Where to invest savings for optimal growth and tax efficiency remains a top priority for most investors when they seek professional financial planning advice. Saving for retirement through retirement annuities and preservation funds has always been widely recommended due to the tax benefits available.
Investors are entitled to a tax deduction on their RA contributions of up to 27.5% of their taxable income or remuneration, limited to a maximum of R350,000.
Furthermore, growth on the investment is free of any capital gains or dividend withholding taxes.
“The objective being to encourage investors to save towards their retirement to prevent them from ultimately becoming dependent on government support,” says Danine van Zyl, a financial advisor at Brenthurst Wealth Management.
Legislation designed to protect investors has, however, resulted in poor performance over several years and, as an unintended consequence, has left the assets held by investors in these products vulnerable.
Regulation 28 of the Pension Funds Act prescribes and limits pension funds to 75% equity exposure, listed property to 25% and offshore exposure to 30%.
“This composition is generally reflected in balanced unit trust funds and has been a popular choice for money managers in compliance with Regulation 28, '' says van Zyl. Most of these funds hold around 40% in South African equities. However, over the long term, the returns from the JSE have been extremely poor by global comparison.
The downside of investing in discretionary investment outside of the retirement realm, which is not subject to Regulation 28, is the liability towards interest, dividend and capital gains tax earned on the investment.
Tax-Free Savings Accounts (TFSA) offered by financial service providers in South Africa are not optimally designed to meet the intention of government initiatives.
“The government introduced Tax Free Savings Accounts to encourage long term savings, as South Africans have low and declining savings rates.” This is according to Guy Chennells, head of product at Discovery Employee Benefits.
South Africa’s low savings rate, according to research firm CEIC Data, is on a downward trajectory. The data collected by CEIC shows that from September 2021, the savings rate in South Africa declined from 17.3% to 15.2% in December of the same year.
This could be attributed to the financial burdens faced by high retrenchment rates and a high unemployment rate, with the current official national rate of 34.5% and increasing living costs. The Consumer Price Index (CPI) published by StatsSA shows that inflation has risen to above 7%. This amount is above the 6% cap that the South African Reserve Bank’s monetary policy range is trying to keep inflation in.
It is ideal for people who don’t want to lock up their money over the long term, so they can access it in case of an emergency, says Chennels.
“If you want to make an interest-bearing investment that suits your risk profile, you can get a tax break from any money market or savings account,” he adds. Interest from a South African source, earned by any natural person under 65 years of age, up to R23 800 per annum, and persons 65 and older, up to R34 500 per annum, is exempt from income tax.
“But, if you have used up that tax advantage already, a tax-free savings account will make sense from a tax perspective,” Chennels adds.
But Michael Field, COO and Head of Investments at Fedgroup, says: “In any person’s financial portfolio, tax-free savings should be one of the first considerations, but with low returns, the current offers available may not deliver the value as the government initially intended.”
“In a population with a recorded low savings rate, the accounts that are meant to encourage savings are offering low returns, leaving those wishing to save with even lower returns on their money,” says Field.
The current maximum contribution amount per year for a Tax-Free Savings Account is R36,000 and is capped at a total contribution of R500 000 over an individual’s lifetime. If an investor exceeds this amount, capital gains tax, income tax, or dividends tax from the return on the investment is required by the South African Revenue Service (Sars).
“The poor performance of tax-free savings accounts is a symptom of the disease that is the greed of some financial service providers who undercut an investor's opportunity to grow their personal wealth by offering paltry returns,” says Field.
In South Africa, tax-free savings accounts can offer returns from as low as 0,5%.
“The low returns on offer are not the only concern. Fee structures that are attached to these accounts are not always readily available to the investor or disclosed upfront,” says Field.
“And while the government is consciously losing income by waiving the tax on these accounts, financial service providers are benefiting by limiting returns,” he says.
For tax-free savings accounts to truly offer the benefits for which the accounts were intended, the returns realised should at least be higher than inflation and a zero-fee structure needs to be applied.
Service providers have resources at their fingertips that could enable them to construct products that offer truly competitive returns, adds Field, and this will allow investors the opportunity to benefit from the tax revenue concession that the government has provided to build a stronger economy with a healthier savings culture.
Tax-free savings accounts, however, do not limit investors in terms of the amount of offshore exposure as well as allocation to equities, which is the case with regulation 28.
Samukelo Zwane, Head of Product FNB Wealth and Investments, says an investor can choose several underlying asset classes in a TFSA, which include unit trusts, bank deposits, fixed deposits, exchange-traded funds, etc. “National treasury is ensuring that products with high termination penalties and risky asset classes are not permitted.”
It also provides flexibility with regards to an annual lump sum or monthly contributions made. Contributions can be as little as R300 per month and can be stopped and started at any time to suit the contributors' needs.
"There is flexibility when it comes to withdrawing funds from a TFSA, but your lifetime capital contribution will be impacted. By withdrawing R50,000 from a TFSA, your total lifetime capital contribution for that investor or saver drops to R450,000. It is thus crucial to utilise this instrument for long term savings and investment goals, as any withdrawals impact the total capital balance that can compound tax free," Zwane says.
Zwane advises that investors and savers should keep their capital contributions limited to a maximum of R36,000 per year and a total lifetime contribution of R500 000. "The annual contribution threshold runs in accordance with the tax year. The R 36,000 can be contributed as a capital lump sum at the beginning of the tax year on the 1st of March, or alternatively, monthly. The R36,000 annual threshold, however, should never be exceeded as any contributions above the R36, 000 will be taxed at 40%," says Zwane.
It is very important to note that the entire excess contribution will be taxed at 40%. Some people mistake the penalty to only apply to capital gains, interest, or dividends, but that’s not the case; it applies to the entire contribution. Therefore, avoid exceeding your annual contribution limits in a TFSA.
The R500 000 lifetime contribution does not include returns from investments and savings but rather the contributions into the fund over the lifetime of the investment. The annual contribution limits reset at the end of the tax year, the 28th of February 2022. Thereafter, the limits are reset, and the full R36, 000 can be contributed again from 1 March 2023.
"TFSAs are long-term saving and investment instruments that could be utilised by all South Africans, with 100% of all returns that can be reinvested over the long term. It’s a suitable vehicle in the fact that investors can choose different asset classes to invest in, aligning with their risk appetite and investment goals,” concludes Zwane.
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