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Tax-free savings: Buy, hold, forget

Simon Brown shares his choice.

JOHANNESBURG – Emergencies happen, but investors should restrain from using a tax-free savings account with the aim of withdrawing money after only a few years, as the real benefit of compounding in these accounts will occur in the very long term.

Speaking at a JSE Power Hour session, Simon Brown, founder of JustOneLap, said although investors have access to their money in these accounts at any point, withdrawals will weigh significantly on the compounding effect.

Tax-free savings accounts were launched on March 1 this year and allow individuals to invest up to R30 000 per annum. A capital contribution limit of R500 000 applies over the investor’s lifetime. All returns earned in these accounts (interest, dividends and capital growth) are 100% tax-free.

While National Treasury allows a variety of products within the accounts, including fixed deposits, unit trusts, certain endowments and structured products, Brown personally prefers exchange-traded funds (ETFs).

“To me a tax-free savings account in cash is a waste of a great vehicle to use.”

ETFs are attractive because it can provide superior performance in the long run at low costs, he argues.

Currently, investors have access to about 38 ETFs through various stockbrokers listed on the JSE’s website.

Brown said since some of the ETFs track the same index, investors should compare fees. While a slight difference may seem insignificant, it will compound over the investor’s lifetime.

He said brokers have really come to the party in terms of fees. Strate (South Africa’s Central Securities Depository) has also reduced its fees for the tax-free savings accounts.

Brown’s choice

Brown invested R15 000 in the BettaBeta Equally Weighted Top40 ETF (BBET40) and the db x-trackers MSCI World Index ETF (DBXWD).

The BBET40 is the equally weighted Top40 index – the 40 largest shares on the JSE but held in equal proportions of 2.5%.

Brown said he prefers it to a “vanilla” Top40 ETF because the weighting of SABMiller and Naspers in the latter ETF is collectively around 22%. A vanilla Top40 ETF tracks the 40 largest companies on the JSE by market cap.

Both SABMiller and Naspers have been running hard in recent times and although this is not a bad place to be right now, he expects these two shares to underperform over the next decades and pull the index down.

Brown said the BBET40 has underperformed the Top40 because of the heavyweight exposure to SABMiller and Naspers in the latter index, but over time he expects BBET40 to provide a smoother and slightly better performance.

The DBXWD tracks the MSCI Worldwide index which consists of over 1 600 shares.

Brown said he previously disliked the ETF because of the large number of constituents and some of its exposure.

However, things have changed. Currently around 58% of the exposure is to the United States, 8% to the UK and 8% to Germany and France collectively.

Brown said with the US the powerhouse of the economy at the moment, he is comfortable with this exposure.

During a Twitter conversation someone also asked his views on the Grindrod PropTrax Ten (the name will change to CoreShares PropTrax Ten early next month). The ETF tracks the largest ten companies in the JSE Sapy (Property) Index, but are held in equal weightings of 10% each.

Brown said he likes the ETF (PTXTEN) and might add it to his tax-free savings account next year, but this year he didn’t buy property because it is expensive.

However, he also felt this way two years ago and since then the price rallied substantially, he said.

Ultimately, every investor will have different needs and should make their own choice, but the potential compounding benefits of these accounts over extended time periods shouldn’t be underestimated.

“Shop around for a provider who is offering what you like. Maybe you want vanilla, maybe you want structured, maybe you like cash and you want cash.

“Shop around for that provider that you like and shop around for the price that you like,” Brown said.

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Do these ETFs automatically qualify as the tax-free savings or should they be “ring fenced” by brokers into tax-free accounts or products?

What dividend taxes apply with holding foreign shares in a ETF eg db x-trackers MSCI World Index ETF (DBXWD). Would there not be some foreign dividend tax payable where the stock is listed?

I just called FNB Securities to see if my existing account with them (less than R500k) could qualify for consideration as a tax-free savings account.

In short – No it can’t… Even though FNB Securities is listed as a stockbroker on the JSE’s website (link in the article). Apparently they can only do this through a ‘Share value’ account linked to an FNB cheque account. Seems a bit incongruous. It would be great if those who are already saving to take advantage of the benefits such an account would provide…

you need to have a TFSA account, it needs to be funded with cash within the limits and you can only buy certain assets within it. Hence an existing account can not just be converted.

Hi,

If i have invested in the DBXUS ETF over the past 7 months, can i allocate this investment as my Tax free savings account or do i have to specifically designate the investment as a contribution towards my tax free threshold upfront?

Thanks

you can only transfer cash into a TFSA, so no you can not move the DBXWD

Unless the TFSA is your only savings, it is the worst place to put any of the DBX ETFS. Remember, none of the foreign witholding taxes those returns within the ETF will be subject to will enjoy tax free status. So the only thing you are enjoying a tax break on is your Capital Gains, which is the lowest tax payable (generally).

“To me a tax-free savings account in cash is a waste of a great vehicle to use.” And if one is 66 years old Simon?

we’re living way longer, the old theory that we had to reduce risk to zero at 60 no longer applies. That said everything is person specific.

What about using the TFSA to improve your total portfolio’s tax efficiency through asset location? The way Simon is treating the account is all about market timing (e.g. like the world DX vs. porperty etc). However you should view all your investments (RA, provident funds, TFSA, taxable investments) as a total asset allocation as long as they all form part of the same goal, e.g. retirement savings. In this case a well diversified total asset allocation for retirement should have some exposure to property and if you’re not using a tactical asset allocation (are you really smarter than the market all the time?) and using a strategic asset allocation you would be well served in transferring/buying REITs in your TFSA as they are probably the least tax efficient asset class. I’m surprised there’s been so little said about improving tax efficiency using the TFSA, I’m guessing it’s because most brokers have no idea what’s invested in the funds they put their clients into and (maybe cynically) because it’s too much work and a pain for them to try to manage the accounts in a tax efficient manner.

you can’t out a REIT directly into a TFSA, you can however put a prop ETF. An for me it not about timing, sure I skipped PTXTEN this year, but otherwise bought BBET40 & DBXWD R15k each on day 1 of the account, price be dammed

Yip, meant REITs as an ETF not a stand alone. Out of interest and regarding your preference for the BBET40 over the market weighted ETFs a US investment house (GMO) showed that in the long run equally weighted index funds such as BBET40 should out perform market cap weighted index funds due to the fact that there is an inherit value and small cap bias in equally weighted indices. Market cap weighted indices tend to be more of a momentum play.

Exactly. I am transferring my total property exposure into the TFSA. It will take some time but yes, on principle you should take a portfolio view and allocate based on tax efficiency. However not everyone has that much savings to consider a portfolio approach

Which is currently the most cost-effective tax-free savings account that is currently available? I currently own BBET40. I would like to continue with this, but through a TFSA. I would also like to buy some DBXWD, also through a TFSA. I just need to know who to get my TFSA from.

Afrifocus and standard bank are offering tax free savings accounts with selected etfs.
To get a multi assest allocation using etfs is difficult though. The fees will eat into your profits. Simon only bought 2 etfs.

I am looking at sygnia balanced fund for my 9 month old daughter. It has bonds that im not really keen on but it has a multi assest allocation.

They also have the swix 40 and property funds I will add to when we see a pull back.

2 thoughts, 1) if it’s for your 9 month old daughter max the equity allocation or at very least go with the balanced fund with the highest equity allocation, think it’s the 70. 2) I don’t know your plan for this money but just a heads up, one of my mates had an idea to use it as a study fund for their kid however that doesn’t make sense as you’ll be denying you child the ability to add to the TFSA if you start liquidating the position as your contributions to your child account obviously forms part of the 500k limit.

Must be Sygnia – if you want a total hands of approach
Or EasyEquities if you want the cheapest why do DIY through qualifying ETFs

My last comment on the TFSA – the 500k is actually much smaller than it looks. If you max you annual contribution of R30k it’ll take you over 16 years to reach your 500k limit, assuming an inflation rate of 6% the real value of your contribution will halve every 12 years. So the real value of your contributions will be much, much lower than 500k. It’s really not as much as it sounds unless you compound it for a very long time (i.e. buy it for you kids retirement)

I would expect treasury to increase the annual and life time limits over the years, so buy the time we hit +16 years the limit would be higher

Thanks for this Simon. I notice everybody are talking about the great new investment in TFSA. As far as advice is concerned what I do miss is comparing the same underlying investments within a RA. If one is below the threshold of getting a tax rebate on allowable contributions then a RA would be a better vehicle. With the changes in the laws around RA’s where there s no maximum age that you can contribute one must look at all options and can get cash(tax) back each year. One can then structure pension withdrawals and saving some tax when into retirement.
TFSA does have withdrawing in an emergency as a plus that one cannot do with a RA.
I am sure a lot of readers are not using the full rebate on RA’s.

I did an comparison between an RA hamstrung by Reg 28 and a TFSA with a 100% equity allocation as I believe it to be a better allocation for my age
I used the 10 year return of Foord, Coro and AG equity and balance fund performance and used the average. Even with reinvesting the tax rebate, the TFSA still came out trumps. Plus the added benefit that when you start drawing your money it remains tax free unlike an RA. Now I did not compare balanced v balanced but here I assume thr RA will win come retirement date if you reinvest your tax rebate, but what the effect of the anuity tax will be post retirement on the total scenario I did bot investigate yet

Hi Simon

There seems to be mass confusion in reading the Act. It states the following:-

http://www.treasury.gov.za/legislation/draft%20legislation/20150220%20Regulations%20for%2012T.pdf (Latest version I could find, dated Feb 2015)

13. (1) Where any part of the value of a tax free investment is determined directly or indirectly with reference to any financial instrument that is a share—
(a) not more than 10 per cent of the value of that tax free investment may be derived from shares in any single company; and
(b) not less than 80 per cent of any shares must be listed on a recognised exchange as defined in paragraph 1 of the Eighth Schedule to the Income Tax Act.
(2) Where the value of a tax free investment is determined with reference to any index of listed shares, the value of shares issued by any company may not exceed an amount of 120 per cent of that company’s weighting in that index, subject to a
maximum of 35 per cent of the market value of the tax free investment.

It further states:-

13.(6) This regulation does not apply in respect of any financial instrument in respect of a collective investment scheme

This obviously affects the weighting of an individual’s investment. My understanding is that unit trusts and ETF’s are automatically excluded from the above mentioned restrictions, by clause 13.(6), as they are collective investment schemes. Is my assumption correct and which specific financial instruments will these restrictions apply to? Please expand on 13.(2) if you can.

I’m getting a bit confused now. Your reference to section 13.(1) seems to indicate that one can invest in a TFSA directly through shares. subject to a 10% limit on any particular share. While 13(6) excludes collective investments (from being excluded), it does not state that the corollary is true (i.e. that direct investment in shares is disallowed). I was thinking of using Easy Equities to build a TFSA portfolio, but not through ETF’s. Can someone clarify for me please.

If you look on Easy Equities tax free account you will see they only allow ETF’s.

I am only a little confused as satrix indi, satrix 40 ect has shares with more than 10% allocated.

I too am using easy equities to build my own diversified etf portfolio.

@ Phil99

The link states:-

“issuer” means a person or institution listed in regulation 2,

Part II: Issue of financial instrument and policy:

2. A financial instrument or policy in respect of a tax free investment may only be
issued by—
(a) a bank as defined in section 1 of the Banks Act, 1990 (Act No. 94 of 1990);
(b) a long-term insurer as defined in section 1 of the Long-term Insurance Act,1998 (Act No. 52 of 1998);
(c) a manager as defined in section 1 of the Collective Investment Schemes Control Act, 2002 (Act No. 45 of 2002), other than a manager of a collective investment scheme in participation bonds (subject to paragraph (d));
(d) a manager as defined in section 1 of the Collective Investment Schemes Control Act, 2002 (Act No. 45 of 2002) of a collective investment scheme in participation bonds that complies with the requirements of the relevant Notice that the registrar is empowered to issue in terms of section 114(4)(b) of the Collective Schemes Control Act, 2002 (Act No. 45 of 2002) and only at such time as the requirements have been determined by the Registrar;
(e) the government of the Republic of South Africa in the national sphere.
(f) a mutual bank as defined in section 1 of the Mutual Banks Act, 1993 (Act No. 124 of 1993); or
(g) a co-operative bank as defined in section 1 of the Co-operative Banks Act, 2007 (Act No. 40 of 2007).

From this extract there seems to be a strong theme of a collective investment scheme which doesn’t allow direct investments.

I’ve watched Simon’s JSE Power Hour video about TFSA and he says the clauses I posted to previously pertain to structured investments. He didn’t expand on those and spoke about ETF’s mostly.

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