Matthew Lester: I’m not putting my money into tax-free savings accounts

Finance Minister Nhlanhla Nene’s new tax-free savings accounts have been widely welcomed and described as a “no brainer” by the financial services sector. But as Rhodes Tax Professor Matthew Lester argues, that’s a bit like eliciting response from a big Pick Six winner about the benefits of betting on horse racing. Lester, a member of the Davis Committee that’s examining every element of SA’s tax structure, says the new accounts do require thought and are actually not suitable for everyone. – Alec Hogg

By Matthew Lester*

There seems to be more than a bit of interest in the new tax-free savings and investment products that have been rolling out since March 1 2015. Grannies reckon this is the best stuff since they invented boiled sweets. Or the days when we enjoyed tax-free savings through post office accounts.

First off, a health warning! For goodness' sake don’t exceed the R30 000 per annum maximum contribution. You will get stiffed with a nasty ‘fine’ on your tax computation. The maximum contribution limit of R30 000 pa relates to overall contributions to all funds. Not per fund pa.

I’m not joining the happy throng of tax-free investors.. Here’s why.

The new tax-free products provide shelter from income tax on interest, dividend tax and capital gains tax. And, yes, that’s better than a poke in the eye from SARS.

But many investors don’t have an exposure to tax on interest or CGT in any event. Either they are below the tax threshold (R73 650pa) or their annual tax-free interest allowance (R23 800pa under 65 and R34 500pa over 65) or CGT allowance (R30 000pa).

In reality for most South Africans the tax-free products are really only scoring a dividend tax saving. Even if dividend yields are 3% and with dividend tax being 15%, well, it’s something, but it won’t keep you off landing on your kids.

The big thing tax-free investments are missing is the tax deduction on contribution. Taxpayers enjoy that when contributing to retirement funds. It can represent a subsidy on investment of up to 41% of the contribution. I can blow that on smokes and booze, or reinvest it in the retirement fund and ratchet up the capital.

On a R30 000pa retirement annuity contribution, taxpayers stand to score a benefit of up to R12 400 and tax-free growth thereafter.

Wait for it, there’s more. An investment in a retirement fund escapes estate duty. A tax-free investment doesn’t. Not that many investors have an estate duty exposure in any event.

The arguments to the contrary are

 - Retirement fund capital cannot be withdrawn before 55.
 - Retirement fund benefits are partially taxable on withdrawal. But most South Africans will never accumulate enough for that to become an unmanageable problem.
 - Only one-third of the accumulated capital of a retirement fund can be withdrawn as a cash lump sum. The rest has to be drawn as an annuity.

So, it’s all about horses for courses.

If you’re young and in your prime and you want access to investment to pay off the occasional  divorce or send the kids to university before you are 55, then the tax-free products have an appeal.

But please don’t save it all in a cash only product. Interest rates, even tax-free, are just useless in accumulating anything substantial. Regardless of the tax implications.

Remember not to tell your friends and relatives you’re accumulating tax-free savings or you will inherit more Klingons than Commander Spock.

If you’re old and getting grey –  the tax deduction on retirement fund contributions is very attractive. And retirement funds enjoy the same tax-free status on capital growth.

And if you’re somewhere in the middle – you can’t be doing too much wrong if you do a little of both.

Perhaps it depends on your outlook on life. If you believe that the biggest events in your life are going to be the day you get married or your kids graduate from university, then tax-free investments may be your thing.

But if you believe that the biggest achievement in life is to retire without landing on your kids, then invest through retirement funds.

* Rhodes University Professor Matthew Lester (52) was educated at St Johns College, Wits and Rhodes universities. He is a chartered accountant who has worked at Deloittes, SARS and BDO Spencer Steward. A member of the Davis Tax Committee investigating the structure of aspects of the RSA tax system, he is based in Grahamstown.

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