Incentivising non-retirement savings in South Africa through Tax free savings accounts

National Treasury introduced the Tax free savings account and these accounts have been available since 1 March 2015, available through a variety of providers.

These accounts are intended for discretionary non-retirement savings and have certain distinct features which should make them very appealing to investors. Even though the intention is that they will be used for non-retirement savings, many investors will invariably use them to accumulate wealth for their retirement. The reason for this is that the longer term allows an enhanced compounding effect since you can earn returns on the tax saved.

The better known mechanism to incentivise non-retirement savings in South Africa is the annual interest exemption. Even though this exemption will still be available going forward, it will not be increased in future and will effectively be inflated away over time. This makes the Tax free savings accounts the primary long-term mechanism to incentivise savings.

As part of this incentive, investment companies must ensure that the account which they offer must be simple to understand, transparent, flexible and should not levy undue penalties.

The primary features of the Tax free savings accounts

The Tax free savings accounts allows you to contribute a total of R30,000 per annum into your Tax free saving accounts, whether you have one or many.

• Your contributions will not be tax deductible
• All the return within your accounts (whether it is in the form of dividends, a capital gains or interest) will be free of tax in your hands and in the hands of the life assurer (if the Tax free savings account is housed in an endowment policy)
• Withdrawals from a Tax free savings account will not be taxed in the hands of the individual or in the hands of the life assurer (if applicable)
• The funds within the Tax free savings account will be accessible (even if the Tax free savings account is housed in an endowment policy)

Additional features

• You will have a lifetime contribution limit of R500,000 (It is not intended that the lifetime limit will be increased by inflation in the short term). It is also a reasonable assumption to make that the limit won’t be increased for a very long time period, otherwise it would be of no use
• Once a withdrawal has been made, the amount cannot be placed back into the account (it has to be invested as a new contribution and will count towards the R30,000 annual limit and the lifetime limit)
• The ability to transfer these accounts between product providers (without impacting on the contribution limits) will be made available at a later stage
• The accounts should offer adequate asset class diversification
• The accounts should not have complex pay-off structures, complex guarantees and performance charges
• The remuneration and disclosure on the accounts should comply with KIID’s and RDR
• Any contributions in excess of R30,000 is highly inadvisable and will be heavily penalised (40% on excess contribution)
• Transfer between individuals could lead to penalties (by breaking the contribution limits) which may force investors to rather disinvest and transfer the actual money
• When housed in an endowment policy
  • The untaxed portfolio under the four fund taxation approach will be used
  • No risk benefits included such as contribution waivers and/or contingency benefits
  • The 5 year rules related to withdrawals and the 20% contribution increase rules will not be applicable

Choosing the tax free wrapper

A Tax free savings account should probably now be one of the primary product wrappers to consider when making an investment. Before making a decision however, factors such as the investor’s Tax free savings account limits, the investor’s accessibility requirements, his tax situation, his total wealth and his expected future investable income should be considered.

Additional considerations that should be taken into consideration could include factors such as flexibility, potential early termination charges, the available fund choice and restrictions, fees and product bonuses, features specific to a product, estate planning benefits and the level of protection offered against creditors.

The Rule of thumb

Each year, your first R30,000 should probably be invested into a Tax free savings account (up to the lifetime limit) and money withdrawn from this account should be done as one of your last resorts

Whilst this may seem straightforward, care needs to be taken not to be wasteful of both the annual limit and the lifetime limit if you expect that these limits may affect you over the long term

Please be aware that there are many instances where it will be to your disadvantage to follow the rule of thumb. One example will be when an investor intends to use a Tax free savings account to accumulate wealth for retirement purposes. In this instance, the investor’s circumstances may be such a retirement annuity would be a far better option. It is therefore crucially important that an investor’s individual circumstances must be taken into account before a decision is made

An example of a person trying to maximise his benefit

Jane invests exactly R30,000 into a Tax free savings account at the start of each year. (Even if it happens that the annual limit is increased every year.)

In the first year, her car breaks down and she has to use R20,000 for the repairs. Jane won’t be able to reinvest this R20,000 into her Tax free savings account that year. Had she built up an emergency fund before investing into her Tax free savings account, she would not have been forced to withdraw from the account.

In the following years, she withdraws R10,000 per year from his account to use for holiday purposes and for some minor renovations to her house.

After about 17 years, Jane has reached her Tax free savings account lifetime limit and she won’t be able to benefit on the tax free growth on any future contributions.

Jane could rather have saved R20,000 per year into her Tax free savings account. She could have saved the other R10,000 into a different investment which offers accessibility. This way she would not have wasted her lifetime contribution limit.

When using this approach, the tax liability on the R10,000 investment each year would have been rather small due to the short period of the investment (if the return was not already offset by her tax exemptions).

Should it happen that the R500,000 limit is increased in later years, she would be able to invest into a Tax free savings account again. If this only happens after 25 years, she would have missed the opportunity to contribute for about 9 years.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or ommissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.