Tax-free savings accounts enter next phase

National Treasury is aligning the tax-free savings account (TFSA) rules for fixed deposits with rules for regular fixed deposits to entice banks and other institutions to offer fixed-term deposits with higher rates of return within the wrapper.

It seems that there is a significant demand for these products from pensioners in particular, but almost no such higher-return products are currently available. The annual interest exemption (R23 800 for individuals younger than 65 and R34 500 for people 65 and older) has remained unchanged following the introduction of TFSAs on March 1 2015 and retirees may be paying more tax.

Following an increase in the annual contribution cap announced in the February Budget, individuals are allowed to invest up to R33 000 per annum in one or more TFSAs (collectively) up to a maximum of R500 000 over their lifetime. All the investment returns earned in the accounts are 100% tax-free.

Christopher Axelson, director for personal income taxes and saving at National Treasury, says although it has been encouraged by the enthusiasm from product providers and consumers about the incentive, the absence of higher-return fixed deposit products offered within the wrapper is the one aspect of the programme it is not completely satisfied with.

“Nobody is offering them [fixed deposits] within a TFSA account wrapper and it might have been because we were a bit too prescriptive in terms of the regulations on these types of products.”

He says Treasury has received quite a few emails and letters from members of the public asking for fixed deposit products offering a higher return within the TFSA. Many individuals want a good return, but are worried about being invested in equities.

One of the impediments to offering these products may have been that the initial fixed deposit regulations for TFSAs required product providers to pay the investors within seven days if they asked for the money before the term expired – even on a five-year fixed deposit.

Treasury believes that created problems for banks because they couldn’t classify that capital as medium term – it had to be classified as short-term capital – which has an impact on their capital requirements. It also reduces their flexibility with longer-term deposits.

To resolve the issue, Treasury has proposed that fixed deposit TFSA rules be aligned with regular fixed deposit rules. With regular fixed deposits the bank has discretion to pay out the money before the term expires. In other words, the bank may decide not to pay out a five-year fixed deposit if the investor asks for the money after two years.

Another potential obstacle to higher-return offerings may be the penalty structure within these types of accounts. Treasury has restricted the amount that providers can charge investors as a penalty if they cash out early. For the moment however, the penalty rules will remain in place although Treasury is keeping an eye on the matter.

Fixed deposit TFSA products will also be required to disclose a rate of return measured in the same manner. The methodology will have to be consistent to encourage simplicity and comparability between product providers.

Previously product providers were using two different methodologies for the disclosure of returns on products that were very similar, making it difficult for consumers to compare. On face value, simple interest on a fixed deposit product will look a lot higher than compound interest on an otherwise identical product from a separate service provider.

“Instead of getting everybody to move to simple interest with the higher rate, we’ve put forward a compound interest formula so that everybody is on the same playing field.”

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