I got married in September. My wife and I have four kids from our previous marriages. We are battling to choose an investment vehicle for our kids. My two kids (age two and three) have tax-free savings accounts, while her children (age five and 11) have educational policies, which I am against. What is the better option for our children: TFSA or retirement annuities or endowment policies?
Thank you for your question. In drafting this response, I have assumed that the investment horizon for these investments is a long-term one – either to use for their tertiary education or to put towards a car when they reach age 18. In order to provide a comprehensive answer, I will briefly set out how each of the suggested investment options work so that you can determine whether they will be beneficial to you.
While contributions towards a retirement annuity are tax-deductible, the deductions are only deductible in the hands of the owner of the retirement annuity. This means that opening a retirement annuity in the name of your children would not result in any tax advantage. Further, the investment strategy would be restricted by Regulation 28 of the Pension Funds Act which limits offshore exposure. In addition, your children would only be able to access the funds in the retirement annuity when they reach age 55.
Endowments are policy wrapped investments that have a restriction period of a minimum of five years. There are no rules governing what investment strategy you may invest in and, while there are certain rules to allow some access to the funds even within the restriction period, the main benefit of the endowment policy is the tax rates applicable to the investment. Endowments are taxed at a flat rate of 30%. This means that if an individual is in a tax bracket above 30%, an endowment policy will make financial sense as the tax applicable on income earned would be at a lower rate than if it was in a normal unit trust investment, as well as having a lower effective tax rate on capital gains tax.
Tax-free savings account
A tax-free savings account is exactly what it says on the box. It can be a money-market/cash linked account or an investment that grows tax-free and does not incur any capital gains tax when making a withdrawal. It is important to note though that contributions made towards a tax-free savings account are not tax-deductible and individuals only have a R36 000 contribution limit per year.
Taking the above three investment structures into consideration, if the idea is to invest the money in the name of your children and to have the funds invested for the long-term, it would make sense to make use of a tax-free savings account for them.
Depending on the platform you use and what funds they have available, you would have complete flexibility in choosing how the funds are invested and have no restrictions on offshore or equity exposure. The main advantage would be the tax benefit. No interest or dividends tax can, over a long investment period, result in better returns. No capital gains tax on the withdrawal is also an advantage of the TFSA, especially if the funds have been invested for a long period of time and grown substantially.