Our country has been said to have one of the lowest household savings rates globally. At SFP, we know the benefit of saving for the long-term and building this as a monthly habit rather than a big end goal. One of the challenges with saving towards a large amount of money (for retirement or financial independence) is that we focus on the end goal and feel like it’s too big, and it becomes a hurdle to getting started. But if we can create a habit of saving, one that we can stick to, we are more likely to save more and begin to turn the tide on South African saving statistics.
To encourage the culture of saving, the government introduced tax-free investment and tax-free savings accounts (TFSAs) in 2015 to incentivise good savings habits. As SARS notes on their website, you don’t have to pay income tax, dividends tax or capital gains tax on the returns from these investments. If you don’t have a TFSA, it’s a good option for starting a low monthly savings habit, and if you do have one, it’s good to see how you can invest further in it – but read on to see how limits play into the investment strategy.
You pay no tax on the growth of your investment. This means that tax savings increase over time as you earn compound growth on the tax saved, so the sooner you start, the better. Also, your investment can be paid to your beneficiaries immediately, without any executor fees, making it tax-savvy and an excellent tool for estate planning.
In a recent article that we read about TFSAs, we explored an example where a traditional savings-investment was considered with and without tax. The R500k cap was reached by investing R3000 per month for 13 years and 10 months, with a final contribution of R2000 in the 11th month. It was assumed that the investments would earn 11% per annum with an equal return split between income, dividends and capital gains and a personal tax rate of 45%.
The TFSA forecast a value of R2 264 392 against the traditional savings-investment value of R 1 737 084. That’s about 30% more money simply by investing in a TFSA instead of a regular savings investment.
But it’s not a silver bullet – there is a tax penalty of 40% for any amount invested above the maximum of R 36 000 per tax year and R 500 000 over your lifetime. These limits apply to any tax-free investments held at different companies. The investor’s responsibility is to ensure that they do not invest more than this maximum across all product providers.
Even though one can access their tax-free investment at any time, withdrawals cannot be replenished. Tax-free investments are best-positioned for building wealth over the long term, in line with the goal of creating good savings habits.
Remember, TFSAs were not introduced as the sole source of retirement or financial independence savings. Instead, when coupled with a long term investment strategy, they present an opportunity to boost your nest egg with a tax-free lump sum along with the investment strategy that secures a regular annuity income.