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Tax-free savings account vs discretionary investment

Why you should start investing March 1.

JOHANNESBURG – The introduction of tax-free savings accounts on March 1 this year could result in considerable benefits for long-term investors who previously favoured discretionary investments through unit trusts, exchange-traded funds (ETFs), retail savings bonds and bank deposits.

Although industry is still awaiting the final regulations, individual investors would be able to contribute R30 000 per annum to tax-free savings accounts (R2 500 a month). The lifetime capital contribution will be capped at R500 000 and investors who invest the maximum monthly amount will reach the lifetime limit after 200 months. While no new capital contributions will be allowed beyond this point, the capital and its proceeds could remain invested to reap the benefits of compounding.

Investors will be able to access the funds in these accounts as and when they see fit (although it will not be transactional accounts), but in order to discourage impulse withdrawals, amounts returned to the account will be subject to the annual limit.

The main advantage is that all growth in these accounts – interest, dividends and capital gains – will be completely tax-free.

First mooted in the 2012 Budget Review, the introduction of tax-free savings accounts is an effort by National Treasury to encourage South Africans to save. Treasury hopes that these products will help to reduce the financial vulnerability of individuals and that the overall savings levels in the country will improve as a result.

Government, platforms (linked investment service providers), managers of registered unit trusts, long-term insurance companies and licensed banks will be allowed to offer these accounts.

While one could expect considerable marketing of these accounts in the coming weeks, its true benefit is probably best explained by way of an example.

Crunching the numbers

In an article featured in the South African Index Investor’s Fourth Quarter Newsletter, Daniel Wessels, a financial advisor at Martin Eksteen Jordaan Wessels in Cape Town, compares the benefits of investing in a tax-free savings account with a typical discretionary investment (for example a unit trust, ETF or fixed investment or a combination thereof).

The comparison stems from the fact that many of the underlying investments within these tax-free savings accounts will be exactly the same as current unit trusts, ETFs or fixed investments on offer, with the exception that the tax-free savings account will cover these investments in a “tax-free wrapper”. While most product providers still need to launch their tax-free savings accounts, one assumes that some of them will “relaunch” existing products within a tax-free wrapper.

Wessels used the same assumptions for both scenarios, namely a monthly contribution of R2 500 (thus R30 000 per annum), an investment period of 200 months (the time it takes to reach the R500 000 lifetime contribution limit) and an asset allocation of 65% to equities and 35% to interest-bearing assets.

A dividend yield of 3% on the equity portion of the portfolio applies while interest accrues at 7% per annum.

As far as the discretionary investment is concerned, interest is taxed at the individual’s marginal rate and dividend withholding tax of 15% applies. At the end of the investment period capital gains tax is levied.

In comparison all proceeds on the tax-free savings account are 100% tax-free.

The investor in a tax-free savings account would accumulate R1 594 794 over the period if the nominal portfolio return is 12% per annum (12.68% annualised).

The discretionary investor with a marginal tax rate of 30% will only accumulate R1 419 450 over the same period (after tax).

“Depending on one’s marginal rate of tax, the tax erosion of investment value can be substantial. With an ordinary investment, and a person paying the maximum marginal rate of tax (40%) up to 15% of the final value that would have accumulated in the tax-free savings account will be forsaken,” Wessels notes.

The table below shows the impact of tax on the discretionary investment over a period of 200 months for various marginal tax rates:

Marginal tax rate 18% 25% 30% 35% 38% 40%
After-tax value in discretionary investment as percentage of final value in a tax-free savings account 93% 91% 89% 87% 87% 86%
Source: Daniel Wessels

The numbers highlight the significant tax benefit of utilising one or more of these accounts – potentially using the exact same underlying investments as the discretionary portfolio.

“The benefits of the tax-free savings account are real, especially if the investment is kept for the longer term in so far one is maximising the tax benefits from the investment and the compounding effect thereof is given sufficient time to work its magic,” Wessels says.

This is illustrated in the table below. It highlights the difference between the performance of a discretionary investor with a 40% marginal tax rate and a tax-free savings account investor where both investors cash out their savings after a specified period.

Period of withdrawal Margin of outperformance of tax-free savings account relative to the discretionary investment
36 months 3%
60 months 4%
84 months 6%
120 months 9%

 Source: Daniel Wessels

The tax benefit of the tax-free savings account really becomes significant over a period of 15 or 20 years, Wessels says.

Investors who stay invested over the long term and resist the urge to cash out the funds will reap the rewards, he says.

* If your company will offer tax-free savings account products from March 1 (or thereafter) I would like to hear from you. Please send an e-mail with information about the product(s) to


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