Most investors understand how a retirement annuity (RA) can supplement their retirement savings, but there are money-saving benefits for you now, in addition to the retirement income that you’ll enjoy, years from now. Roenica Tyson, investment product manager at Glacier by Sanlam, unpacks the tax benefits of a tax-free savings account (TFSA) or an RA.
RAs can do no wrong
An RA is the ideal vehicle for increasing your retirement savings. The added advantage would be receiving tax benefits when you invest up to 27.5% of the greater amount of your taxable income or remuneration into an RA or pension and/or . The tax-deductible amount is capped at R350 000 per year and re-investing the tax saving can significantly increase the final value of your investment. In addition, while saving in an RA, you don’t pay tax on any interest or dividends, and no capital gains tax is applicable on the growth in the investment.
Depending on the investment platform, investors can select from a wide choice of underlying investments in their RA, including risk-profiled investment funds, local or foreign funds, actively managed or passive index-tracking funds, single manager or multi-manager funds, as well as an individual or exchange traded funds. The maximum exposure to asset classes, however, is governed by Regulation 28 of the Pension Funds Act. Current limits include a 75% maximum exposure to equities, 25% to property and 30% to offshore investments, although an extra 10% can be invested in Africa.
Investors have until the end of February each year to take advantage of the tax benefits for that particular tax year, by adding a lump sum to their RAs.
A tax-free savings account as part of your investment portfolio
The benefits of tax-free savings accounts (TFSAs) are well-known by now – no tax on interest or dividends received, and no capital gains tax or tax on funds withdrawn. Making a TFSA work for you and within the context of your overall investment portfolio, requires some careful consideration and consulting with an appropriately authorised financial adviser is critically important.
Based on the current annual limits, it will take investors 14 years to reach the maximum lifetime contribution limit of R500 000 to their TFSA. While you can access the money at any time, any amount withdrawn will be regarded as a further contribution (towards your lifetime contribution limit) when re-invested in the TFSA. Given this negative impact of withdrawals on your contribution limit, your TFSA should be viewed as more of a long-term investment; there are other investment vehicles more suited to short-term savings or emergency funds. So, a TFSA is a great way to keep your hands off your investment and it can truly be worth the wait.
If you’re wondering how a TFSA measures up against a regular investment plan, here are some points to think about:
TFSA vs Investment Plan
If an investor is currently investing, for example, R5 000 a month into a discretionary savings plan, it will make financial sense to split the investment, i.e., invest R2 000 into the discretionary savings plan and R3 000 into a tax-free savings plan in order to utilise the tax benefits of the TFSA.
TFSA vs RA
Weighing up contributions to an RA versus a TFSA is a slightly more complex decision. Together with your adviser, look at the advantages and disadvantages from a tax perspective. While for both options the growth within the product is free of dividends tax, income tax on interest and capital gains tax, only contributions into an RA are tax-deductible. The TFSA will, however, offer more flexibility in terms of access to money, whereas RA funds can only be accessed from age 55 upwards. Lump sum withdrawals from RAs are only tax-free up to certain limits, while there is no tax when withdrawing from a TFSA.
However, it doesn’t need to be a hard and fast choice. Using an RA and a TFSA combined could deliver superior investment outcomes.
Investing on behalf of your children
Parents can also open tax-free savings plans for their children, and from 1 March 2020, the limit increased to R36 000 per individual per year, while a family of four can invest up to R144 000 per year. This is an ideal way to save for a child’s education and can also help to foster a savings ethic from a young age.
Note that when investing on behalf of your children or transferring an investment to them, donations tax of 20% of the amount donated is payable. As an investor, you have an annual donations tax exemption of R100 000.
You are encouraged to consult with an appropriately authorised financial adviser to ensure that your investment portfolio is in line with your needs, personal circumstances and risk profile.
