With a number of tax-free savings accounts (TFSAs) on offer, ranging from fixed deposit accounts at your local bank to tax-free exchange-traded funds (ETFs), unit trusts and endowment policies, it may feel overwhelming to choose a product and start saving. finweek has asked six experts to share their tips and recommendations.
Are you using your existing tax exemptions?
The biggest allure of a TFSA is the tax exemption, but many investors may still have other tax relief available to them that they are unaware of, says Taryn Hirsch, a senior policy adviser at the Association of Savings and Investment South Africa (Asisa). With numerous tax exemptions in place for individuals (the first R23 800 interest earned by an individual younger than 65 is tax-free, for example), it may be worthwhile for the individual to first exhaust these options available to them before they consider taking out an extra product, Hirsch says. (See box for a full list of current investment-related tax exemptions.)
For someone who currently pays no tax or is taxed at a minimum marginal rate and who wants an insurance product such as an endowment policy, a TFSA can be a tax-efficient solution, says Rosemary Lightbody, a senior policy adviser at Asisa.
Currently the tax rate within an endowment policy is 30%, which would have negative implications for someone who pays a lower marginal tax rate than that.
“Now, if you go into a tax-free savings product, there is no tax at all, at any level. So you are not being compromised by the product’s tax being at a higher rate than the tax rate you would normally pay,” says Lightbody.
Jaco van Tonder, director: advisory services at Investec Asset Management, says before opening a TFSA, investors should also consider whether they have three to four months’ living expenses in an emergency account. At current money-market rates of about 8% and the R23?800 tax exemption on interest, an investor can have about R300 000 invested in a money-market account before returns will be taxed, he says. Money-market accounts are more suitable for short-term savings goals (e.g. saving for a deposit on a house, a new car or an overseas holiday) or emergencies than a TFSA.
How to pick a TFSA
With a large number of different financial players offering a range of tax-free savings products, investors should choose the product that is best suited to the investment objective they have for this money, says Van Tonder.
“People often think a TFSA is a short-term savings vehicle in which I save money for an expense that I expect to have in two to three years’ time. The real value of your tax savings on a TFSA needs time to compound with your investment return. So if you contribute to a TFSA and you withdraw that money in two years’ time, you’ve used up two years of contribution limits, but you’ve actually gained very little in the way of tax savings,” he says.
Warren Ingram, director at Galileo Capital, agrees, saying people should have a 10 year or longer investment horizon when choosing a tax-free savings account.
“A lot of people think because it’s an account, it is only bank accounts or fixed deposits. Yet it is important to understand that they should rather consider very long-term investments, in other words things like investments in shares or listed property, or balanced type portfolios. I really wouldn’t consider cash, which will never give you inflation-beating growth,” Ingram says.
Van Tonder suggests that you choose a fund provider who can satisfy those long-term objectives in a cost-effective way. “Ideally, you want to invest in an actively managed balanced fund, with at least 60% in equity, some property exposure, bonds, cash, and some offshore exposure, and then you invest that for 10 years or longer.”
TFSA versus a pension fund or retirement annuity contribution
Critics of tax-free savings accounts often say that many South Africans can save more tax by simply increasing their pension fund or retirement annuity (RA) contribution to the maximum that is tax-deductible (currently 27.5% of the higher of their gross remuneration or taxable income, subject to an annual limit of R350 000), rather than investing in a TFSA, where contributions are made from after-tax income.
Sonia du Plessis, certified financial planner at Brenthurst Wealth, says the first priority should be to make provision for retirement through a pension fund or RA. “RAs are still great to protect yourself from the money. You can’t access it before 55. You still get a big tax saving off your contributions, where with a TFSA you have to use after-tax money and you only see that [tax benefit] later on.” Your RA and/or pension fund contributions will also remain untouchable should you go bankrupt.
The TFSA is a great product to supplement retirement income tax-free one day, thereby also lowering your overall tax rate in retirement, says Du Plessis. Most advisers agree that a TFSA should ideally be used to save for retirement as a complementary product to pension funds and RAs.
“It’s all about balance. If you can, the golden rule is to try and save at least 15% of your gross income in an RA or other retirement savings vehicles, so if you are saving 15%, maybe then start a TFSA as well, and max that out. If you’re in the fortunate position that you still have money left, then max out your retirement contribution,” says Du Plessis.
A TFSA also offers the benefit of liquidity. “If you make a long-term investment into a TFSA with the express purpose of leaving it there for a long term, at least you have the comfort of knowing that if the wheels do fall off and something unexpected does happen, you have access to money that will then be tax-free,” says Galileo’s Ingram.
Active funds versus passive funds
Passively managed funds (such as ETFs) typically offer a more attractive cost structure than actively managed unit trusts, but costs are not the only factor to consider. “It’s not to say that if you pay fewer fees that you would earn a better return at the end of the day. Most of the time it is better to pay slightly more and get an actively managed fund,” says Du Plessis.
Investec Asset Management’s Van Tonder says that most of the time, an actively managed balanced fund would deliver excellent results as a qualified fund manager picks the asset classes for the portfolio. More skilled investors, or investors assisted by qualified financial advisors, can manage asset class blends themselves and in these cases a balance of active and passive can deliver excellent results, he says.
Investing for children
As a TFSA is an ideal vehicle to invest for the long term – 10 years or longer – it is a good option to start saving money for a child’s education or studies, says Brenthurst’s Du Plessis. “You only need a birth certificate to start saving for a child, and the account can be opened in the child’s name. The only thing that you must remember is that if the guardian or parent wants to withdraw money, it must go to a child’s bank account,” she says.
These contributions will be subject to the same limits – R30 000 per tax year and R500 000 over the child’s lifetime – and can therefore mean the parent exhausts the child’s lifetime contribution before he/she is an adult, says Asisa’s Hirsch. “This is not necessarily a bad thing as long as it has been wisely invested – the compounding effect of the investment having been exposed to the markets as early as possible will give the child a significant advantage,” she adds. Another factor to consider is the implication of donations tax – currently, an individual can donate R100 000 a year tax-free.
Treasury’s aim with the TFSA initiative is to provide simple, cost-efficient products that can be easily understood by the average person, says Asisa’s Lightbody. Performance or other variable fees are for example not allowed, making it easier to understand the costs involved and to compare different products.
Wouter Fourie, director at Ascor Financial Advisors and a certified financial planner, says the following fees may be applicable to a TFSA:
- Service fee of the fund selected;
- Financial adviser service charge;
- Platform service charge (in the case of a linked service provider account); and
- An initial fee may be charged at the discretion of the investor and broker, depending on the fund selected.
Investec Asset Management’s Van Tonder says providers (who are Asisa members) must disclose their effective annual charge, or EAC, and this should ideally not be much higher than 2.5%.
“Since you don't pay performance fees in a TFSA, I would investigate carefully if the EAC is substantially more than 2.5% per annum. Also look at the components of your fee administration, advice and fund management) and make sure you are getting value for money at each of these levels. Look for products with a reasonable EAC, and make sure that the investment options you have give you long-term equity and growth exposure consistent with your long-term growth objective,” he says.
Transferring from one TFSA to another
Currently, investors are not allowed to transfer money from one TFSA to another due to administrative challenges that Treasury, the South African Revenue Service (Sars) and the financial services industry are busy working on. The expectation is that this feature will become available over the course of the next 12 to 18 months. This will increase competition among TFSA providers and help ensure that products stay competitive, Van Tonder says. Investors are allowed to invest in more than one TFSA, as long as the R30 000 annual limit for total investments is not breached.
What if Treasury changes the rules?
With tax legislation, you can never know what will happen in future, says Van Tonder. “The comfort that we’ve got, though, is that generally when SA changes tax regulation, the changes are never effective retrospectively. If people are disadvantaged by a change in income tax regulation on their historical assets, Treasury and Sars tend to give people a grandfathering period. In other words, they would say that the new dispensation, which may be more restrictive, will only apply to new contributions after a certain date, and that on the built-up contributions that you’ve made in the past, you’d still have the vested rights that you had before,” he says.
“We will definitely have changes to the TFSA regulations – they’ll most likely increase the limits as they did with the UK’s equivalent, the ISA, but I think we can feel comfortable that in order to incentivise savings, investors’ rights will be protected.”
This is a shortened version of the cover story that originally appeared in the 26 January edition of finweek. Buy and download the magazine here.