the savings account until they reach the annual cumulative contribution limit of R 33 000.
“It is vital that investors understand that these limits do not refer to the balance in their account but as to how much they are allowed to contribute for a specific period. Importantly, this limit is applied to investors, as individuals and not per account. In other words, if one opens multiple TFSAs at one bank, or at various banks and financial institutions, one is still only allowed to invest R33 000 per year collectively in the various taxfree accounts.
“In the example above, we have created a simple scenario in which a client makes deposits and withdrawals. One needs to pay special attention to the total contribution column. This column is the sum of all the deposits made to the account and this amount may not exceed R33 000 per year.
“Notice that because the client below made two withdrawals during the year, the balance in his account was only R26 000, though he had reached his contribution limit in December.
“The deposits made after the limit of R33 000 was reached in December are deemed to be an over-contribution and the client will be penalised. In this case, the R7 000 deposited in January and the R1 000 deposited in February, are over-contributions and the client will be penalised 40% of the R8 000. (See table Above)
“As money experts who believe in providing good solutions for civil society, small businesses and industry we urge investors to review their total contributions made during the current tax year before investing any bonuses and to talk to a financial advisor,” concludes McCall. TAX-FREE savings accounts are one of the most useful savings vehicles in South Africa because you do not need to pay tax on investment growth. It is however important to invest your money in a tax-free savings account (TFSA) correctly to ensure you obtain tax benefits.
“It is not necessarily a good idea to use a taxfree savings account to invest in a fixed deposit, or a short-term interest bearing account,” explains Grant Locke, head of OUTvest, a wholly owned subsidiary of OUTsurance Holdings Limited.
“This is because the first R23 800 of annual interest income earned is currently not taxed.
“To earn more than R23 800 annual interest and therefore enjoy the benefits of additional income qualifying for tax free status, you would need to have roughly R300 000 invested in a fixed deposit or similar account earning approximately 8% per annum.
‘Because contributions to tax free savings accounts are restricted to R33 000 per annum, it would take about 10 years to accumulate that amount of capital.
“It will therefore take a long time before you realise any benefit in this scenario.
A TFSA gives you the flexibility of being able to invest in a wide range of investment vehicles, including unit trusts and exchange traded funds.
However, the problem is that unless you are a professional, it is not always clear as to when it is advantageous to use a TFSA and when not.
“OUTvest has built an online advice system that will help you understand when it may be a good idea to use a TFSA.
“The system takes into account your goal, your contributions and the suggested investment portfolio to help you decide whether a TFSA is appropriate or not – all online.
“An interesting way to use tax-free savings accounts is as a part of your retirement savings. This is because you have much more flexibility in which to invest.
‘For example, you could invest all of your taxfree savings allowance in overseas companies if you want, whilst you would ordinarily only be allowed 25% offshore exposure in a retirement annuity.
“Secondly, if for some reason you fall on hard times, you can take some money out of a tax-free savings account – which you cannot do with a retirement annuity.”
The other useful aspect to a TFSA is that you do not have to use only one provider. You can have tax-free savings accounts with a number of providers, as long as you do not contribute more than R33 000 per tax year (from February to March).
However, the onus is on you to ensure that this does not happen; otherwise, the penalties can be severe.
You can track your contributions across all your OUTvest goals to ensure you do not exceed the maximum annual contribution,” concludes Locke.
OUTvest offers goal based advice and passive investment solutions, via a website and an app, combining sophisticated technology and financial advisors based in a call centre.
The service includes an intuitive do-it-yourself digital front end, low fees and intelligent goal-based calculators, which help investors understand how much to save to achieve their goals and whether a tax-free savings account is recommended.
Clients benefit from both algorithmic passive investment strategies and professional human advice.