Tax-free savings accounts are to be launched in an effort to encourage more of us to set aside money regularly. They’re a nice idea in theory because the intention is to help us grow our savings. However, there are some challenges: Firstly, the perks are dependent on government rules – and rules can, and do, change. Secondly, financial services industry players, with few exceptions, have a reputation for pocketing tax savings for themselves through various fees. The Retirement Annuity (RA), marketed as a tax-efficient vehicle, is a case in point. It makes huge profits for life assurance giants and others. – JC
By Kelsey Moodley*
The tax-free savings account – how will it affect you?
Much of the reform being proposed by National Treasury will affect the income that people receive in retirement. In addition, Treasury has set out plans for the implementation of tax-free savings accounts with the intention of promoting pre-retirement savings. Here’s a round-up of some of the main features of these savings accounts and why it’s a good idea for you to invest in one.
What are tax-free savings accounts?
A tax-free savings account is an investment product that will allow South Africans to make contributions to a savings account from their post-tax salary. Contributions will be limited to R30 000 per year and a lifetime limit of R500 000 – meaning that no person may ever contribute more than R500 000 to such an account. But the kicker is that all returns earned on those invested contributions will be tax-free.
Some of the finer details of this account include:
· Individuals can purchase the product from a number of different financial services providers, including banks, and they can select a product that has assets which are most suitable for their risk and investment profile;
· Individuals will be allowed to change providers and can withdraw funds at any point to place the money with another company, possibly subject to a small withdrawal fees;
· Individuals can withdraw money from the account at any time. However, this will reduce the lifetime limit of the account. For example, if a person currently has R100 000 in the fund and they decide to make a first withdrawal of R50 000 they will now only ever be able to contribute a further R400 000 to the account;
· Individuals can hold up to two different accounts, possibly from different providers at a time, however the total of the contributions made to both accounts cannot exceed R30 000 per year and R500 000 over their lifetime;
Exemptions and deductions on savings already exist to some degree: individuals under the age of 65 are currently allowed R23 800 in interest income tax free per year and a capital gains exemption of R30 000. This income exemption limit will no longer be increased in line with inflation, which should encourage investors to move over to tax free savings accounts. Tax free savings accounts will therefore benefit investors who contribute over a number of years and end up with gains in excess of these current exemptions.
Tax-free savings accounts: The rationale
As mentioned previously, Treasury has proposed compulsory preservation of retirement fund contributions. However, in many instances retirement savings represents the largest and most liquid asset pool for South Africans. It is, at present, easily accessible and often required when people are retrenched or simply between jobs. There have even been cases where people in financial distress have resigned to access their retirement savings.
These tax-preferred savings vehicles have hence been introduced to encourage individuals to save for short- and medium-term needs without relying on retirement savings.
How does this savings account differ from a normal retirement fund or retirement annuity?
Many people will struggle to see the value in having accounts like this when they can save in their retirement fund out of their pre-tax earnings, but the fact that these savings accounts are funded from post-tax income and are then tax exempt can often lead to a bigger gain depending on the return that is earned.
Also, these accounts are intended to fund more immediate needs than your expenses in retirement. Some accounts and their accompanying asset mix may be structured around a particular goal, like accumulating enough money to fund 12 years of school for your child and an additional four years for university.
Furthermore, this money will be available to an individual at any time, not just at retirement or, at present, when changing jobs. And while contributions to a retirement fund are unlimited, contributions to a tax-free savings account are capped, as described above.
Why you need a tax-free savings account
If you are already making discretionary savings out of post-tax income, re-directing those savings into these accounts just makes sense. There will not be any tax on the interest that is earned on the investments held or any capital gain. This can give savings a big boost in the long run.
The principle aim of the tax-free savings account is to provide a product that are simple in terms of you being able to identify the underlying assets. The ultimate intention is to give you a savings product that raises the after-tax rate of return on accessible savings, whilst providing a high level of security for investors.
Tax free savings accounts will be introduced from March 2015 onwards. For more information about these accounts you can download the National Treasury paper – Non-retirement savings Tax free savings accounts.
* Kelsey Moodley is Actuarial Analyst at Alexander Forbes Financial Services.