A TFSA is a flexible and transparent discretionary savings solution for individuals to encourage them to save more in addition to the contributions they already make to Retirement Annuities, Pension- or Provident Funds. Any type of growth, e.g. interest, dividends and capital gains on the investments are tax free.

INTRODUCTION

Our high net worth investors keep asking our wealth advisors “Is it really worth opening a TFSA only to invest a maximum allowed amount of R33,000 per annum?”

When I ponder about the water crisis of 2017/2018 in the Western Cape, I realise that we would have been in a much stronger position if we had adequately planned for such a “black swan” (an extreme event which has major adverse consequences) 10 years ago.

Even small adjustments to our water usage habits back then may have made a difference today. At least most of us have woken up to the risk of running out of water and we’ve become responsible in our water usage. We have to be responsible – not only by looking after the planet but also by saving sufficiently for our retirement.

When it comes to a TFSA, start investing today even if you make small investments. Albert Einstein famously stated that compounding is the 8th wonder of the world.

Our business motto is “always count”. So, we did the numbers. In this article, we illustrate how a few extra “drops in the savings bucket” on a tax-free basis can accumulate to material savings in the longer term.

EXECUTIVE SUMMARY

A TFSA investor will outperform the taxable investor. We conducted a comparison of the following investors:

Investor A – 30-year savings period

Investor B – 20-year savings period

Investor C – 10-year savings period

Over a 30-year period (based on certain assumptions), the TFSA investor will enjoy a fund value that is almost 18% (or R2,560,803) more than the investor within a taxable fund. For a 20-year and 10-year investment period, the TFSA investor will have a fund value of approximately 11% (R378,169) and 3% (R17,782), respectably, more than the taxable investor.

Furthermore, the TFSA benefits become more significant when looking at drawing an income from the TFSA compared to drawing from a taxable fund. Investor A will enjoy a monthly income of approximately 41% (or R20,549) more within a TFSA versus a taxable fund. Investor B will also be in a materially better position with approximately 25% (or R3,183) more in income within a TFSA and 3% (or R74) for investor C.

All these values are in nominal terms. We also compare the real values in this article.

Certain TFSA’s also offer estate duty benefits. For instance, a cost saving of 3.99% (which is the maximum executors fee) on the value of a TFSA on Executor’s fees which will be payable on a taxable fund.

MAIN CHARACTERISTICS OF A TFSA

Herewith a few important aspects when investing in a tax-free savings product:

  • After-tax money is used to invest.
  • There is no tax payable on any growth – this includes dividend tax, income tax on interest or Capital Gains Tax (CGT).
  • Contributions are not tax-deductible.
  • Certain administrators (not all) allow you to nominate a beneficiary and in such instance, a TFSA will not attract any Executor’s fees albeit that it is deemed an asset in your estate.
  • The current annual limit is R 33,000, previously R30,000, with a lifetime total limit of R 500,000. Keep in mind that both the annual and lifetime limit may change over time.
  • A tax penalty of 40% is applicable on any amount invested above the annual limit. For example, if you invest R35,000, which exceeds the annual limit by R2 000, you will be liable to pay R 800 (40% times R2,000 excess) to SARS as per your annual tax assessment.
  • The abovementioned limits are applicable per individual investor and not per TFSA. Thus, you can have more than one TFSA but combined the annual limit of contributions across all the TFSA’s may not exceed R33,000.
  • Withdrawals can be made from your TFSA investment at any time. However, such withdrawals do not affect how much you are allowed to contribute. In other words, you cannot replace any amount which you have previously withdrawn. For example, if you invested R 33,000 this tax year, the annual limit, and you make a withdrawal of R3,000, you are not allowed to replace the R 3,000 in order to replace the annual contributions back to the annual limit of R  33,000 again.

DOES IT MAKE SENSE TO INVEST IN A TFSA?

Some investors argue that investing in a TFSA as opposed to a product that does attract tax does not make a material difference towards their “retirement” (as we refer to it in this article although a TFSA can be accessed at any time) due to the monetary limitations. Let us put this hypothesis to the test. The table below outlines the various assumptions we have used to illustrate that it is “time in the markets and not timing the markets that counts”.

ASSUMPTIONSINVESTORS AINVESTOR BINVESTOR C
Years until retirement 302010
Monthly contribution (totaling the annual maximum contribution of R33,000)R 2,750 R 2,750 R 2,750
Inflation (CPI)6%6%6%
Maximum lifetime contributionsR500,000R500,000R500,000
Income drawdown % after retirement5%5%5%
Marginal tax rate (current maximum)45%45%45%

Our calculations are based on an investor that has invested 100% into a local equity fund. The proxy that we used for the investment was the JSE All Share Index (ALSI). We calculated the actual historic annual returns over a 30-year, 20-year and 10-year period for the market.

Over these periods, the ALSI performed as follows on a total return basis (price return + dividends and income):

  • 30 years – 16.03% per year (includes 3.77% per year from dividends and income)
  • 20 years – 15.97% per year (includes 4.02% per year from dividends and income)
  • 10 years – 10.25% per year (includes 3.11% per year from dividends and income)

A TFSA has no tax implications and therefore the investor would have yielded the above returns. However, an investment into a local equity fund that is not tax-free will yield a lower return as the tax is payable on:

  1. Interest
  2. Dividends
  3. Capital gains

For purposes of this exercise, we have not taken into account the interest component as it is negligible on an equity investment.

For a taxable local equity fund, we have stripped out 80% of the dividend returns as investors are currently taxed at 20% (withheld) on all dividends. We have also considered CGT. CGT is applicable when the local equity fund is liquidated or when withdrawals are made.

EFFECT OF DIVIDENDS TAX

The chart below illustrates the future values at retirement for investor A, B and C based on the historical performance of the ALSI:

It is not surprising to see Investor A come out on top as this investor enjoys the longest time horizon before reaching retirement. However, it is interesting to note the material difference that the dividend tax makes to the value of the portfolio. The tax-free growth of a TFSA should therefore not be underestimated.

The following contributions were made over this period by each investor for both the TFSA and the taxable fund:

Investor A – R500,000

Investor B – R500,000

Investor C – R350,000

Importantly, an investor with a time horizon of fewer than 15 years will miss out on utilizing the full lifetime limit of R500,000. In our example above Investor C only saved for 10 years and therefore only accumulates R330,000 in contributions and therefore misses the opportunity of tax-free savings on R170,000.

Over a 30-year period, the TFSA investor will enjoy a fund value that is almost 18% (or R2,560,803) more than the investor within a taxable fund. Although this benefit reduces over a shorter investment horizon, it is still clear that the TFSA remains beneficial for investors over a shorter period as well. For a 20-year and 10-year investment horizon, the TFSA investor will have approximately 11% (or R378,169) and 3% (or R17,782), respectably, more than the taxable investor.

In today’s terms (after adjusting for inflation), the abovementioned future values are:

Investor A – R2,990,190 (TFSA) and R2,539,242 (taxable fund)

Investor B – R1,201,319 (TFSA) and R1,081,800 (taxable fund)

Investor C -R 310,642 (TFSA) and R300,530 (taxable fund)

The abovementioned values are also known as “real” values. The benefits remain exactly the same for all three investors as we have just simply discounted the nominal future values with inflation.

EFFECT OF CGT

We will now take a look at the potential income from each investment which will give you a better idea of the additional tax-advantages of a TFSA.

For purpose of the calculation we have utilised an annual drawdown percentage of 5%. The above-mentioned values are an estimate of the investor’s first tax-free/after-tax monthly income at retirement.

CGT will be payable when an income is being drawn from a discretionary unit trust investment. Current legislation provides for an annual capital gains tax exemption of R 40,000 per individual in any given tax year. Furthermore, only 40% of capital gains above the exemption will be taxable at the marginal tax rate of the investor. For purposes of this exercise, we have used the current highest marginal tax rate which is 45%.

There will be no capital gains tax payable within a TFSA when an income is being drawn post-retirement. The effect of this can be observed by comparing the monthly incomes above.

The TFSA benefits become more significant when calculating the nominal income advantages thereof. Investor A will enjoy a monthly income of approximately 41% (or R20,549?) more within a TFSA versus a taxable fund. Investor B will also be in a material better position with approximately 25% (or R3,183) more in income within a TFSA and 3% (or R74) for investor C.

In today’s terms (after adjusting for inflation), the abovementioned monthly income values are:

Investor A -R12,459 (TFSA) and R8,822 (taxable fund)

Investor B -R5,005 (TFSA) and R3,991 (taxable fund)

Investor C – R1,294 (TFSA) and R1,254 (taxable fund)

The abovementioned values are also known as “real” values. The benefits remain exactly the same for all three investors as we have just simply discounted the nominal future values with inflation.

The income differentials are due to the CGT payable within a taxable fund which is not applicable to a TFSA.

SUMMARY

We conclude that a TFSA is a powerful investment option for investors and should be utilised to its full maximum allowed the investable amount of R500,000.

Herewith some savings tips with regards to a TFSA:

  • Open a TFSA if you do not have one (the benefits of compounding are exponentially more significant for younger investors most investors will benefit).
  • Use your maximum contribution of R33,000 per person per annum. Remember children under the age of 18 are also allowed to open a TFSA. Consider opening these accounts for your children, the compounding tax-free effect would be material over such a long period.
  • Save for at least 15 years at R33,000 per annum to maximize the tax benefits.
  • Only withdraw funds from your TFSA if you really don’t have other sources of income available.
  • You are allowed to invest in shares or unit trusts within a TFSA – most investors incorrectly think they are only limited to invest in bank deposits and money market assets. You can define your risk tolerance and you can select a combination of underlying funds to match your risk tolerance and to meet your long-term performance objectives.
  • Every drop really does count!

In order to reap the rewards of the TFSA it is important that you are invested via an administrator that offers the most cost-effective as well as other benefits. Secondly, define your risk tolerance and invest in a well-diversified, low-cost investment portfolio.

If you require any assistance to open a TFSA today kindly contact one of our advisors for immediate assistance.

CONTACT US TODAY


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