The amounts you will be able to invest in a tax-free savings account may be limited, but this is no reason to dismiss the benefits of saving in these accounts.
The benefits will be in the long-term tax-free build-up in these accounts, particularly the saving on capital gains tax (CGT), an analysis of the potential tax saving on such an investment shows.
The Income Tax Act is being amended to allow financial institutions to offer you tax-free savings accounts with underlying life assurance, bank, collective investment and/or government investments from March 1 next year.
You will be able to invest R30 000 a year (or R2 500 a month), and R500 000 over a lifetime. However, there is no limit on the growth within the investment, and no interest, dividends and capital gains will be taxed.
National Treasury recently released draft regulations outlining which financial services providers can provide the tax-free savings accounts and the requirements for the underlying investments.
Alexander Forbes says it has calculated that if you save R30 000 a year in a typical local balanced fund within a tax-free savings account until you reach your lifetime limit of R500 000 (about 16 years) and earn returns similar to average returns of these funds over the past decade, you could have added growth of just under R1 million after 20 years.
John Anderson, the company’s managing director of research and development, says Alexander Forbes’s calculations show that the benefits are low initially, but the longer you leave your savings invested, the more they accumulate, thanks particularly to the saving on CGT.
Alexander Forbes used an investment in an average balanced fund with 70 percent in equities, 15 percent in bonds and 15 percent in cash.
Anderson says although the tax saving is only R10 000 in the 10th year and R70 000 in the 20th year, the compounding effect is a saving of almost R1 million after 20 years, compared with the return on an investment on which taxes were payable (see graphs, link below).
Kavir Ramjee, a product actuary at Sanlam, says the accounts offer a massive opportunity for all income groups, but agrees you will need to save for a long time to get the benefits of the tax-free growth.
While you could use the tax-free savings accounts for short-term savings goals, the benefits would be lower, and Ramjee says you would need to be careful not to affect your access to the account by using up your annual limits.
Financial services companies say your best tax savings will still come from your retirement fund, because contributions to your pension fund or retirement annuity are tax-deductible. Provident fund contributions are expected to become tax-deductible in future, possibly from March 2016 or 2017.
The growth on your savings in your retirement fund is not taxed, and the first R500 000 of your savings is tax-free at retirement if you have not withdrawn anything in the years before retirement.
Two-thirds of your retirement savings must be used to buy a pension, and only when you receive the pension are you taxed – at your applicable income tax rate.
The contributions you make to a tax-free savings account, however, will be with after-tax money, but whatever you withdraw from the account will be tax-free.
Derick Ferreira, head of product management, customer and intermediary solutions at Old Mutual, says the tax-free savings accounts will give you access to your savings at any time, but access is the enemy of compounding interest. Most people’s biggest asset is their retirement fund because they have been unable to access the money in it.
Ramjee says a financial adviser should assist you to use the tax-incentivised savings products to your best advantage.
He says the financial services industry will seek clarity from Treasury on whether each member of a family can save in a separate tax-free savings account.
Saving in the name of a child could provide a tax-free savings vehicle for money you set aside for a child’s education.
Iain Williamson, the managing director of Retail Affluent at Old Mutual, says the tax-free savings accounts may well become a substitute for existing products aimed at saving for a child’s education.
Some of the existing products include life cover that pays out if you die or are disabled before you have saved enough for your child’s education. But the draft regulations on the tax-free accounts state that they cannot include life cover, which means that parents using these accounts for education savings will need to provide for the required life cover separately.
Anderson says employers should consider making the savings accounts available to their employees as part of their employee benefit arrangements.
He says the tax-free accounts can supplement employee benefit programmes, and employers will be able to provide these to employees on a more cost-effective basis than the general financial adviser market. This would encourage employees to take advantage of the tax benefits and save for goals other than retirement, and would encourage individuals to improve their financial wellbeing.
A well-run employee benefit programme, in turn, helps employers to improve productivity and reduces fraud in the workplace over time, Anderson says.
Tax exemptions for interest earned on investments will remain at the current levels of R23 800 for taxpayers under the age of 65 or R34 500 for taxpayers over the age of 65. This means you can still invest R340 000 (or about R493 000 if you are over 65) and, at an interest rate of seven percent, your interest income will be tax-free.
INVESTMENTS YOU ARE LIKELY TO BE OFFERED
The financial services industry is seeking clarity on a number of issues relating to tax-free savings accounts and may even challenge some of National Treasury’s proposals on what can be included in these accounts – particularly its ban on investments with performance fees.
But in the meantime, providers are continuing to prepare to make some investments through these accounts available for you to invest in from March next year.
It seems likely that, as an investor in the accounts, you will get access to many collective investment schemes and a choice of funds through linked- investment service providers (lisps).
Amendments to the Income Tax Act currently before Parliament provide the legal framework for these accounts.
On November 14, Treasury released draft regulations stating that banks, life assurers and the government will be able to offer you these accounts with underlying investments that meet certain requirements.
Many life assurance savings products do not comply with Treasury’s requirements, because they prohibit policies that have penalties for stopping or reducing your premiums.
However, life assurers are likely to design new savings products that are suitable for the accounts, Kavir Ramjee, a product actuary at Sanlam says.
Competition among providers could result in reduced costs on the products, Iain Williamson, the managing director of Retail Affluent at Old Mutual, says.
Investors in unit trust funds and other investments, such as government retail bonds or bank savings accounts, who want to switch into the tax-free savings accounts, will have to disinvest and use the proceeds to invest into the new accounts.
Jurgen Boyd, the deputy registrar for collective investment schemes at the Financial Services Board (FSB), says that asset managers will have to create a new class within existing unit trust portfolios for investors using the tax-free accounts and report the investments to the South African Revenue Service.
There is some confusion over whether the proposed regulations ban fees charged as a percentage of assets, because most unit trust companies do this, but it is understood that this is not Treasury’s intention.
A key issue in the regulations is that investments that charge performance fees will not be allowed. Many large unit trust companies, such as Allan Gray, Coronation, Investec and Foord, and many boutique managers have funds with performance fees.
Asset management companies are expected to make submissions to Treasury before the deadline on Wednesday next week on why the regulations should not exclude performance fees.
Pieter Koekemoer, the head of retail at Coronation Fund Managers, says Coronation is disappointed that Treasury is proposing prohibiting funds that charge performance fees from being offered through the tax-free savings accounts.
He says this will exclude Coronation’s Top 20 Fund, which invests in selected large capitalisation shares, its Equity Fund and its Global Managed Fund. However, Coronation's multi-asset funds, which do not have performance fees, will be offered.
Darryll Welsh, the head of product at Investec Investment Management Services, says Investec has flat-fee classes, and it will offer these classes for the tax- free savings accounts if the ban on funds charging performance fees goes ahead.
Koekemoer says that after Treasury released a discussion paper on charges in the retirement fund industry in July last year, stating that performance fees were complex and difficult to understand, the Association for Savings & Investment SA (Asisa) committed itself to developing best practice on performance fees for the unit trust industry.
Asisa has completed the initial draft of a paper outlining performance-fee best practice and expects this to be the basis of a discussion with Treasury on regulations to reform these practices.
Anet Ahern, the chief executive at PSG Asset Management, says PSG has flat-fee classes for all its unit trust funds except its flexible multi-asset fund, and so it will still have a range of funds to offer through the tax-free savings accounts if funds with performance fees are prohibited.
Welsh says lisps are widely used by savers in Britain’s equivalent of Treasury’s tax-free savings account, known as the Individual Savings Account (ISA), and he expects them to be used widely in South Africa too.
Lisps offer a wide choice of underlying funds and give you a view of all your investments, be they in a retirement annuity fund, a tax-free savings account or a discretionary investment, on a single statement.
While lisps charge their own fees, fees on unit trusts offered through the platforms can be discounted, and Welsh says the total fees are likely to match those of investing directly.
Richard Treagus, the head of investment products at Old Mutual, says that although they are excited about the opportunity for customers to save in a tax-free manner, a big concern arising from the draft regulations is that it may be difficult to remunerate advisers for selling investments to low-income earners.