By Vivienne Fouche
On 1 March 2015, the National Treasury introduced the long-awaited legislation allowing discretionary tax-free savings for individuals. As well as playing a role in traditional savings, this could be an excellent way for individuals to supplement their retirement income, and/or save for medical expenses in retirement.
Those individuals who choose to save in a tax-free savings account will not pay any tax on their investment of up to R30 000 per year and a lifetime limit of R500 000. No tax is payable on interest, dividends or capital gains.
New beginnings
Rupert Giessing, Head of Product Development at PSG Wealth, says, “Treasury has given South Africans a wonderful opportunity to save on a tax-free basis, and we believe that every investor who can should take advantage of this opportunity. This type of tax-free product has been available in the UK and the USA for some time, and PSG is delighted that it has come to South Africa. This is really a milestone in the financial services industry; there hasn’t been a new class of investment product available to investors for some time.”
Bradley Drury, Research & Product Development, Alexander Forbes Financial Services, explains that the government has introduced tax-free savings accounts to incentivise South Africans to be savers rather than spenders. Drury comments, “While the introduction of these accounts is a step in the right direction, some issues need to be considered, such as who benefits from these accounts, what are some of the considerations in taking advantage of the tax benefits, and when will the benefits be realised?”
Maximising the new offering
Bongani Mageba, STANLIB Retail Managing Director, says, “Although investing R30 000 a year may not sound like a substantial amount, the compounding effect – together with the fact that all the income is tax-free – proves significant over time. We believe the national savings product is an efficient and powerful way to build up one’s savings pool over the long term. It is especially potent when combined with a retirement annuity, which also gives investors tax benefits.”
Drury says the initial starting point is obviously the approximately five million tax payers who would gain a tax advantage. “Those individuals who are currently putting aside savings which are subject to tax will feel the immediate benefits by redirecting their future savings into these accounts. To consider the overall benefits of these accounts, one needs to allow for the variety of tax exemptions and deductions that are currently offered to individuals.”
Best practice advice for most individuals would be to consult a financial adviser when looking at the tax-free savings products as part of their holistic financial planning needs. John Kinsley, MD of Prudential Unit Trusts, says, “It is important for investors to remember that the maximum contribution limits imposed by the FSB are R30 000 in a year and R500 000 over the individual’s lifetime. Investors should keep close track of their contributions because they face a stiff penalty from SARS should they exceed these limits – 40 per cent of the excess contribution.”
The real benefits of the tax-free savings account are felt in the longer term when the benefits of compound interest come through. Drury says, “For this reason it is most suited for individuals who can attach the savings account to a long-term goal with savings terms of at least eight years. These goals may include saving for children’s university education, supplementing retirement funding, post-retirement medical expenses or even a life-goal like the overseas holiday of a life time.”
Number crunching
Drury says, “Given that exemptions and deductions already existed to a certain degree, how would this new account provide an incentive that was not previously there? Individuals under the age of 65 are currently allowed R23 800 in interest income tax-free per year. This will no longer be increased in line with inflation and will effectively be replaced by the tax-free savings account.
“Individuals are also currently exempt from paying tax on the first R30 000 of any capital gains. Comparing the level of these exemptions to the annual limit available in the tax-free savings account of R30 000, it is apparent that the account isn’t suitable for all types of savings a person may have.”
Seugnet van der Merwe, Investment Analyst at Nedgroup Investments, says, “To give an example, a tax payer who pays R2 000 per month over 20 years into a low-cost unit trust, earning inflation plus five per cent (i.e. 11 per cent) per annum on their investment, will have a total contributions amount of R480 000 over the period. The fact that income on investments is tax-free amounts to an estimated additional R166 000. Based on this broad estimation an investor will earn 3.4 times their initial investment, thanks to compounding investment returns, low fees and tax savings over 20 years.
“We believe the ideal product for tax-free investment is one which offers an expected return and tax saving ranging from moderate to high, as this will allow you to capitalise your tax saving, effectively increasing your invested assets annually. Less money spent on taxes means more money that will work towards your savings goal, while lower fees allow even more of your capital to compound over a longer time.’