Tax free savings accounts continue to be a topical subject amongst South Africa’s financial services companies as a number of them make these products available to customers.
HANNA BARRY (HB): Tax free savings accounts continue to be a topical subject amongst South Africa’s financial services companies as a number of them make these products available to customers. Tax free savings accounts allow South Africans to make investments of up to R30 000 a year, and R500 000 over a life time into a range of asset classes, the bonus being of course, that all interest, dividends and returns earned on these investments will be completely tax free when you do eventually cash them out.
Certainly an appealing proposition. Nadia Muller is the manager of legal and compliance at Sygnia and she joins us now. Nadia thanks for your time today. What do you think is the best asset class for tax free savings accounts and why?
NADIA MULLER (NM): Hello Hanna and yes, thank you for this opportunity. The purpose behind the tax free savings account is that this is for your long-term savings, therefore your savings horizon should not be two to three years. The whole idea with the tax free savings account is therefore long-term longevity, what is your investment goals as part of your broader financial plan? So this must be taken into consideration when you decide what asset class to invest into. Your personal circumstances and other current investments will also play a part in determining your asset class. I do know that a few IFAs have been very vocal about putting your tax free savings money into property funds. The reason for that is that all income from a property fund, including your rental distribution, will be tax free. This is of course fund dependent and this could provide you with the most tax benefits. Then on the other hand, investments in a money market fund in the short term will not provide much tax benefit as you already have an interest tax allowance.
However this interest amount will build up if you are contributing the R30 000 per year that you mentioned, to a money market type investment. And then therefore generally, when one looks at what is the best asset class, generally investments providing a long term capital and income return where your tax cost would have been the greatest, are the products that you should be considering in your tax free savings accounts and that of course is on the assumption that these would have formed part of your overall financial plan even without this tax free savings benefits.
HB: When it comes to those exchange traded funds those have of course gained popularity in recent years, and I think continue to gain prominence and popularity because of the low fees many of those funds charge. Are exchange traded funds a good asset class or what would be the benefit of those when it comes to a tax free savings account that is also an ETF?
NM: Well generally ETFs together with unit trusts for example, are underlying instruments that tax free savings accounts can invest into and as such most unit trusts, exchange traded funds, savings accounts your fixed deposits, your RSA Retail savings bonds need to meet requirements to be classified as tax free savings accounts, bearing in mind that as long as none of these previously mentioned ask performance fees. ETFs also have further investment restrictions unless they fall under the Collective Investment Schemes Control Act, so when looking at these types of investments, one should also take into consideration the investment restrictions that have been placed in terms of regulations.
HB: Let’s talk about people that have existing investments and suddenly now want to pull them into tax free savings accounts or transfer those investments – I think that question is often asked – is that something that I should be doing? And especially people with long term investments already which is something you mentioned, tax free savings accounts are really trying to achieve amongst South Africans is long term savings. So with something let’s say like a retirement annuity is this an either/or – should someone if they have an RA, either have an RA or a tax free savings account, or should they pull money from one to the other. How should they approach it?
NM: Hanna one should not look at an either/or scenario, as both these savings vehicles have their own specific benefits. A tax free savings account is a highly tax efficient way of supplementing an investor’s regular pre-retirement savings and one should also take into consideration that the intention of the tax free savings account was not to replace the retirement annuity. Then if one also looks at a few differences between a tax free savings account and retirement annuity that sort of would assist in answering the question would be that from a tax perspective, a retirement annuity is invested with your pre-tax money, whereas in a tax free savings account you invest with post-tax money. Another consideration is that your tax free savings account will form part of your estate for estate duty purposes whereas a retirement annuity won’t. In the tax free savings account, again the investor can access capital and income at any time, obviously dependent on the turnaround time for the specific product provider. But both the capital and income in an RA you can only access at a future time. Your contributions are also limited with a life term cap in your tax free savings account where there’s no limit placed on your retirement annuity for a lifetime contribution. And also a very important consideration is a tax free savings account can also be attached by your creditors, where you are afforded protection against creditors in terms of your retirement annuity. So for me personally one should never look at either a tax free savings account or a retirement annuity, one should look at a holistic view in terms of your financial plan and see which one can supplement the other.
HB: Nadia is there a minimum age that you have to be in order to invest in a tax free savings account or could for arguments sake a 13 year old decide to invest in one?
NM: Yes. Hanna there is no age restriction, children can invest in a tax free savings account. One must just remember that your tax free savings account must be in the name of the actual child. Even if the parent contributes on behalf of the child, that investment must be in the name of the 13-year old. One must also take note that no deposit or transfer in respect of the tax free savings account owned by a child, may be paid into an account of another person. Meaning when money is paid and it’s for the purpose of the child, all money paid into that account and all money taken out of that account must always be in the name of the child. Another consideration also is the R500 000 lifetime limit is based on the tax free savings owner, not the person who paid the money. So those limits that have been placed of R30 000 for a year and R500 000 for a lifetime, is that of the child. So once the child in later years reaches a certain age and needs money, the child in later years may not be able to still contribute towards that tax free savings account if that R500 000 limit has already been reached. But in saying that the state of the investment, when the child does want to take money out of that account, at that stage the investment should have grown fairly substantially. So the benefits again probably outweigh the loss of a tax free savings account investment in later years of not being able to contribute additionally to it.
HB: You mentioned some of the limits that are imposed on these accounts in terms of maximum contribution and I brought those up at the beginning. It does seem though that these tax benefits are hard to beat and the compounding interest that one would achieve over a long term. So certainly this seems like a cheap way to save, do you think it’s an effective way to save?
NM: Well any fee charge in respect of a tax free investment must be reasonable and that is what is stipulated in terms of the regulation. Now a distinction therefore needs to be made between tax savings and management or other fee savings associated with tax free savings accounts. These accounts are definitely a cost effective way to save from a tax perspective, and although investments with performance fees are not allowed, one should ascertain whether the management fee or other fees that you will pay is the lowest fee available. For example, your management fees, your broker fees, the advisor fees etc. will differ between different product offerings and underlying investment choice. So therefore when looking at it from a tax perspective, it is definitely a cost effective way to save, but it’s not necessarily the cheapest way if you are not sort of shopping around between your product providers and ensuring that you know exactly what your administration fees you are paying, what platform fees you are paying, what management fees you are paying.
HB: Nadia Muller is the manager of legal and compliance at Sygnia.