I was chatting to my mother at dinner this weekend. She asked me about the Tax free savings plan (TFSA), as she thinks it will work for her.
There has been a great deal of advertising for this new product over the past few months since Treasury announced its implementation on the 1 March. Most financial institutions have launched at least one of these products.
A little background
As a result of South Africa’s very poor savings culture, this investment was introduced and is aimed at the mass market to encourage a greater savings ethos. The big benefit is that any money invested in this vehicle is free of income tax, dividends tax and capital gains tax. I am not sure that many people in the mass market can afford to invest R30 000pa – many are not paying tax, anyway.
This investment may find more appeal in the middle to upper income group, but potential investors should balance the advantages and disadvantages. The most important consideration is that it’s a long-term investment; you can only invest a maximum of R30 000 per annum and no more than R500 000 in your lifetime. The biggest pitfall is that once you take money out of the investment, you can never replace it.
Weighing up the benefits
So if I go back to my Mum’s query, should she have one?
Well, the question must be: what does she want to achieve? If it’s an alternative to an emergency fund – most likely a fixed deposit or money market account – then it will probably be worthwhile. Let’s quantify that in the short term: on R30,000, she will earn about R1,800 interest a year, on which she would pay about 40% tax in a fixed deposit or money market savings scheme. So, her tax savings with this new product in the first year will be R720. After 16 years, she will have about R820,000 in her investment with the interest earned; she will be saving about R19,680 per annum in tax which in today’s value of money will be about R7,746 per annum. You can see the benefit of time here, but we are still not talking about significant money. The pitfall is that this is now her emergency fund and if she needs to draw down on it, she cannot replace it.
If she invested in a pure equity fund and enjoyed a return of 10% per annum, after 16 years, she would have R1,168 000 invested. There would have been no income tax benefit to this as there are no interest-bearing investments. She would, however, have benefitted from having no dividends tax, which is nominal; but the big savings here would be on capital gains tax. Over 16 years, her capital gain would be R668,000, resulting in a capital gains tax of approximately R86,840 then; if we discount by inflation to today’s value of money, it is R33,000. So, assuming you are in the highest tax bracket, these are two extreme examples of the tax benefits of this product.
In summary, I would not go hurrying out to market to buy one of these vehicles; but if you would like to discuss this, please feel free to contact your Financial Planner about these investments or respond to me on my email (firstname.lastname@example.org) with any questions.