TAX-FREE vs OTHER TYPES OF SAVINGS
I’ve only become aware of tax-free savings recently. How does this sort of saving differ from other savings accounts, and how will this change my retirement picture in the long run?
Name withheld
Jacqui Kruger, Financial Adviser at PSG Wealth, Silver Lakes Pretoria replies: The three main differences between a tax-free savings account (TFSA) and a traditional savings account (at the bank) are: types of return; the manner in which returns are taxed; and limitations on contributions
In a conventional savings account your capital will typically be allocated to money market instruments on which you will receive interest. Each individual enjoys an annual interest exemption of R23 800 if you are under the age of 65 or R34 500 if you are 65 or older. In other words, the total interest earned per year needs to exceed these amounts before income tax becomes payable on interest.
With a TFSA, you can invest in a variety of investment instruments that provide different types of return. If for example, you invest in a balanced fund, returns might include interest, dividends and capital growth. Regardless of instrument, all returns earned will be exempt from income tax in this product. It is however important to note that SARS have limited contributions to these products to R36 000 per year or R500 000 during the lifetime of the individual. You can have more than one tax-free savings account, but should then ensure that you remain within the contribution limits across all products to avoid penalties. The current penalty for excess contributions is 40%.
If you want to utilise it specifically for retirement, the total contributions and growth can then be withdrawn free of tax and re-invested to substitute your post-retirement income, or alternatively be kept aside to make provision for unforeseen expenses.
THE LIMITATIONS ON TFSAs
Can I have more than one TFSA and how does the maximum tax-free allowance work in this case?
Name withheld
Jac De Wet, Wealth Manager at PSG Wealth, Somerset West, replies: A TFSA is an investment product available to individuals to assist and encourage them to invest, tax-free. The growth (interest, dividends, capital gains) within the investment is free of tax. Estate duty upon death may effectively be the only tax that could be applicable. In many instances, a TFSA will be the starting point when allocating capital for investment.
Contributions, limits and tax implications: Investors can have more than one tax-free savings account. There are annual and lifetime contribution limits that may not be exceeded. Investors are only allowed to contribute a maximum of R36 000 per tax year (annual limit) and R500 000 over their lifetime to a TFSA or TFSAs. These limits are calculated across all TFSAs, and the combined contributions may not exceed these product limits. Any portion of unused allowable annual contributions is forfeited (it is not carried forward to the new tax year). Any excess contributions are taxed at 40%. It is thus extremely important that contributions to the TFSA(s) are monitored and not exceeded.
There is also a possibility that when returns on investment are added to the capital contributed, the balance may exceed both the annual and/or lifetime limits. The capitalisation of these returns within the account does not affect the annual or lifetime limit.
Transfers and consolidations: There is no real need to have more than one TFSA. TFSAs can be transferred from one product provider to another and consolidation of products is therefore possible.
Withdrawals: Where investors withdraw an amount from a TFSA and reinvests the same amount, that amount is regarded as a new contribution and counts towards both the annual and lifetime limits. Withdrawals made can’t be replaced within the investment.
WITHDRAWALS FROM TFSAs AND RAs
What happens if I want to withdraw money from my tax-free savings account or retirement annuity?
Name withheld
Graeme Franck, Financial Planner at PSG Wealth, PSG Grayston Sandton, replies: Any capital withdrawal made from your TFSA cannot then be re-contributed. Your lifetime contribution limit stays at R500 000. So, as an example, you have R100 000 saved in your TFSA and make a withdrawal of R60 000 (of which R50 000 is contributed capital). You cannot “replace” the R50 000 withdrawn capital, as your lifetime contribution limit remains unchanged. You cannot then make this up by contributing R86 000 in the next tax year.
With regards to withdrawing from a retirement annuity (RA), since March 1, you can withdraw from an RA if you meet one of the below requirements:
- Fund contributions has ceased and the investment value in the fund is less than R15 000,
- You suffer from permanent ill-health due to sickness, accident, injury or incapacity through infirmity of mind or body,
- You depart from the Republic on expiry of a visa for work purposes, or a visa for “visit” purposes,
- You have been a tax “non-resident” for at least 3 years on/or after 1 March 2021, or
- You are 55 years or older
If a withdrawal is actioned based on the first three points, you will be triggering tax at (withdrawal tax table) rates much higher than the (retirement tax table) rates.
If at retirement age (55) the retirement annuity is less than R247 500, you could withdraw the full amount subject to the retirement tax tables which allows for the first R500 000 tax free. If however, the value of the retirement annuity exceeds R247 500 you may only access one third of the capital subject to the retirement tax tables.
TFSAs and RAs: WHY TAX-SAVVY?
People talk about RAs and tax-free savings as being tax-savvy savings options – please explain how they are actually tax-savvy?
Name withheld
Alexi Coutsoudis, Wealth Adviser at PSG Wealth, Umhlanga Ridge, replies: The benefit in an RA lies in the ability to enjoy income tax deductible contributions up to a maximum of 27.5% of the higher of taxable income or remuneration, limited to R350 000 per tax year. Depending on where you sit in the tax tables this equates to between 18% - 45% of the amount contributed to the RA paid back to you by SARS annually. Therefore, if you are in the 30% tax bracket the government is effectively funding 30% of your retirement contributions annually. On top of this upfront tax deduction which leverages up your retirement savings, all funds within the RA grow in a tax-free vacuum. I don’t have the liberty to look at all the cons in detail but suffice to say if used in a balanced retirement plan for a portion of your retirement savings, RAs remain an excellent tax-savvy tool.
TFSAs should be the first stop for tax-efficient discretionary savings and investments. Whilst RAs may have some limitations, TFSA’s offer more flexibility. Quite simply when you invest in a TFSA you do not pay any tax on growth (no tax on interest, dividends or capital gains). Currently, you are restricted to an annual contribution of R 36 000 per year and a lifetime limit of R 500 000. There is no restriction on underlying asset allocation or withdrawals making TFSAs a complimentary product for tax-savvy investing alongside an RA. As always, chat to a Certified Financial Planner to receive suitable advice for your unique retirement/investment plan.
This feature, sponsored by PSG Wealth, was published in the Saturday newspapers as “Your Questions Answered”, Personal Finance’s regular monthly letters feature. Send your money queries to [email protected]