Karin Muller, head of growth market solutions at Sanlam Personal Finance, explains how tax-free savings accounts can be used to your best advantage at different stages of your life.
The main advantage of tax-free savings accounts is that no dividend, capital gains or income tax is payable, so your money will grow faster than in a regular savings account. “It depends how long you stay invested; however, 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. Investing in a tax-free savings account in your 20s is therefore an excellent idea, since you have many years ahead of you for your savings to grow,” says Muller.
Tax-free savings accounts also have the advantage of liquidity – you can withdraw funds at any time. Muller says many young people may not be ready for savings vehicles that require a long-term commitment, and that don’t allow access to funds. “However, you shouldn’t treat a tax-free savings account as if it were a short-term savings vehicle, since you will lose the benefit of the long-term tax-free investment return. Also, it is important to remember that if you withdraw funds and later decide to replace this money again, it will count towards your annual threshold amount of R30 000, and your lifetime limit of R500 000.”
At this life stage, people generally have increased responsibilities and more specific savings plans, such as for children’s education. “If you think you won’t exceed your lifetime limit, then by all means use a tax-free savings account as an education fund. But don’t use it as an emergency fund – for this purpose, a money market fund, where you will not ‘lose out’ if you withdraw funds, is more appropriate. You could use a tax-free savings account for extra financial support, however, for example for a life event, which is unlikely but could have a huge financial impact, such as retrenchment. Again, keep in mind that a tax-free savings account is a long-term investment vehicle, not a short-term fix.”
You need to start saving for retirement as soon as possible after you start working. When you reach your 40s, your time to retirement is becoming shorter, so you need to start thinking about balancing your tax-free savings account with your retirement investments. Although both retirement annuities 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).
“For most people, a tax-free savings account is not the best retirement savings option. In this case, retirement annuities are the more appropriate vehicle. Although both types of savings offer tax-free returns, it is not just a case of looking at the figures – there are a number of other factors to consider when deciding between which savings product to use, such as protection from creditors, estate duty, liquidity and asset allocation. When saving for retirement, retirement annuities remain tops,” Muller says.
Given that the tax benefits of tax-free savings accounts are incurred over the long term, it will be difficult for older people to obtain the same benefits that they could enjoy from other investments, taking into account interest exemption after the age of 65. “At this life stage, you should think carefully whether to invest in a tax-free savings account or an asset which provides an income where you can offset the interest exemption. An ordinary unit trust may be a better option. An exception might be if you are 51 and want to invest to leave your children an estate 20 or more years from now.”
Muller says the most important factors to consider at all age groups are the time frame available for investment and the purpose of your savings. “It is crucial that investment in tax-free savings accounts form part of a holistic, well-considered financial plan drawn up with the assistance of a professional financial adviser. It must take into account all your financial needs, both short and long term,” she concludes.