I have received quite a few requests to expand on the tax-free savings accounts (TSA) that were launched on March 1 this year. Many people would like to know where they should invest their money to benefit from the TSA and are wondering if they should sell existing investments so that they can transfer their money into the TSA.
As a reminder, tax-free savings accounts are savings products on which no income tax, capital gains tax or dividend withholdings tax will be charged. Most unit trusts, exchange traded funds (ETF), savings accounts, fixed deposits and RSA Retail Savings Bonds meet the requirements to be classified as a TSA. In other words these are not new investment products, rather the way that the South African Revenue Service (Sars) will treat them is new and so product providers need to keep record of these to ensure that they remain separate from your other investments.
You are allowed to invest R30 000 per year into a TSA subject to a maximum lifetime limit of R500 000. Sars will charge a 40% tax on contributions above these thresholds so please don’t add more. If you withdraw money from the TSA, you will lose the value of that withdrawal from your lifetime limit; that means you should only use the TSA for long-term investments i.e. 20 years and longer. You are not forced to keep your money in a TSA, you can withdraw at any time with no penalties or tax.
When should you use a TSA?
If you were to prioritise your long-term savings, I would suggest the following:
- Pay off your short-term debts (credit cards, personal loans, expensive vehicle debt etc.)
- Build up an emergency fund (not in a TSA) equal to three months’ worth of your expenses
- Make full use of your retirement fund contribution allowance (15% of taxable income)
- Put R30 000 per year into the TSA
- Normal discretionary savings i.e. shares, unit trusts, ETFs etc.
I believe that every young person should take advantage of the TSA as it will take more than 16 years to reach your lifetime allowance. The benefits of allowing the capital to grow without tax over the long term are very significant and should not be ignored. I cannot understand why some advisors would discourage young people from using TSA.
If you are an older investor or you will only be investing your money for a short period of time, the benefits of the TSA are less obvious. However investors who are in the higher income tax brackets should make use of a TSA because they will save on tax.
Any parents who want to start investments for their children should definitely use a TSA – to me this is the easiest investment decision to make. If you are able to invest the R30 000 per year for them from the time they are born, they could have a few million when they are in their 20s, this would be a wonderful start in life for them – tax free.
My preferred TSA investments
We have not seen all the new TSA investment products yet as some of the product providers are still in discussion with Treasury about issues such as performance fees. In the interim, I like the following categories of products:
- Listed property unit trusts or property index trackers
- Equity index trackers, equity ETFs or equity unit trusts
- Balanced funds or balanced index trackers
Listed property is at the top of my rankings for TSAs because the income is normally taxable and this can make them less attractive than normal equities. However, investing in listed property via a TSA means the income is tax-free and this is very attractive. Most balanced funds and retirement funds are underinvested in listed property so this is a great way to gain some more property exposure. I realise that listed property is currently very expensive, so you might consider investing via a monthly debit order to spread your purchase price over time.
I would not normally use a TSA to hold cash or fixed deposits as I would not invest in cash for ten years or longer. You will be able to transfer your TSA investments from one product provider to another so, if new products come to market that are better, you will be able to take advantage of them without losing part of your lifetime allowance.
Some people have asked whether you should sell existing investments so that you can use the TSA. If you do not have new cashflows to invest and you plan to invest for the long term then it might make sense but you should consider the impact of potential CGT before making this decision.