Many pros to tax-free savings plans
LONG TERM: NOT MEANT FOR SHORT-TERM GOALS A tax-free savings account is not meant for all seasons, but it is a benefit the whole family can access.
It’s often said there are no right or wrong investments, only appropriate and inappropriate ones. Taxfree savings and investment accounts (TFSA) offer novel benefits but are designed for a specific purpose. With a TFSA, you are entitled to invest up to R30 000 a year, tax free, and your contributions are capped at a lifetime limit of R500 000 (which will take about 17 years if you invest R30 000 a year). TFSAs are not intended for short-term savings. You would only benefit meaningfully from the TFSA once the value of the investment exceeded the annual interest exemption and capital gains exclusion.
For instance, the capital gains tax exclusion is R40 000 a year. If you chose investments with strong capital growth it could exceed the capital gains exclusion within five years. Thereafter, you would be better off having this money in a TFSA.
The annual interest exemption for people below the age of 65 is R23 800. If you are younger than 65 and select only interest-bearing funds earning, say, 6%, the fund would have to be worth R396 667 before the interest exemption was exceeded.
It would take you just over 10 years to reach those levels at R30 000 a year when earning 6% per annum. 1. When wanting to achieve long-term investment goals; 2. Saving for retirement when your income is below the income tax threshold, and you’ll not enjoy personal income tax relief from retirement contributions; 3. Topping up retirement savings above the annual maximum amount (R350 000) one can receive tax breaks on. Given that most South Africans are underfunded for retirement, there is a need to contribute more than the deductible limits in retirement funds. Investors should use all tax breaks available for retirement before using TFSA; 4. Saving for retirement when you are uncertain about your long-term income or job security and therefore may need to access the capital; and 5. Saving for retirement if you are uncertain as to whether or not you will emigrate, in which case you may want to realise the investment to expatriate your capital.
Couples stand to gain a double benefit as a household if they both invest in TFSAs for the long term. This same principle applies to families: each member (including children) can invest up to R30 000 a year, meaning that parents can invest in their children’s names for the long term. Consider, though, that each child has a R500 000 lifetime limit and if the parent uses some of the child’s lifetime limit, then the child is denied the opportunity as an adult.
If the child withdraws the investment before he/she starts to pay tax, then some of his/her lifetime limit has been wasted.
Even though a fully utilised TFSA may form a small proportion of a high net worth portfolio, it would still dilute the individual’s– or their family’s – overall tax rate somewhat.
Paul Leonard, CFP, is Regional Head at Citadel