Parents are increasingly asking financial planners whether it is a good idea to invest in tax-free savings accounts (TFSAs) in the names of their children.
Jaco van Tonder, director of advisory services at Investec Asset Management, says the question may seem simple, but the answer can be quite complicated.
A TFSA offers a tax saving on all the growth within the account. This means investors are exempt from any dividend or capital gains tax on the growth, as well as the interest earned on savings in the account.
The reality is that tax is only saved if one is liable for tax, says Van Tonder. Children are rarely liable for tax as most people only start paying taxes when they are deep in their 20s. Most individuals are also not going to pay a significant amount of tax until a decade later.
He adds that there are also several variables to consider when deciding on whether to use a TFSA or another savings vehicle.
He says a crucial consideration is the reason for saving in a TFSA. Are you saving to assist your children to start their own businesses when they are in their early 30s? Are you saving for them to go on a year-long gap year after finishing high school, or are you saving for their university education?
The TFSA currently only allows for an annual R33 000 investment into an approved TFSA with a lifetime investment limit of R500 000.
If parents start saving when their child is five years old, and the full investment (the lifetime limit) is withdrawn at 22, they have exhausted the child’s tax-free savings allowance – with little tax benefits because the child’s tax liability up to that point would have been minimal.
“If the parent used a normal investment vehicle in the name of the child over the same period, the capital gains and income tax charges for the child will generally be zero, and they will still have their lifetime allowance.”
The ideal outcome is to invest the entire allowance and allow the portfolio to grow for a number of years (preferably at least 10 years) after the child has become liable for tax.
“That is the sweet spot. Only when you have the full allowance and it grows tax-free until the child is actually liable for tax is it really a meaningful tax-free benefit.”
Lizl Budhram, head of advice at Old Mutual Personal Finance, says any parent or legal guardian can open a TFSA for minors who have valid South African identification with an identity number, for example, a birth certificate.
The child holds the account, but the parent is the “payer”. If any money is withdrawn from the child’s TFSA, it can only be paid into the bank account of the contracting
party, in this case the child’s bank account.
Budhram explains that the parent or the legal guardian does not own the account, the minor does. The parent or guardian will be able to make changes to the account until the child reaches the age of 18.
“Do bear in mind the lifetime investment limit of R500 000, which will be applicable to each child,” she says.
Ansie de Beer, wealth adviser at PSG, says that people who are reaching retirement age should not be discouraged by those who say there is little benefit for them to use
TFSAs as saving vehicles.
She explains that people are living longer – they are stronger and healthier because of better lifestyle choices than before.
Someone who is 50 years old can contribute their annual allowance for 10 years and then enjoy that as an augmented “retirement fund” tax-free.
“Even if you reach the age of 80 you can still withdraw from a tax-free savings account to have additional spending money for when the grandchildren come to visit, or when there are unexpected expenses you have not provided for.”
An advantage of the TFSA is that there are no tax penalties on withdrawals as is the case with early withdrawals from traditional passive savings such as employer-provided pension funds, provident funds or retirement annuities.
This article originally appeared in the 1 February edition of finweek. Buy and download the magazine here.