With it being National Savings Months, this article takes a closer look at seven vehicles which can be used to house your savings, how to use them most appropriately and effectively, and the tax implications of doing so.
If you have an access bond, this facility is an excellent place to house any additional savings. An access bond allows you to make additional payments towards your home loan and then to draw from these funds as and when needed. In most instances, where you make surplus contributions to your home loan, the bank will use the money to reduce the capital amount which means you will effectively pay interest on a smaller amount, with the added benefit that you do not pay tax on the interest saved. Most home loans do not automatically come with an access bond facility, meaning you will need to apply to your bank to have this facility activated either when your bond is registered, or at any stage thereafter provided you have conducted your home loan account well.
Important to bear in mind is that an access bond does not allow you to borrow or withdraw all the money you have paid towards your bond. You can only access the funds that you have paid over and above your monthly bond repayment. Because of their flexibility and ease of access, access bonds are excellent vehicles for housing emergency cash while at the same time reducing the interest payable on your home loan. Some people transfer their salaries into their access bond and leave only sufficient funds in their current accounts to cover their monthly deductions. If you are contributing towards a retirement annuity, you can use your access bond to ‘park’ any tax refunds received from Sars in respect of your tax-deductible RA contributions. Then, at the end of the tax year, you can use the funds in your access bond to maximise your tax-deductible RA contributions for the next tax year.
Fixed deposit account
Fixed deposits are savings accounts that are linked to a specific time period depending on your savings goals. Generally speaking, you are able to choose an investment period of 12 months, 24 months or 60 months, with the interest rate largely depending on your investment horizon. The applicable interest rate, which is generally higher than that of a savings account or notice deposit account, will be applied for the duration of the investment. Depending on the financial institution that you have chosen, you may elect to get paid your interest on a monthly basis or compound your interest at the end of the period, bearing in mind that interest earned is taxable. Once your money is locked away in a fixed deposit account, you are not able to access your capital before the end of the period without incurring penalties. In general, banks will insist on a minimum deposit amount of around R5 000 when setting up a fixed deposit account.
Money market accounts
Most banks or financial institutions operate money market accounts, which are effectively savings accounts with more favourable interest rates which are advertised upfront. Money market accounts are generally low-risk, highly liquid investments which allow account holders to easily and quickly access their cash. The only real risk that a money market account presents is the risk that your money is exposed to a single bank. Most financial institutions that offer money market accounts include online user functionality to allow account holders to easily transfer or withdraw funds, together with ATM, debit order and stop order capabilities.
Generally speaking, the interest earned on money market accounts is higher than that of savings accounts but lower than what is offered on fixed or notice deposit accounts, with most institutions offering tiered interest rates based on the balance in the account. The minimum deposit amount on money market accounts ranges from between R10 000 and R20 000 depending on the bank. In essence, money market accounts are similar to savings accounts in most respects but with more favourable interest rates if you need to leave your money parked in the short- to medium-term.
Money market fund
Unlike a money market account, a money market fund is an actively managed investment product that is generally invested in a range of instruments including promissory notes, commercial papers and Negotiable Certificates of Deposit. Because the money held in a money market fund is diversified across numerous institutions, the investment risk is spread and not limited to a single bank as in the case of money market accounts. Asset managers of money market funds actively seek investment opportunities to provide higher returns for their investors which means that investors can expect to generate better returns than if they were to leave their money in a money market account. However, unlike a money market account, cash held in a money market fund will fluctuate in line with market movements.
Money market funds generally require minimum deposits of around R20 000, and accessing the funds will take anywhere between one and five working days, depending on the institution. As such, money market funds are generally not ideal for emergency capital as you will likely not have instant access to your cash. Rather, these vehicles are more suitable for parking cash earmarked for medium-term goals such as paying a deposit on a home or an overseas trip or to park funds while you are making investment decisions.
Tax-free savings accounts
Tax-free savings accounts are tax-efficient savings vehicles that are more appropriate for longer-term savings goals. This is because all proceeds earned from TFSAs – including interest income, capital gains and dividends – are exempt from tax, meaning that you get your full investment return without being taxed on the growth you earn. Unlike retirement fund contributions, it is important to bear in mind that contributions towards a TFSA are not tax-deductible. TFSA investors are limited to investing a maximum of R36 000 per year, and a total lifetime contribution of R500 000, towards the fund. Where an investor does not use their annual contribution of R36 000 in a tax year, they will not be permitted to roll it over to the following year, and the contribution will therefore be forfeited.
Most TFSAs provide complete contribution flexibility, allowing investors to stop and start their contributions at will. Investors can choose to contribute monthly, quarterly, annually or on an ad hoc basis, although some providers insist on a minimum contribution level for administrative purposes. TFSAs can take the form of money market or fixed-term bank accounts, a unit trust investment or a JSE-listed exchange-traded fund. TFSAs can be issued by banks, long-term insurers, unit trust managers, mutual banks or cooperative banks.
Before investing in a TFSA, it is important to understand the longer-term implications of doing so. Any withdrawal made from a TFSAs is deducted from the investor’s lifetime contribution limit. So, if an investor has R200 000 saved in their TFSA and makes a full withdrawal, they will only have a remaining lifetime contribution of R300 000. Further, the annual contribution limit of R36 000 per individual is strictly enforced, and any contributions in excess of this annual limit can be subject to a penalty tax of 40% of the excess – keeping in mind that the onus is on the investor to keep track of their contributions.
Because of the longer-term nature of these investment vehicles, a TFSA is an excellent way to save for a child’s tertiary education although one should be careful of opening a TFSA in the name of one’s child. In doing so, you will effectively use part or all of your child’s tax-free allowance which may prevent them from saving in a TFSA later in life.
Preservation funds are excellent vehicles to house and preserve the proceeds of a pension or provident fund where a person has been retrenched or dismissed, or where they have resigned. Upon leaving your employment, one of the options you have is to transfer your retirement fund capital tax-free into a preservation fund where you will also not be taxed on the investment returns achieved in the fund. All funds invested in a preservation fund fall outside of your estate and are therefore exempt from estate duty.
One of the benefits of a preservation fund is that you are permitted to make one full or partial withdrawal from the fund before you reach age 55, keeping in mind that only the first R25 000 is tax-free provided you have not made any prior withdrawals. Thereafter, any withdrawn capital will be taxed as per the retirement withdrawal tables. From age 55 onwards, where your pension preservation fund balance exceeds R247 500, you are permitted to take no more than a one-third cash withdrawal which will be taxed accordingly. Thereafter, you are required to use the remaining two-thirds to purchase a life or living annuity in accordance with your needs.
As part of the retirement fund harmonisation process which became effective 1 March 2021, benefits from contributions made to provident funds from 1 March 2021 onwards will be subject to the same rules at retirement as pension fund benefits, except where provident fund members are 55 or older on 1 March 2021 and remain members of the same provident fund. For members of provident and provident preservation funds on 1 March 2021, all benefits as at 28 February 2021, plus any future growth on these benefits, will not be impacted by the changes, which means that members will still be able to withdraw up to 100% of their vested benefits in cash at retirement.
Collective investments or unit trusts are transparent, well-regulated and easy-to-understand investment vehicles, and are well-suited to a wide range of investment objectives. Unit trusts, which are regulated by the Collective Investment Schemes Control Act, provide investors with an economical way to invest any quantity of money whilst still obtaining the same level of professional management and diversification of investment. Distinct advantages of unit trusts are that they include professional portfolio management, the ability to diversify a portfolio cost-effectively, relatively low transaction costs and the ability to buy and sell at will.
Capital gains tax (CGT) is only triggered when the investor sells a unit or units, with CGT being levied on the difference between the purchase price and the final sale price of a unit trust in the case of lump-sum investments, or the average acquisition price in the event of debit order investments.
Fund managers of unit trusts are permitted to use a range of sophisticated mechanisms to protect their portfolios in downward markets. These strategies usually fall outside the skill set of small investors, which is why the use of professional fund managers is strongly advised. As the owner of unit trusts, you would essentially be a unit holder in a fund that in turn invests its money in a range of assets, including shares, property, bonds and/or money market instruments, depending on the mandate of the fund.