Should you open a tax-free account for your child?
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By Anna Rich
Just as the government is trying in various ways to incentivise positive financial behaviour such as saving, you could do this within your own family. Your children have time on their side; an appropriate savings vehicle could show them the power of compounding – and more so when these funds are not eroded by taxes.
Enter the tax-free savings account. Tax-free savings accounts, introduced in 2015, are a government initiative to encourage South Africans to save for the long term. But can you open one for your child?
“Yes,” says the South African Revenue Service (SARS), “parents can invest on behalf of their minor children.” And this applies to other adults, including grandparents. “Any person can open a tax-free account for a minor child.”
With a tax-free savings account, none of the regular taxes on investments (capital gains, interest and dividend taxes) applies. But you can incur donations tax by contributing to an account for your children or grandchildren. The normal rules apply here, says SARS: there is no donations tax on total annual donations up to R100 000.
So, if you can afford it, is opening a tax free savings account for your child in his or her best interests? On the face of it, it seems like a great idea. However, this rider appears on the SARS website, after the statement that parents can invest on behalf of their child: “The minor child will use his/her own annual or lifetime limits.”
For this reason, Palesa Tlholoe, a Certified Financial Planner and wealth manager at Imvelo Wealth Solutions, does not recommend tax-free savings accounts for children. “An individual is only allowed to contribute up to R36 000 a year into a tax-free savings account, and R500 000 in their lifetime. Using your child’s tax-free allowance depletes this amount.”
In other words, this means that if your child wants to open a tax-free savings account of his or her own later in life as an adult, the lifetime limit is reduced by whatever you have already contributed.
If you contribute less than R36 000 a year, you cannot roll over the difference to a subsequent year and use it to contribute more than R36 000 in that year. The point of this rule is “to address the problem of procrastination”. The SARS document elaborates: “If individuals were allowed to roll over any unused amount … [they] would most likely put off actually saving the money until later.” The no-rollover rule is thus intended to encourage individuals to save “today’.
It takes 13 years and 9 months to reach the lifetime limit at current annual limits, notes Sisandile Cikido, head of retail investments at Nedbank. If you contribute less per year, it will take longer.
Another salient question is whether opening a tax-free savings account for your child is in your best interests. “Make sure you maximise every opportunity to improve your own financial situation,” advises Tlholoe. “Use it as a tax-free supplement to your retirement savings. While you are likely to have to pay tax on your pension or retirement annuity withdrawals, a tax-free savings account allows for a nice tax free nest egg.”
FURTHER POINTS YOU NEED TO KNOW
- Investments are aggregated over the tax year, not the calendar year.
- Returns on investments don’t count towards annual or lifetime limits.
- Tax-free savings accounts are not just savings vehicles.
- Transfers between products are allowed.
- Replacement of withdrawn funds is seen as a new contribution.
- Tax-free does not mean fee-free.