Many people are under the impression that bank accounts are the best − even the only − tax-free savings accounts, according to a recent survey by Sanlam.
But experts say the term tax-free savings “account” has given the wrong impression, leading many people to opt for cash deposits rather than other tax-free investments, which offer better growth opportunities and in some cases lower costs for investors.
These include exchange-traded funds (ETFs), money-market funds and unit trusts.
With tax-free bank accounts, there is no tax on interest, but with other tax-free investments, there is the opportunity for greater capital growth and no tax on any dividends or capital gains.
Whichever investment option they choose, anyone with taxable income, no matter how little or how much money they have to invest, should utilise the R30 000 a year tax-free investment option.
Since March 2015, South Africans have been able to invest R30 000 a year, or R2 500 a month, in a tax-free investment to a lifetime maximum of R500 000. If they do this religiously, investors will, after some 17 years, have R500 000 plus capital growth, interests and dividends, as a tax-free investment.
Aimed at increasing savings in a country with an exceptionally poor savings rate, tax-free investments allow you to save without incurring any tax on the growth of your investment. This means you pay no tax on interest (normally charged at your marginal rate after a R23?800 exemption, or a R34 500 exemption if you are over 65), dividends (normally at 15%) or capital gains tax (normally at a maximum 16.4% after a R30 000 annual exemption).
Tax-free savings products include cash deposits, unit trusts, insurance products and ETFs, and are offered by nearly all banks, unit trust managers, investment companies and stockbrokers.
The regulations and the process are transparent and simple in order to encourage people to use tax-free savings.
Tax is saved on the growth of the investment, but there are still costs in the form of fees and transaction costs, and this is why investment options need to be carefully scrutinised before investment.
While you can’t get away from costs, you cannot be charged performance fees or penalties for early withdrawal from fixed-term investments as all tax-free investments must be accessible. Most are accessible within seven days, but longer term investments can take longer.
There are penalties in some cases on withdrawal of funds in an investment with guaranteed interest rates and set maturity dates.
There are also heavy penalties of 40% tax for exceeding contribution limits.
For those already invested in a tax-free account, you should be able to transfer some or all of your investment to another tax-free account from 1 November.
It is worth noting that investments cannot be transferred from currently held investments into tax-free ones. In other words, you need to withdraw the amounts and invest them in the tax-free account.
There has been some criticism of tax-free accounts, notably by Rhodes University professor Matthew Lester, who was quoted by biznews.com as saying many investors are not exposed to tax on interest or capital gains tax, and that tax-free accounts are really only a saving in dividend tax.
However, many other experts say that investors should take advantage of all tax benefits afforded them, and that tax-free accounts, while they have tax benefits, are really there to encourage people to save, and that the R2 500 a month represents a target that people can aim for.
We asked these experts about their favourite tax-free products, who should use them and how to decide which product suits you best. They also comment on potential problems and benefits and on costs and other important things to keep in mind when starting a tax-free savings account.
Managing director of Ascor Independent Wealth Managers
Fourie favours two tax-free accounts – a new generation, low-cost retirement annuity on a linked investment platform (LISP), as well as a tax-free savings account.
In both cases, you must check fees as “high fees could negate the tax-free growth of your investment and eat up your returns”.
He says that to best grow your portfolio, you should use all the tax-free benefits you can. “The first and most important one is your retirement annuity, where you should use your full tax deductible contribution. After that, a tax-free savings account is the best way to save because you are not paying any income or capital gains tax on the returns.”
Tax-free savings are suitable for anyone with a taxable income so it makes no sense, for example, to use a tax-free savings account in the name of a child to save for their education.
To really benefit from a tax-free savings account, Fourie says, investors need to reach the R500 000 cap as early as possible, after which “the power of compound interest will kick in” and you can sit back and see your money grow.
Fourie warns investors not to go above the annual R30 000 limit − as there are tax penalties − and that this limit applies to the combined annual payments to all your approved tax-free savings accounts.
If you are donating to a number of children or grandchildren for tax-free investments, be careful not to donate more than R100 000 a year, or you will be liable for donations tax.
Fourie also says investors should be careful of making withdrawals from tax-free accounts. Withdrawals can’t be “topped up” in the same year.
This is a shortened version of an article that originally appeared in the 11 August edition of finweek. Buy and download the magazine here.