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Tax-free savings accounts: what you should know

Open gift with star prints and textured red ribbon.

Open gift with star prints and textured red ribbon.

Published Sep 30, 2015


This article was first published in the second-quarter 2015 edition of Personal Finance magazine.

The first flurry of tax-free savings accounts were launched in the first quarter of 2015, when an amendment to the Income Tax Act creating these new vehicles came into effect on March 1. The regulations setting out which investment products may be included in these accounts were, however, published in the Government Gazette only days before. Product providers who had products that were in line with the regulations were able to launch quickly, but others will need more time.

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The benefits of the accounts are simple to grasp: you pay no tax on any interest income or dividends earned by the investment, regardless of how long you stay invested, and you do not pay any capital gains tax (CGT) when you withdraw your investment.

If you are considering investing through one or more tax-free savings accounts, here are a few things you should know.

1. The maximum investment amount

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You can invest only R30 000 a year in a tax-free savings account, and once the amounts you have invested (without taking growth into account) add up to R500 000, you cannot contribute any more. It does not matter how much growth you earn on your annual contributions, as long as the amounts you put in do not add up to more than the annual or the lifetime limit.

If you contribute R30 000 a year, it will take you more than 16 years to contribute the maximum amount. It is likely that the annual and lifetime limits will be adjusted for inflation in future years, which means that the goalposts may shift before you reach the current limits.

Pensioners have been quick to point out that they may not have 16 years to reach the lifetime limit. National Treasury is aware of this and Treasury officials say they will, in future, propose measures to allow older people to contribute to the accounts at an accelerated rate.

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2. What you can invest in

Providers are offering a wide array of investments as tax-free savings accounts, so you will find bank deposits, unit trust funds and exchange traded products (ETPs) on offer by the time you read this article.

National Treasury is expected to offer RSA Retail Bonds within tax-free savings accounts before the end of 2015. Treasury says it is working on a new retail bond system and new product offerings.

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The regulations permit investments from mutual and co-operative banks. Participation bonds will be included in future if they comply with requirements that have yet to be issued by the Financial Services Board (FSB).

There are restrictions on the type of products that can be offered within tax-free accounts:

* Investments with performance fees are not allowed. A number of unit trusts charge these fees. If a unit trust company has funds with performance fees, either you will be offered funds that do not have performance fees or, if a fund has more than one class, you will be offered the fund class that charges a flat fee. At the time of writing, in March 2015, some managers, notably Allan Gray and Coronation, were not offering tax-free savings accounts, because their funds have performance fees.

* ETPs must be registered as collective investment schemes in order to be offered as underlying investments in tax-free accounts. The implication is that most exchange traded funds (ETFs) will be available as underlying investments, but exchange traded notes (ETNs) will not, because they are not registered as collective investment schemes. Whereas collective investment schemes must invest in the underlying securities, such as shares or bonds, local ETNs do not always invest in underlying securities.

An ETN provider promises only to deliver the return of a selected security, commodity or market, and may invest in that security, commodity or market only partially, or not all. Instead, your money may be invested in derivative instruments that the ETN provider expects will deliver the promised returns. ETNs are often offered on commodities or illiquid shares, such as those listed on African stock markets.

* The regulations specifically exclude any investment products in which part of the return is withheld from you. As a result, the underlying investments in a tax-free savings account cannot include structured products or smoothed-bonus portfolios.

Structured products typically have a fixed term and offer a limited percentage of the performance of a market index and use the balance to offer you a capital guarantee. In smoothed-bonus portfolios, some investment returns are withheld from you in years of good returns, and are used to provide you with a better return in years when returns are bad.

A media release issued with the regulations says National Treasury and the FSB plan to develop regulations for these complex products by the end of this year. Once a customer-friendly framework has been developed, some of these products could become eligible for inclusion.

* Underlying investments may not pay bonuses if you stay invested for a particular term.

* Hedge funds are excluded, even though, as of April 1 this year, they have to register as collective investment schemes.

* If the value of the underlying investment is determined directly or indirectly from the value of shares, the investment may not invest more than 10 percent in a single share or commodity, and 80 percent of the shares must be listed on a stock exchange. This does not apply if the underlying investment is a collective investment, because collective investments must comply with the diversification requirements and maximum holding limits in the Collective Investment Schemes Control Act.

* Underlying investments may not include derivatives, except to reduce potential loss.

* Investments with high penalties for early withdrawals are not allowed (see “Withdrawals” below).

* Individual stockbroking accounts through which you can select your own shares do not qualify as tax-free accounts.

* Your investment cannot include life assurance or disability cover.

The FSB will regulate the investments offered through tax-free savings accounts.

3. Penalty if you exceed the contribution limit

National Treasury and the investment industry explored various ways to prevent the tax benefits of the savings accounts from being abused, and they settled on a penalty for contributions that exceed the limits.

The regulations under the Income Tax Act prevent financial services companies from accepting contributions that exceed the annual or lifetime limits. But, in most cases, a company can monitor only the investments that it holds. If you open two or more accounts with different companies, each company might not know how much you have invested in total.

Every tax year, companies must report how much you have invested in their tax-free savings accounts to the South African Revenue Service (SARS), which will enable SARS to determine whether you have contributed more than is permitted.

The Income Tax Act provides for a stiff penalty tax of 40 percent on any amount you invest in an account that takes you above the annual or lifetime contribution limit. The penalty applies in the tax year in which you make the excess contribution. SARS will expect you to complete a tax return and will issue you with an assessment, and you will have to find the money to pay the tax.

So, if, in one tax year, you invest R20 000 in an account with one provider and R20 000 in an account with another provider, you will have contributed R10 000 more than the annual limit. SARS will levy tax of 40 percent on the R10 000 excess contribution.

Treasury has calculated that it would work in your favour to pay the once-off penalty of 40 percent (in order to benefit from the tax-free interest, dividends and capital gains earned by your investment) only if your savings in the account had earned a relatively high return for a very long period.

4. Withdrawals

You must be able to withdraw your investments easily from a tax-free savings account, according to the regulations under the Income Tax Act. If the investment has no maturity date, you must be able to access your money within seven days of requesting it.

If the investment has a maturity date – for example, if you invested with a bank offering a one-year fixed deposit – the investment must be payable to you within 32 days of your request to withdraw.

Investment providers are not allowed to charge high penalties for early withdrawals. Those that offer investments with a guaranteed return, such as a particular interest rate for an investment for a defined period, such as a fixed deposit, can charge a penalty that is the higher of R300 or the value according to a formula. The formula takes into account: the period you have been invested, the total amount at withdrawal, the years remaining until maturity, and the interest rate that could have been earned if the investment had been held to maturity.

The maximum penalty for products that have a maturity date, but in which returns are not linked to an interest rate, is R500, and the penalty must gradually decrease to zero if the investment is held for five years or more.

Withdrawals are not taken into account when your annual or lifetime limits are determined. For example, if, in one year, you contribute R30 000 and then withdraw R10 000, your net contribution is R20 000, but if you contributed R10 000 in the same year, you would exceed the annual limit and be penalised.

5. The benefits can be significant

High-income earners may think that the R30 000 annual and R500 000 lifetime limits are too low to make the tax-free savings accounts worthwhile. However, the growth on investments in these accounts can be significant over time, and there could be a considerable saving on CGT when the investment is realised.

Alexander Forbes calculates that if you save R30 000 a year in a typical South African balanced fund within a tax-free savings account until you reach your lifetime limit of R500 000, and the fund earns returns similar to the average returns of these funds over the past decade, you could have added growth on your investment of just under R1 million after 20 years. Alexander Forbes based its calculation on a balanced fund with 70 percent in equities, 15 percent in bonds and 15 percent in cash.

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, in particular, to the saving on CGT.

Anderson says that, 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 are payable.

Nedgroup Investments cites an example of a R2 000 monthly contribution to a tax-free savings account over 20 years – that is, a total contribution of R480 000. It says if this contribution is invested in an equity portfolio targeting a return of inflation plus seven percentage points and has low costs, the contribution could be multiplied 3.5 times after 20 years and the tax saving would be R150 000. Similarly, Nedgroup Investments says if the money is invested in a property portfolio in a tax-free savings account targeting inflation plus 4.5 percentage points, the contributions could be multiplied 2.8 times after 20 years and the tax saving would be R175 000.

In an update on a recent article on his website, the Index Investor (, independent financial adviser Daniel Wessels, of Martin Eksteen Jordaan Wessels, says that, if you invest R500 000 in a balanced fund in a tax-free savings account and the same amount in a balanced fund that is not tax-free, the final value of the investment in the tax-free savings account could be between three and 64 percent higher than the discretionary investment, depending on your marginal tax rate and the holding period.

Wessels assumed an investment of R30 000 a year for 16 years and R20 000 a year in the 17th year into a balanced fund with 75 percent in equities and 25 percent in interest-bearing assets. He assumed a dividend yield of three percent on the equity portion and interest of seven percent on the interest-bearing assets. In the discretionary portfolio, the dividends attract dividends tax of 15 percent and CGT would apply at the end of the investment term. Assuming an annual return of eight percent, Wessels says the final amount after 20 years for a person on a marginal tax rate of 31 percent will be 25 percent higher in the tax-free savings account than in the discretionary investment and 33 percent for a person on a marginal tax rate of 41 percent.

Wessels says the after-tax values of a tax-free investment invested 50 percent in equities and 50 percent in interest-bearing investments, with an expected return of 10 percent, will after 30 years out-perform a discretionary investment with the same investment and return by: 24 percent on a marginal rate of 18 percent; 33 percent on a marginal rate of 26 percent; 39 percent on a marginal rate of 31 percent; 45 percent on a rate of 36 percent; 49 percent on a rate of 39 percent; and 51 percent on a rate of 41 percent.

Although Wessels agrees that you will derive the biggest benefit if you remain invested for the long term, he says you can still benefit from the accounts if you invest for relatively short terms.

At the highest marginal tax rates of 36, 39 and 41 percent, your investment in a tax-free account would out-perform a discretionary investment by six percent even if you withdrew the money after five years. If you withdraw after 10 years, the out-performance will be 11 percent on a marginal tax rate of 36 percent and 12 percent on a marginal tax rate of 39 or 41 percent. The benefit of remaining invested for longer periods means you should consider withdrawals carefully, Wessels says, particularly because you cannot “replace” the amounts you withdraw.

It might be better to make short-term discretionary investments in products where you can use other tax breaks, such as the tax exemption on interest (R23 800 for taxpayers under the age of 65, or R34 500 for taxpayers over the age of 65) or the annual capital gains tax exclusion of R30 000. However, there is no exemption on dividends.

6. Retirement funds are more tax-efficient

Despite the benefits of investing in a tax-free savings account, your retirement fund is still likely to provide better tax savings, because contributions to your pension fund or retirement annuity (RA) fund are tax-deductible, within certain limits. Employers can make contributions to your provident fund and deduct these from their taxable income. An employee’s contributions to a provident fund are not tax-deductible, but they are expected to become so in future, possibly from March 2016 or 2017.

With both a tax-free savings account and a retirement fund, your savings grow free of dividends tax, income tax on interest or CGT, but your retirement fund has the edge, because you make contributions with earnings on which you have not paid tax.

For example, if you are on a marginal tax rate of 31 percent, 31 cents of every rand you contribute to a retirement fund is a tax saving. If you contribute to a tax-free savings account or a discretionary investment, you can contribute only 69 cents for each rand you earn, instead of the entire R1 with tax-deductible contributions to a retirement fund.

Retirement funds provide a better tax saving even though you pay tax on the lump-sum withdrawal at retirement and the annuity you purchase is taxed at your marginal rate. The first R500 000 of any lump sum you withdraw from your savings – you can withdraw up to one-third – is tax-free (assuming you made no pre-retirement withdrawals).

In a recent newsletter, Freddie Mwabi, an actuarial specialist at Simeka, a retirement fund consulting company in the Sanlam stable, illustrates the point with the following example calculated using the 2014/15 tax rates (that is, before the rates were increased). A 40-year-old earns R10 000 a month and his employer contributes R1 000 a month to a provident fund for 20 years, escalating at salary inflation, which is assumed to be the inflation rate plus two percentage points.

* If the money is invested in a retirement fund that earns an annual return equal to an inflation rate of six percent plus five percentage points (a total return of 11 percent), the investment will be worth R1 468 000 after 20 years.

* If the fund member withdraws the entire amount as a lump sum at retirement, tax of R281 000 will be deducted, leaving him with R1 187 000.

* In comparison, if the 40-year-old was paid another R1 000 a month, and he paid tax on it and then deposited the after-tax amount in a tax-free savings account, his savings after 20 years would be worth R1 075 000.

The difference is that the investor has R567 000 paid into his retirement fund by his employer, whereas he has only R340 000 to pay into the tax-free savings account. At a return of five percent above inflation, this makes a difference of R220 000 in the returns earned from the retirement fund, compared with the tax-free savings account.

Mwabi says the final after-tax amount is 10 percent higher in the retirement fund, which highlights the tax-efficient nature of retirement funds.

However, if you have used your entire retirement fund tax deduction, or you want to withdraw your savings at any time, tax-free accounts offer a much better deal than any other discretionary investment.

Mwabi’s example assumes the man earns R100 000 a month, which means he paid tax at the highest marginal tax rate of 40 percent in the 2014/15 tax year (see the table – link at the end of this article). The example illustrates that the savings are greater for higher-earners. In the exercise, Mwabi assumed the same cost structure for all three types of investment. He says the differences are bigger if the costs of each investment type are taken into account.

Wessels says a taxpayer on a marginal rate of 40 percent (last year’s highest tax rate) would save R12 000 a year (40 percent of R30 000) for every R30 000 contributed to the retirement fund. This means you could contribute R30 000 of after-tax money to a tax-free savings account, or R42 000 a year to a retirement fund, without the higher contribution (to the retirement fund) making a difference to your financial position, because you would get the additional R12 000 as a tax saving. Assuming you earned a real (after-inflation) return of six percent from either fund, your investment values at the end of 16 years and eight months would be R860 037 in the tax-free account or R1 204 052 in the retirement fund.

The savings in the tax-free account could be withdrawn at a sustainable rate of five percent to produce a tax-free income of R43 001 a year, Wessels says.

If you take the full one-third of the R1 204 052 as a cash lump sum and use the balance to buy a pension, and pay the relevant tax on the retirement fund savings, Wessels calculates that, at a drawdown rate of five percent, these savings could produce an after-tax income of R42 141 a year.

These assumptions show that a tax-free savings account will give you a slightly better income than a retirement fund, Wessels says. However, at a marginal tax rate of 30 percent or less, the retirement fund will yield a slightly better outcome.

He says you should also bear in mind that retirement fund assets are exempt from estate duty, whereas the tax-free savings account will form part of your estate (see “One tax you will pay”, below).

In addition, Wessels says you should consider that retirement fund assets are protected against the claims of creditors – in other words, retirement fund assets do not form part of your insolvent estate and cannot be attached by a creditor, whereas a tax-free savings account does not have this protection. The exception is where the account is offered as a life assurance investment policy.

Another aspect to consider is that you can withdraw your retirement savings only when you retire or resign from an employer-sponsored fund or, if they are in an RA fund, from the age of 55, whereas your savings in a tax-free savings account are always available.

7. One tax you will pay

When you die, your investments in a tax-free savings account will be added to your estate and be subject to estate duty after the exemption of R3.5 million. The Estate Duty Act has not been amended to exempt the amounts in the accounts.

However, the returns from the investments will remain exempt from income tax and dividends withholding tax, and your estate will not be liable for CGT when the investments in the account are disposed of on your death.

Neither you nor your estate can transfer investments in a tax-free savings account to someone else. Your heir can inherit the savings and transfer them to his or her own tax-free savings account, but the amount transferred will be regarded as a contribution by the beneficiary to his or her account and count towards his or her annual and lifetime limits.

If a life assurance investment policy is an underlying investment in your tax-free savings account and you nominate a beneficiary, the proceeds from the policy can be distributed to him or her before your estate is wound up. You will also save on executor’s fees on the investment, but you will not escape estate duty, because the amount will be an asset in your estate.

8. Fees

The fees you can be charged for investing through a tax-free savings account must be “reasonable”, according to the regulations under the Income Tax Act. Many product providers appear to be pricing their tax-free savings accounts attractively, because they are competing for your savings.

In addition, the accounts are being launched amid an intense focus on fees and charges in the financial services industry. The initiatives include:

* The implementation of the Treating Customers Fairly regime;

* Reforms to the retirement-funding system that include a focus on the cost of saving in retirement products; and

* The Retail Distribution Review (RDR), which is an attempt to force providers to disclose the fees you pay for each service they provide.

Many providers are not levying charges on their tax-free savings accounts, only on the underlying investments. Unlike a retirement fund, where costs are incurred to set up the fund, the tax-free savings account is not a structure and requires only different reporting to that of a discretionary investment.

Most unit trust companies are not charging fees for investing in their tax-free savings accounts; charges apply only to the underlying funds. You will pay an advice fee if you invest through a financial adviser, but this fee is negotiable.

Linked-investment services providers (Lisps) and investment platforms typically charge an administration fee, but some do not. Sygnia, for example, is offering, through a tax-free savings account, five index-tracking funds on its Alchemy investment platform, with no administration fee, no platform fee and an annual management fee of only 0.4 percent.

In the past, investment platforms received undeclared rebates from unit trust companies, which may or may not have been passed on to you as a reduced administration fee. Many Lisps have now introduced what is known as “clean pricing”, which means that unit trust fees reflect what the unit trust companies actually charge to invest through the platform, while a separate administration fee reflects the charge collected by the platform provider.

The fee of a fund offered on a platform is typically cheaper than the fee charged by a fund that is offered directly, because the unit trust company receives investments in bulk through a platform.

If you invest through an investment platform, check the total fee (the platform fee plus the fund fee) you will pay if you invest in a certain class of fund, and don’t forget that there may be costs for switching between funds. Some investment platforms offer cheaper fees on funds offered by a unit trust company that is within their own group, but the proposals in the RDR suggest that this practice may not be allowed in future.

Investments that charge performance fees cannot be included in tax-free savings accounts, so investment platforms say they have alternative “flat-fee” classes for funds that would normally charge performance fees. These may be the old “R” classes, where fees were typically one percent, or newer classes.

Some companies are advertising what they regard as attractive fees, but you need to assess whether there are merits to each offer for you.

Old Mutual, for example, is offering a tax-free savings account with an administration charge of 0.75 percent for an investment that enables you to access a range of unit trust funds from top managers. There will be asset management fees on the underlying funds. Old Mutual says it will reduce the administration fee to 0.5 percent if you agree to invest only in Old Mutual funds, and the fee will be reduced by half if you invest the maximum allowed annually, R30 000.

Sanlam Life is offering a tax-free investment policy with the investments in unit trusts and Satrix ETFs. The administration fee for the policy is a relatively high 1.45 percent, but this can be discounted as low as 0.2 percent for group investments once the group has invested R1 million. If the group’s investment is R500 000, the fee will be 0.825 percent, Sanlam says. However, the fee discount is based on the amount invested by the group in the tax-free accounts.

Sanlam says an investor group may be set up by a financial adviser for his or her clients, or an employer for its employees, or it may be a group of friends or a family. Accounts, however, remain in the name of the person who opens the account.

Anderson too says employers will be able to offer tax-free savings accounts that can be priced for a group. And if your employer enables you to make contributions through its payroll system, you can save on the debit order charges that come with making a contribution as an individual.

9. An account in your minor child’s name

You can open a tax-free account in the name of a minor child, but withdrawals must be paid to that child or to the child’s deceased estate.

Franscois van Gijsen, a member of the Fiduciary Institute of South Africa and director of legal services at Finlac Risk and Legal Management, says this provision in the regulations addresses the potential abuse of the account by parents who use their child’s tax benefit for themselves by fraudulently purporting to contribute on behalf of a minor child.

Parents have signing powers on their minor children’s bank accounts, Van Gijsen says. However, the lifetime contribution limit means that parents who do abuse a child’s tax-free investment will be restricting their child’s ability to contribute to tax-free investments in future.

He also notes that there are tax law provisions in terms of which SARS can view an investment on behalf of a minor child as a form of tax avoidance.

You can donate up to R100 000 a year to a natural person free of donations tax, so this would cover a R30 000 contribution to a child’s account.

Anderson says saving for a child could help instil a savings culture from a young age, which would be an invaluable lesson later in life.

A tax-free savings account for a child could be used for a child’s education, but if you use it in place of an education-savings product that includes cover that pays out if you die or are disabled before you have saved enough for your child’s education, remember that tax-free savings accounts cannot include life cover and you must provide separately for this cover.

10. Transfers into and out of the accounts

You cannot convert an existing investment into an investment within a tax-free savings account, or have an existing investment reclassified as a tax-free one. If you want to transfer an investment to a tax-free account, you will have to cash in your investment and reinvest, even if you are investing in the same unit trust fund, for example, through a tax-free savings account.

Cashing in an investment that is not within a tax-free savings account could result in CGT, although annually you enjoy an exemption of up to R30 000 on capital gains.

National Treasury is considering allowing low-income earners who have inappropriate life assurance savings products to convert them into tax-free savings accounts. This is a reference to people who pay tax at an average rate of less than 30 percent and who are invested in endowment policies in which the life assurer pays tax on the policyholder’s behalf at a rate of 30 percent.

In the first year in which tax-free savings accounts are offered, you won’t be able to transfer your tax-free savings from one provider to another. Treasury will, in consultation with product providers and SARS, develop regulations that will allow you to transfer your investment to another provider without this being regarded as a new investment.

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