Need to know: all about tax-free savings

Last updated on 2nd June, 2021 at 04:02 pm

South Africans are notoriously poor savers. According to the SA Reserve Bank, our household savings as a percentage of our disposable income have declined over the past few years. So the National Treasury’s introduction of tax-free savings accounts has been widely welcomed as a way of encouraging South Africans to save.

How does a tax-free savings account work?

According to Karin Muller, head of growth market solutions at Sanlam, the main advantage of tax-free savings accounts is that no dividend, capital gains or income tax is payable, as long as contributions remain within an annual threshold amount of R36 000, and a lifetime limit of R500 000. Individual investors will also be able to access their funds at any time.

“Since you won’t pay any tax on the growth on your investment, a tax-free savings account is an effective way to save for your goals. Your money will grow faster than in a regular investment or savings account. It all depends on how long you stay invested, as the longer you invest the more benefit you will get. Although the tax benefits will be low in the beginning, they will grow over time due to the power of compound interest,” Muller explains.

Individuals will be able to open multiple tax-free savings accounts with different underlying investments, as long as the annual limit and the lifetime limit is not exceeded. The limit only applies to the money you actually invest. You’ll be able to withdraw your money at any time, but it is important to remember that if you then decide to replace this money again, it will count towards your annual and lifetime limits.

Tax-free savings accounts vs retirement annuities

“A tax-free savings account is an excellent savings solution for longer term savings, such as an education fund. In most cases, retirement annuities are more appropriate retirement savings vehicles. This would, however, depend on your own personal circumstances,” she says.

Although both RAs and tax-free savings accounts earn tax-free investment returns, retirement annuities defer income tax to the post-retirement phase, whereas with tax-free savings accounts income tax is paid before every contribution is made (since you make the payments with after-tax money).

“In the long run, RAs give the same or better value compared to a tax-free savings account when used for retirement saving. It is not just a case of adding up the figures – there are a number of other factors to consider when deciding which savings product to use, such as protection from creditors, estate duty, liquidity and asset allocation,” Muller says.

Potential pitfalls of tax-free savings accounts

Even though tax-free savings accounts offer investors a new way to save with many benefits, Muller advises that before considering an investment in a tax-free savings account, you should take note of the following potential pitfalls:

• Investing for short periods To benefit from the tax relief of investment returns in a tax-free savings account, your investment needs enough time to earn investment returns.
• Investing more than the annual contribution limit Any unused portion of the R36 000 annual contribution limit per tax year may not be rolled over. It’s a case of “use it or lose it”. On the other hand, if the overall payments exceed the annual cap, you will pay a tax penalty of 40% on the excess contributions. A similar penalty will apply on payments in excess of the lifetime limit of R500 000. “Consumers therefore need to be vigilant – if you have multiple tax-free accounts and don’t keep tabs on your annual and lifetime caps, you will be taxed as for a normal investment.”
• Investing in inappropriate funds As with any other savings vehicle, you have to make sure that your investment portfolio is appropriate for your investment horizon and will provide optimal returns at an acceptable level of risk.

To ensure you benefit from a tax-free savings account in the way intended by the National Treasury, Muller advises speaking to a professional financial adviser first.