Warren Buffet once wrote, “Someone’s sitting in the shade today because someone planted a tree a long time ago.” This advice from one of the world’s most successful investors highlights the importance of planning for your financial future.
Whether you’re a 22-year-old starting out at your first job, or a 55-year-old dreaming of retirement, the best time to start saving is now: especially as the end of the tax year approaches on 28 February. The small steps we take today can have a big impact later, through the power of compound interest.
Put simply, compound interest is when you earn interest on both the money you’ve saved and the interest you earn. It is best explained using a practical example: Thandeka puts R1 000 in a savings account at the age of 25. Her investment grows 5% each year. In the first year, she earns R50 in interest. By the second year, that goes up to R52.50, made up of R50 on her initial investment of R1 000 and R2.50 on the R50 of interest earned the year before. By the time she turns 60, her savings will have grown by 451% to R4 510*.
While it’s true that you will benefit more from starting to save early, it’s never too late to start. Compound interest has a powerful effect no matter the time period in which you save – so every little bit helps to make retirement more comfortable for you and your family.
Put your money to work
More than half of South Africans do not have a retirement plan. With many people losing their jobs or receiving lower salaries during the COVID-19 pandemic, it has become even more challenging for families to save. For those who can save a little each month, the wide range of investment options can be overwhelming. Fortunately, there are many user-friendly investment platforms available that can help a new investor create and manage their own portfolio.
There are two products, amongst others, that are particularly beneficial when saving for the future: retirement annuities and tax-free savings accounts. To encourage South Africans to save, the South African government has made both these products tax-free – which means any money you make from your investment is not subject to tax, and this tax saving is added to your return on investment.
A retirement annuity is a private fund that an individual opens to save for retirement, as opposed to a company-linked pension fund, that is associated with a specific employer. A person has to be in an employer/employee relationship in order to be a member of its pension fund. Retirement annuities are strictly governed by specific regulations to make sure that no unnecessary risks are taken with retirement investments.
Having a retirement annuity allows you to reduce your income tax, effectively rewarding you for making provision for your retirement.
A maximum of 27.5% or R350 000 of your taxable income is tax deductible in each tax year. There are no limits on the contributions you make, but you can only access your money after you retire. This rule could be subject to change if the SA government’s proposal for a “two-pot” system is approved, which could allow investors to access a small portion of their retirement savings before they retire.
A tax-free savings account allows an individual to invest in a range of funds on the market in an easy, flexible and affordable way. Because they are not governed by the same strict regulations as retirement annuities, you can select other options – such as an offshore fund – if it suits your needs and your risk profile**. While this type of account can be used for any long-term saving goal, it’s a smart way to use benefits from tax-free investments together with an annuity to maximise returns for retirement.
A tax-free savings account is considered more flexible than a retirement annuity, giving you access to your money throughout your investment. Should you elect to withdraw your savings, either as a lump sum or as a monthly income, there is no tax on the withdrawals. With this option, the contributions you make do not reduce your income tax, but you will not be taxed on the returns you earn on your investment. A practical example is that your contribution can be as little as R250 per month or a lump-sum contribution of up to R36 000 per tax year for 15 years, with a lifetime limit of R500 000. It is important to note that exceeding those limits, could result in the excess contributions being penalised at a steep tax rate of up to 40%.***
Tax-free savings accounts may have lower fees than other investment options. Take the Absa Investment Management Service’s tax-free investment account, as an example. It offers a transparent annual fee of 0.10%****, regardless of the investment value.
When and where to start
It’s always a good time to start saving, but the end of February marks the end of the tax year, which means there isn’t much time left to take advantage of this year’s tax benefits.
As a first-time investor it’s a good idea to read up on the tax-free options available, identify your saving goals and choose the product best suited to those goals. A professional financial advisor can help ensure you invest your hard-earned money responsibly.
It’s time to plant that tree and enjoy the shade in years to come.
Shaan Watkins is head of Absa Linked Investments
*This example is used for illustrative purposes only.
** It is acknowledged that each person who reads this article has unique financial needs, and this article is not intended to provide financial advice.
*** Depending on tax rate of investor
****Fee as at 25 February 2022