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By Gavin Butchart*
The tax-free savings account (TFSA) is yet to be taken seriously as an investment option for adults. It is considered a start-out kit for kids with a tax benefit that dwarfs the relief provided by retirement annuities for example.
But it is a jaded perception and not a technically sound argument.
TFSAs are serious contenders. It offers a host of benefits that will complement any balanced investment portfolio, preferably over the long run.
The discretionary investment product is only available to individuals in South Africa and was introduced by the State to encourage a greater savings culture in the country.
What sweetens the deal, are the tax exemptions that come with it, from withholding tax on dividends or interest to income and capital gains tax on any switches or withdrawals from the account.
The only drawback of the product is the R33,000 limit in annual contribution and R500,000 over an investor’s lifetime.
But the view that a tax-friendly saving of R33,000 per annum is pocket change is a fallacy, as a built-up kitty eventually shows significant growth.
If an investor utilises the maximum benefit allocation every year, it will take just over 15 years to reach the lifetime limit of R500,000. At a rate of 12% in capital over 12 months the value added every year, the investment should be worth approximately R1.4 million in 15 years’ time or R580,000 in today’s money terms (assuming 6% average inflation).
That shows great value for money and is a plausible portfolio filler for any family member in any age range. It is a fantastic starter-solution and a tax haven where investors can hoard their cash, and just forget about it as it takes care of itself in years to come.
There is an abundance of TFSAs available in the market. They come in all kinds of shapes and sizes and are offered by anybody ranging from a commercial bank to an asset manager.
TFSAs can take the form of money market or fixed-term bank accounts, a unit trust investment or a JSE-listed exchange-traded fund. TFSAs can be issued by banks, long-term insurers, unit trust managers, mutual banks or cooperative banks.
TFSAs are very flexible in their structure and allow investors to cease or increase contributions at will, whether monthly, quarterly, annually or on an ad hoc basis, however some providers insist on a minimum contribution level for administrative purposes.
While the investor is free to withdraw funds from a TFSA at any time, early withdrawal penalties do apply and differ between providers.
It is essential to understand the longer-term implications of early withdrawals that compromise investment returns. Any withdrawal made from a TFSA is deducted from the lifetime contribution limit.
For example, if R200,000 has been saved in a TFSA and a full fund withdrawal is made, the total remaining lifetime contribution will reduce to R300,000.
TFSAs are offered from banks and linked investment services providers (LISPs). A LISP offers better variety as most banks only offer money market funds while most LISPs offer a wider selection of money market and growth unit trust funds both locally and offshore.
Even though the capital will never be invested for a fixed term and will always remain fully liquid, here are the other specifications of the TFSA:
Parents may make contributions to a TFSA on behalf of a minor, however, proceeds from withdrawals must be paid into a bank account in the minor’s name.
When accessing the investment, funds will be available within three business days, but this may also depend on the financial institution’s processes.
Any amounts exceeding the R33,000 annual limit will be taxed at a rate of 40%. This means, if the investor paid R1,000 over the limit, he or she will be liable for R400 tax. Should investors have more than one savings account, it will remain their responsibility to ensure that they do not over-contribute to their tax-free savings accounts they may have with various financial service providers.
When it comes to estate planning the full value of the investment is paid to an investor’s estate in the unfortunate event of death and unfortunately cannot be paid out directly to a beneficiary.
The TFSA will be frozen; and beneficiaries will not have immediate access to this investment until the estate is wound up. This means a beneficiary should be nominated in the will and full estate duty and executor’s fees will be applicable.
* The end of the tax year is 29 February 2020. There are a few more days available for investors to open tax-free savings accounts or add to existing accounts. Our team at all offices nationwide can assist investors interested to add this option to their investment strategies. Contact details: Brenthurst Wealth. Investors are urged to do this as soon as possible as a few days are required for processing.
More about tax efficiency here: Tax planning
- Gavin Butchart is the Financial Director and Head of Mauritius office at Brenthurst Wealth. He started his career in accounting and tax at law firms and joined Brenthurst in 2007. Gavin is a registered General Tax Practitioner (SA) and a member of the South African Institute of Tax Professionals.