TFSA vs RA

Deciphering the investment choices.
‘Retirement annuity’ or 'tax-free savings account' – it’s actually a choice between great and awesome, and will depend on your circumstances and goals. Image: Shutterstock

I know, you’ve heard it all before – you need to save for retirement, pay yourself first, and look after your future so you don’t have to leech off your kids in your old age.

And it’s true. One day you won’t be able to earn an income, and you’ll have to have an investment big enough to pay the bills and hopefully leave you with a little extra.

Everybody knows the theory, and many have every intention of putting it into practice, then … bam! The industry hits you with some abbreviations – “To start investing for your retirement, consider an RA and/or a TFSA because there are some really great tax benefits.”

Those who make it past finding out that RA stands for ‘retirement annuity’ and TFSA stands for ‘tax-free savings account’ are hit with something even worse – having to choose.

And this is where I feel many potential investors who want to start looking out for their future end up freezing and doing nothing. Petrified of choosing the wrong option, they never actually invest in an RA or a TFSA because making the ‘wrong’ choice seems worse than doing nothing.

But the great news is that there’s no right or wrong choice here. It’s a choice between great and awesome.

RAs and TFSAs are both fantastic ways to invest for retirement, while protecting you from paying tax. Here’s how each works and the rules around them:

How an RA works

An RA is basically an investment account that holds some investments. You can put unit trusts, exchange-traded funds (ETFs) or even cash in your RA, and they will be protected from tax while they are inside the RA.

  • Tax treatment of RA contributions

The money you allocate to an RA can be deducted from your annual income before you pay tax. For example, if you earned R250 000 for the year and put R1 000 a month or R12 000 for the year [into an RA] you’re only taxed on R238 000 (not the full R250 000 that you earned). The cool kids will tell you that contributions to an RA are ‘tax deductible’.

This is what it looks like:

Source: Stealthy Wealth

  • RA contribution limits

Sars is quite generous in allowing you to deduct contributions to an RA from your income before you’re taxed.

But this doesn’t mean that if you could contribute your entire salary to an RA (maybe by living in your parents garage) you’d pay zero tax. Sars caps the amount of RA contributions you’re allowed to deduct from your income.

The maximum you may deduct is 27.5% of your annual income or R350 000, whichever is lower. Unless you’re earning over R1.27 million a year, you won’t have to worry about the R350 000 number – for us mere mortals the 27.5% applies. If you want to calculate your maximum tax deductible RA contribution, here’s how.

  • Tax on RA investments

A really great feature of RAs is that you don’t pay any tax on the investments inside. This means no tax on interest earned, dividends or income and no capital gains tax on sales. That’s a lot of ‘no tax’, which means your investments work harder for you because you keep more of your returns.

  • RA investment rules

There are some rules around what you can and can’t put inside an RA. Sars has a local-is-lekker approach to RAs, so no more than 30% of your investments can be outside of South Africa. (You’re allowed an additional 10% into Africa, which means the offshore maximum is then 40%).

You’re also not allowed to have more than 75% in equities or 25% in listed property.

  • When can you access your RA?

RAs were specifically designed to help people save for retirement. And since the commonly accepted ‘earliest’ retirement age is 55 (of course those of you aiming for FIRE or ‘Financial Independence, Retire Early’ know this minimum age is a crock), you cannot access the money inside an RA until you’re 55.

Read: What it takes to retire at 45

But this might actually be a good thing. No access before 55 forces you to be disciplined and to stay invested until you’re retired.

There are a few ways you can get your money out sooner, but these are pretty much limited to financially emigrating from South Africa or as part of a divorce settlement. There may also be tax payable if you take the funds out early.

  • Rules when accessing the money inside an RA

Once you reach age 55, and your RA matures there are some rules around what you can do with the funds inside it. You’re only allowed to take a maximum of one third of the value as cash (unless the total value of the RA is less than R247 500, in which case you can take it all out as cash).

The remaining two-thirds of the value of the RA must be used to buy either a living or a guaranteed annuity (or a combination of both). The idea is that this annuity will pay you an income when you’re retired.

  • Tax when accessing an RA investment

Since Sars has allowed you to deduct tax while contributing to an RA, and allowed the RA investments to grow tax-free, it unfortunately has no issue trying to get some tax out of you once you retire.

The up to one-third cash you’re allowed to take is taxed according to a retirement tax table.

In addition, the monthly income generated from the living/guaranteed annuity you buy with the remaining two-thirds is subject to income tax according to the income tax table.

How does a TFSA work?

A tax-free savings account is basically also an investment account that holds some investments. You can put unit trusts, ETFs or even cash inside a TFSA, and these investments will be protected from tax while inside the TFSA.

  • Tax treatment of TFSA contributions

The money you put into a TFSA cannot be deducted from your income for tax purposes. In other words the money you invest will be after-tax money. Something like this:

Source: Stealthy Wealth

  • TFSA contribution limits

As it stands, you aren’t allowed to contribute more than R33 000 in a tax year to a TFSA (or R2 750 a month). If you invest more than the limit, you’ll be taxed at 40% of the amount by which you exceeded the limit (eina!).

There’s also a limit on the total amount you can contribute to a TFSA over your lifetime. This is currently set at R500 000. If you contribute the maximum annual amount (R33 000) each year it’ll take you a little over 15 years to reach the lifetime limit.

Note, contribution limits only apply to money that you put into a TFSA. Thus any interest, dividends or proceeds earned from the investments inside the account won’t affect your annual or lifetime limits.

  • Tax on TFSA investments

Just like RAs, there’s no SA tax payable on any of the investments inside a TFSA. No tax on interest earned, dividends or income and no capital gains tax on sales.

Thus your returns will be super-charged because of the tax protection you get. 

  • TFSA investment rules

Because Sars is incentivising you to save for your retirement (by giving you some pretty cool tax breaks) it does impose a few rules around what you can invest in. Most unit trusts and ETFs are available, but you aren’t allowed to invest in commodities (such as gold and platinum). This is because without this restriction, there would be nothing to stop an investor from putting their entire retirement savings into gold, for example, which is not diversified and therefore really risky.

You’re also not allowed to invest in exchange-traded notes (ETNs) since it’s technically possible for you to lose all your money in an ETN if the provider goes bankrupt (no such problem exists with ETFs).

  • When can you access your TFSA?

The hinges of the door to your TFSA money are pretty lose. You can take money out at any time. This is great for those who are pursuing early retirement (guilty as charged) because it means you can access your money at whatever age you need it. It’s maybe not so great for those who will be tempted to dip into their investment when they’re short of cash.

Note, any money taken out of a TFSA cannot be ‘replaced’ without affecting your limits. For example if you put R20 000 into your TFSA and then took it out again, you’ll only have R13 000 you can put in for the rest of the year before you hit the R33 000 annual limit. You will also only be able to contribute another R480 000 over your lifetime.

  • Rules when accessing the money inside a TFSA

TFSAs are the gymnasts of the retirement product world – they’re really flexible!

Unlike an RA, there are no restrictions about how much you can take out as cash, or what you have to use that cash for.

  • Tax when accessing a TFSA investment

There’s no tax payable when accessing the money inside a TFSA. Because you use after-tax money to make contributions to a TFSA, Sars has already taken its cut and is happy to let you keep everything that comes out of your TFSA.

TFSA vs RA – A summary

The above may still seem a little overwhelming, so I summarised the most important aspects into a compact picture:

 

Source: Stealthy Wealth

So, which way to go?

Now that you know the ins and outs of RAs and TFSAs, you may be wondering which would work better for you.

They’re both excellent ways to save for retirement and the tax breaks are awesome, so you will do well in either one.

However, a few game-changers may make one much better suited for your goals than the other:

  • When do you plan to retire? If you plan to retire early, you may prefer a TFSA since you won’t be allowed to access any money in an RA until you’re 55.
  • Do you have a work pension fund? The tax treatment and rules around pension funds and RAs are pretty similar. This means you already have a RA-type product through your employer and may want to consider a TFSA instead of an RA so you can diversify your tax treatment.
  • Are you in a high tax bracket? If you’re a high income earner and find yourself in one of the higher tax brackets, the tax deductions on RA contributions can really super-charge your investments and could leave you better off than if you used a TFSA (especially if you will find yourself in a much lower tax bracket once you retire).

The combo option

If you’re still undecided, there’s nothing wrong with doing a combination of an RA and a TFSA (there are no rules preventing you from having both). That way you can get the benefits of both types of retirement products. Going this route will also give you a lot of flexibility when you do retire.

Finally, here’s a really great tax hack (which I first came across courtesy of Nerina Visser from etfsa.co.za):

Because RA contributions are tax-deductible, you get a tax refund after you submit your tax return. Take this refund and plug it straight into your TFSA, and let Sars fund your TFSA for you.

What a win!

This article was originally published on the Stealthy Wealth blog here

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COMMENTS   41

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R500 000.00 is the limit. R33 000.00 per year for 15 years. That is not even close enough to retire with.

At least it’s something! Glass half full mentality!

No, the glass should be full. Accepting a half full glass is what is wrong with this country.

The contribution limit is 500k.This could grow over time to say R2 million. The growth is absolutely tax free. Still not great but certainly better than nothing.

The R500k cap is the total of contributions you can make. However the benefit is that the growth on your capital contributions over a period of 15 years can be staggering. And THAT …. is all TAX FREE.
So for instance, over the period of 15 years you earn interst and dividends and that is all reinvested, the market recovers every now and then and you end up with a way above inflation growth. You may have a few million earning interst and dividends on which you now pay ZERO TAX.

The contribution time limit is over 15 years.BUT you could start at 21, stop contributing at 36, 15 years later, and leave the investment to grow until you are 65. There is no limit on the length of time of the investment.

If the TFSA scheme is successful, treasury would probably have to increase the maximum limit over time. Inflation over 20 years would cause the maximum 500k to kill TFSAs. 5% inflation over 20 years, the effective 500k is 188k in todays money. I believe it is highly probably that the maximum cap would be adjusted so that we will be able to make the annual contribution adjusted for inflation periodically, forever. And even if that doesn’t happen, it is still tax efficient.

raymondbc, R500k is the limit to the contributions and not the end value of your TFSA. While inflation does its damage, compund interest will be fighting for you. So the end result of a maxed out TFSA might surprise you.

This morally bankrupt government entice you with these little “Tax gifts” to keep investing locally. In addition they know exactly where your money is.

Wont be long before they will get their grubby little paws on it.

Take your money and run.

I think some of the ETFSs under TFSA invest internationally. Yes, you don’t take the money out of the country.
In any case, if you really want to move your money out then why not use the R10m annual allowance?

Your TFSA can be 100% international. There are any number of suitable ETFs for international equities, property and bonds.

Agree Raymondbc. Just be mindful that (unlike local dividends which are tax-free within TFSA) and foreign dividends from international-ETF funds, will still be TAXED within TFSA.

I may be wrong, but I think the same goes for REIT income as well….local REIT income within TFSA are tax-free (along with interest & CGT gains), but foreign REIT income may still be taxable (even if within TFSA)

In UK limit is 20 000 pounds per annum. 33 000 zar sucks in comparison.

Yes, the UK has a higher contribution rate (GBP20k vs our GBP1.7k) but they have a Median disposable income per person of USD22k whilst we have USD4k (per quick wikipedia search). So it does not look that out of whack. Plus, they have more limitations on their contributions into their RA equivalent.

The UK offer is better; I use to have a TFSA and closed it. You have many options with an ISA and you can do pure share trading to help to buy your first house with government help, including a co-contribution from government for saving…

The RSA/TFSA is a poor offer.

The cash ISA actually started at GBP3,000 and share ISA at GBP7,000. It stayed that way for 10 years before being increased.

Whilst in SA the annual contribution has already increased from R30,000 to R33K since inception.

The UK ISA equivalent is great if you living in the UK and paying tax in the UK, but if you in SA, SARS does not recognize the tax benefits of an ISA – so it is a totally irrelevant point.

Not using your TFSA as an investment wrapper each year is just plain stupid.

Why doesn’t the author tell the readers about the real risk with retirement annuities, namely the ruling regime’s threat to force the service providers to “invest” in loss-making state enterprises? Any young person needs to think really, really carefully if he wants to take that risk.

Agreed.

For me, asset allocation and risk considerations first, tax efficiency second.

This is a very real concern with RA’s and pensions. Quite a few people I know of have resigned on retirement age rather than take pretty handsome pension payouts. You take a tax knock but, if you are talking substantial money, you have enough left to do as you please with and for it to be under your control.

Of course advisers will hum and ha as they, and probably no one outside of (a few) of the ANC regime elites, know what the future for prescribed asset investment is.

Thanks, I’d read about that but not thought about it deeply (23 year old). Is a regulation 28 compliant set of unit trusts a better alternative to an RA? Can you link me to something I can read?

Negus, you’re still young. There’s a high likelihood that you’ll find employment abroad one day (and lesser so with our older commentators).

An RA, while it’s a great tax deduction (especially if your marginal tax brackets are high…but you may still be starting off your career path in lower tax brackets..), you’ll have to wait until 55-age before you can withdraw. And ask yourself, what would the SA tax rates be like when you reach 55-age(?) (the tax-free R500K, God forbid, could be left the same, i.e. became worthlessly small). You lock yourself in until 55 age…OK…creditors can’t touch you prior 55-age…but you invest NOW in something that you don’t know how the Tax-environment is going to be when you withdraw upon retirement (even if you go abroad while the RA is left paid up in SA…it will still be taxed based on SA tax rules, irrespective where you find yourself one day).

Young people are more globally mobile these days. I’d rather start with a local TFSA savings investment and use the limits to the max (and add with Unit Trust if you want to save more than R33K p.a.), with the OPEN-ENDED ability to withdraw at any time. There’s no tax deduction on contributions, but you can one day transfer your money abroad under the R1mil p.a. (‘SDA’) without SARS clearance.

Easy Equities happens to be a great starting platform (and low trading cost), and besides offering shares on the JSE, they offer RA Funds, TFSA, ETF’s (and you can switch funds to a US-dollar share-trading account, investing abroad, in a broker-nominee account setup).

“Love, from Dad” 😉

Ok 6% and no tax means it’s a bit more than that but what about eg. STDs Global Feeder Fund which did 22% last year? Ok there are fees but am I missing something here???

I think everyone is forgetting that the two options are not mutually exclusive. Why not save R33 000 per year in a tax free savings account and as much as one can in a RA. Obviously one could do it the other way round as well i.e. save in a RA and put any surplus funds in a tax free account.

For people concerned about SA their are tax free options that are 100% invested in offshore investments. Investing in RA’s the maximum that one can invest offshore is 30% although I did see something to the effect that one can invest a further 10% into the rest of Africa.

TFSA is a great way to supplement a pension. Assume you need a pension of R40k per month. Then calculate how much tax you save by taking R10k from the TFSA and the balance from your living annuity. Don’t forget the R500k tax free from the RA can also be used to pay monthly income needs.

I am still working but we have retired from all our RA’s. The 2.5% pension is paid back to a new RA. Freedom at last! Now the headache is how to invest the LA funds in bubble territory.

Maybe I have got it wrong about RA’s but please hear me out: Suppose you invest R100,000 at 10% per annum for 5 years then it is worth R161,051. After tax of 40% on income, you have R96,630 left. However suppose you invest R100,000 – R40,000 = R60,000 at 10% per annum for 5 years then it becomes R96,630 which is exactly the same, but your money is not fixed until you are 55. (Given the political situation in SA and things that are changing so fast, I do not want to invest my money for the next 12 years.) So what is so great about an RA?

What RA is giving you 10% a year????

My RA did 14.49% over the last year. I had ZERO SA equity and property exposure.

@magszinovich – I said what RA, you still didn’t disclose it

It’s not the RA that matters, but the underlying funds. I manage my RA myself.

Magzinovitch, regulation 28 stipulates that you can only have 30% offshore. Please explain how you had 0% SA equity exposure.

Bob, it is quite possible to get over 10% but then you must manage it yourself.

This is what is possible with Allan Grey – one can do much better with PSG, Sanlam and others as they offer more funds to choose from.

REGULATION IS A BUGGER BECAUSE OF THE LIMITS ON TOTAL EQUITY OF 75% AND GLOBAL EQUITY OF 30%.

The model maximises equity @ 83.5% (30 + 53.5) with the balance an income fund and this is my version of a balanced fund (for my wife). The returns are for a lump sum made at the beginning of the tax year.

I used PSG’s unit trust data spreadsheet for the 12 months returns.

% Holding 12 mths Return
Coronation Optimum Growth Fund (Class P) 30,0% 26,75% 8,03%
Coronation Top 20 Fund (Class P) 53,5% 17,14% 9,17%
Investec Diversified Income Fund (Class H) 16,5% 8,67% 1,43%
Total Gross Income 18,63%
Less fees 0,56%
Net Return 18,07%

(my wife will have to balance beginning of March as AG enforces Reg 28 very strictly)

Note that most of the gains came from global equities. The investment in the income fund was necessary to balance the allocation.

If you contribute to a RA now you ‘save’ tax at your marginal tax rate, e.g. 40% in your example. In retirement after age 65 you will pay tax on the monthly pension based on the tax scale, starting at 18%, with a higher tax threshold; meaning you should pay less tax. You also expect to receive higher growth in a RA than an after-tax investments since there is no tax payable in a RA (income and CGT).

If your marginal tax rate is 40% a R100k investment costs you R60k. You only pay any tax after retirement when you draw income. There are several ways to reduce your marginal rate at that time.

You are ignoring the lower tax rate on the 1/3 lump sum, and the CGT (or tax on interest depending on the underlying investments) on the R36,630.

Great article, but this of course ignores two great risks of your RA:

1) Regulation 28, which limits the amount of offshore exposure. If SA is going to be left to the dogs, then why the hell should you be forced to invest 75% of your retirement earnings in this country.

2) All this talk about prescribed assets of pension funds. Essentially, the government will force you to donate some of your pension money to save Eskom, SAA, etc. So essentially, you will be losing some or all of your tax benefit.

Although with the limits in the TFSA you will likely never be able to retire, it has the very attractive benefit of allowing you to invest where you want, sell when you want, and being protected from cadres.

My humble advice: maximise your TFSA contributions yearly and get your money into low cost ETFs ASAP (Sygnia, Satrix, etc).

@Dannymyboy. Agree with your points. I also prefer TFSA (over UT) if the low annual cap is not a hindrance.

However, I believe ALL local asset manager products (be it TFSA, UT, ETF’s) may also be subject to “prescribed assets” along with all the Reg 28 compulsory funds 🙁

(It’s as simple as enacting a law to encompass everything. Govt may start with Reg 28 funds, but may not end there…)

The only area where one may escape “prescribed assets” are, if you own direct shares on the JSE (…but “PA” could also have a depressing effect on the local market. Same pond…little escape?)

The best alternative is direct offshore investments (be it via a foreign bank account / asset manager / or via stock-broker) held in your name abroad. Be aware that a foreign Will is recommended, and Estate Duties in some counties could be higher than SA.

Let’s send Ace to Davos to try and explain prescribed assets

It’s 30% offshore (plus 10% Africa ex.SA)

A TFSA with global ETF-funds remains a great rand hedge. Do like them.

Only caveat, is that withdrawals can only be received in rands.

While it’s a very cost effective rand hedge, any TFSA investment (irrespective the underlying fund it holds) may not escape prescribed assets if/when implemented (along with Reg 28 funds). Because its “locally domiciled” registered funds facing this potential sovereign risk.

Prescribed assets just need the amendment of an act / Parliament approval. (…look how far legislative steps of EWC & NHI have come thus far….since the years of it being a mere ‘rumour’)

There is a reason why Govt made TFSA (& RA’s) tax friendly: notwithstanding it’s a way to save for retirement….the bulk of capital is re-employed back into the SA economy.

This allow for the ANC-regime to gleefully jump into the ENCLOSED chicken pen.

What about the cash flow problem of a RA. If you’re not careful you might have millions in your RA but not be able to draw enough to cover your monthly expenses.

End of comments.

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