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Nuts and bolts of tax-free savings accounts

The benefits of allowing capital to grow without tax over the long term are significant.

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.

Background

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:

  1. Pay off your short-term debts (credit cards, personal loans, expensive vehicle debt etc.)
  2. Build up an emergency fund (not in a TSA) equal to three months’ worth of your expenses
  3. Make full use of your retirement fund contribution allowance (15% of taxable income)
  4. Put R30 000 per year into the TSA
  5. 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.

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COMMENTS   13

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It will be appreciated if more information can be provided about how the capital value of the Tax Free Savings Products, will be taxed at death. (below and above the R7 million threshold)

Hello Warren, you vouch for this and it seems a good investment vehicle. But as this government is not trust worthy, I still think moving the R30000.00 annually offshore into say, the S&P 500 etf’s by Vanguard is a more secure way to a stress free mind. Even paying the US$35.00 every three years to pay the 15% dividend tax for South Africa out weighs the risk of the rand depreciation over the longterm.

However this vehicle is ideal if one wants a local investment to cover kids “Kick start” to university or a gap over seas.

hi Warren,
something i cant get my mind around:
how does SARS/ or the fund managers identify what portion of your annual investment is your annual R30,000 tsa investment?
If one already has say a few hundred thousand invested in a qualifying TSAs, say split between a balanced fund and a property equity fund for example, and your normal contribution is 50k annually, do you have to specify what portion of that investment is the R30,000 tax free portion? and if you invest 50k and withdraw 15k later in the year, who specifies if that withdrawal is part of your 30k tax free investment of a portion of the excess amount you invested?
Not sure if my questions are making sense.
If you invest 100k, who monitors what portion of the return on that investment is/ will be tax free?
or does one have to have a separate TSA, and only your tax free investment go in there??

Hi Warren, I agree with your first choice of listed property. My wife and I invested the whole amount in a Global property investment fund with a longer term view.

Just a question for Jeremiah or others, how would you open a Vanguard account as a South African. I thought they only support US citizens?

steverowles, the tax-free accounts are completely separate, ring-fenced accounts.

JFK .I like your approach. Please give details on how to do this. R30 000 seems very low for a true offshore investment account?

Hi Warren, you mentioned that you can transfer the TSA investment to another product. I’ve heard that once you have invested in a particular product you are locked in, unable to move, but that it was still a grey area. This doesnt make sense to me as I would like the option to move product based on market conditions in future. Are you 100% sure?

Thank you for the article, now I understand it also much better. Just a word of advice to young people, do not pay off all your short term debt, you must have some for a credit record otherwise you struggle to get finance for bigger purchases.

Aggenee Man: You are free to switch your TSA investments from one approved product to another (and you can have more than one product, and from different providers) within the ring-fence of your TSA.

Hi, i dont understand point 5 under “When should you use a TSA?” it makes no sense at all. What about it ?

@ steverowles Please note that information is submitted to SARS. The amount over R30 000 p.a. attracts a tax to be paid on the amount over R30 000.
Also once you withdraw the R15 000 you cannot put it back. This mean on ur example you will only be able to contribute R10 000 in the following year. Also if you invest over R500 000 whole life you will also be taxed at ur tax rate on the amount over R500 000.
This meant to be a savings plan and not a trading account.

@patrickza the easiest way I found to get into Vanguard was to open a USD denominated Webtrader account at Standard Bank online securities, get your offshore allowance deposited there (once you have your tax clearance certificate and FICA done which they will help you with), and then buy the etf’s like Vanguard on the platform. One can then build a bit of a portfolio including other etf’s like Schwab’s which are even lower cost, both in US and international markets, all in USD and reported on a single platform for SA CGT and income tax purposes. Instant online visibility and nice research tools come in the package. Trading costs are low, liquidity is good and admin is pretty simple once you have got the hang of the Webtrader software which takes a trade or two and you are fine. Much cheaper and more transparent than buying an international unit trust marketed in SA, and has the advantage of CGT being computed in the stronger USD currency making your gains lower in rand terms

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