By: Jaco van Tonder, Advisor Services Director
Many advisors are gearing up for the upcoming annual tax season – and since 2016, tax season includes helping clients with their annual contribution to a Tax-free Savings Account (TFSA). Many product houses, including life companies, banks, unit trust management companies and LISP investment platforms, have jumped on the bandwagon to launch TFSAs over the past year. This proliferation of TFSA product options has left many investors and advisors wondering how best to utilise a TFSA as one of many tax-efficient savings tools.
Having discussed this problem with many financial advisor firms, we have drawn some conclusions on the appropriate use of TFSAs for investors.
- A TFSA is not the only tax-efficient savings option
All the media hype about TFSAs appear to have taken people’s eyes off the fact that the first savings priority for any investor should still be their contribution to a registered retirement fund (either through their employer, or via a retirement annuity). As a rule of thumb, investors should first provide for an adequate contribution to their retirement fund before taking out a TFSA.
Secondly, investors should remember to use their annual tax-free interest exemption (currently R23 800 for individuals under age 65). At current money-market rates of close to 8%, an investor in South Africa can keep close on R300 000 in a money market fund before paying any tax on the interest. Ideally this allowance should be used to set up an investor’s emergency cash pool.
- TFSAs are excellent long-term savings vehicles
This point took a while for the industry to realise, and there are two main drivers behind this. Firstly, since a TFSA contribution is not tax-deductible upfront like a retirement fund contribution, an investor has to wait patiently for the TFSA tax benefit to be realised on the investment return of the assets. Our calculations show that it takes at least ten years for the investment returns of the TFSA to grow the value of the tax saving to a material proportion of the investment.
Secondly, an investor cannot recover any of their lifetime TFSA contribution allowances if they make a withdrawal from the product. Any redemptions from a TFSA therefore represents a waste of part of an investor’s lifetime contribution allowance – ideally something to be avoided.
- Investment portfolios should be consistent with investment horizon
For any financial advisor this goes without saying. But read together with the previous point about TFSAs being long-term savings vehicles, it follows that TFSA investment portfolios should be consistent with an investment horizon of at least ten years. For this reason the Investec IMS TFSA offers a range of in-house and third party investment options ideally suited to longer-term investment horizons.
TFSAs are a great initiative from government to encourage savings in South Africa, and they are important tools for a financial advisor. However it is important to set them up correctly in order to maximise the value of the client’s tax benefit.
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