TFSA: what we know now

SIKI MGABADELI: It’s close to the end of the first year where you are able to invest R30 000 in a tax-free savings account. So we are going to talk about the benefits of the accounts.

They are quite simple to gasp, really. You pay no tax on any interest income or dividends that you’ve earned through the investment, regardless of how long you stay invested. And you don’t pay any capital gains tax when you withdraw your investment.

We are chatting to Nerina Visser, who is ETF strategist at ETF.co.za. Hi, Nerina. Am I still allowed to say Happy New Year?

NERINA VISSER: Yes, you are. Next week we can start saying Merry Christmas again.

SIKI MGABADELI: [Laughs] All right, there we go. Do we know if there has been an influx of people rushing off to open tax-free savings accounts?

NERINA VISSER: I don’t think a rushing off or an influx. Yes, there have been some steady streams into it, but I think it has been a good experience, considering it’s the first year. A year ago this time we didn’t even know about these. They were on the cards, but they hadn’t been confirmed. It was only announced during the budget speech last year in parliament, so really still very new.

And clearly also, because it was announced close to the start of the new tax year, a lot of providers took some time to actually clarify their offering, position it correctly and so on. So it certainly was a relatively late start to the year.

But I think there has been a good uptake in it. Probably one of the big lessons that has been learned is that I think that, because these are typically referred to a tax-free savings accounts, many people think of them only as something that you can do with a bank, with a savings account – something that you are going to earn interest on. The official term is a “tax-free savings and investment account”.

I think if you look at the tax benefits that you get from these tax-free accounts, it goes so much further than not having to pay tax on interest. You also don’t pay tax on dividends, you don’t pay tax on any distribution, you don’t pay any tax on capital gains, which of course in the investment environment, especially over the longer term, suddenly becomes a lot more relevant.

And I think that maybe has been one of the biggest almost paradigm shifts or learnings that people make in terms of where do they use this, how does it fit into my overall savings and investment plan.

SIKI MGABADELI: And that’s perfect, because I actually have a question from Natie on Twitter who asks do we have the luxury of picking any asset class that you can find on the JSE, or does it have to be limited to certain products?

NERINA VISSER: That’s a wonderful question. The criterion, especially when you look towards the JSE as an opportunity, one of the limits is that it has to be a collective investment scheme, so a unit trust. You are not allowed to buy an individual share or company security for your tax-free account. But of course most of the ETFs that are listed on the JSE are also regulated as collective investment schemes, and therefore qualify.

So some of the other limitations when you look towards unit trusts that are not traded as ETFs on the stock exchange is that you are not allowed to include anything that has a performance-based fee in it. So only those unit trusts that are offered, that have got relatively clean pricing and no sort of performance-fee kickers in them have been allowed to be used in tax-free investment accounts.

SIKI MGABADELI: And that is so important because, as you were saying, a lot of people here hear “saving account” and they ordinarily think, bank, and the banks do offer…

NERINA VISSER: Yes, they do. But, you know what, if you think in terms of, let’s say, even an interest rate of 7%, which is quite a high interest rate for a savings account, on your R30 000 limit that means R2 100 worth of interest that you will earn, which you will now get tax-free. But you already have a lot more tax-free interest that you can earn a year. So putting it into a savings account is really a bit of a waste of your tax-free allowance, because you only have one R30 000 that you can put in every year. So putting that into a savings account means that you are wasting the opportunity that you have of saving all those other taxes also on your R30 000 allowance.

SIKI MGABADELI: Another question I received – I’m 67, is it too late to actually invest in these? Does it matter if you are in retirement?

NERINA VISSER: No, it is never too late. Clearly the longer you can stay in the investment the better opportunity you have to allow the capital market and the capital gains to work for you. But the great advantage of using a tax-free account when you are already older or approaching retirement, is that when you think of building up even over a period of 10 years in such a tax-free account, then you withdraw from that account, Even though your annual limit of contribution is R30 000, that contribution can grow to an unlimited amount. And whatever you withdraw from it is then tax-free.

Now think in terms of somebody who is retired, earns a pension, maybe from an occupational pension fund or another annuity – those typically pay a fixed monthly pension amount. So it covers your sort of normal expenses in retirement. But we are living longer and longer in retirement and you’ve got the situation of where must somebody actually get access to capital amounts in retirement. You’ve got to replace the car, replace the hips or the knees, maybe. They are capital expenses that cannot be covered by your normal monthly pension, and that is where having a lump sum invested in your tax-free account that has built up over the years and sits there waiting is a perfect way for you to actually supplement your monthly annuity or pension income in retirement, and you can draw on that capital that has been accruing there tax-free.

SIKI MGABADELI: And how often are you allowed to withdraw?

NERINA VISSER: You can withdraw whenever you want to. There are no restrictions on it. But you cannot re-contribute anything that you’ve withdrawn.

Let’s use this as an example. If I have invested my full R30 000 during this first year and I decide, because it’s January and times are tough and school fees need to be paid, that I’m going to withdraw R10 000 of my R30 000, the other R20 000 is still in my tax-free account and it grows. I’m not allowed, a couple of months down the line, to re-invest that R10 000 that I have withdrawn from it.

So people must think very carefully before they withdraw from a tax-free account. Even though you are allowed to do it, you are really then limiting your own ability to participate in the full benefit of the tax-free account.

I think that’s maybe one of the things that we’ve seen, unfortunately, quite a bit of over December and January as people are experiencing financial strain as we typically do at this time of year. A lot of people have taken to their tax-free accounts and said, aha, there is some money that I can cash in. And unfortunately they have of course done it at quite a poor time from a market perspective. So that has been unfortunate. So as much as I encourage people to invest and save in these tax-free accounts, think very carefully and make sure that you are putting money in there that you are not going to need in the next couple of days.

SIKI MGABADELI: How do you choose between all the different options out there? It can be mind-boggling, particularly for people who are not exposed to the market, and maybe the closest they’ve ever gone into savings is a savings account or a fixed deposit.

NERINA VISSER: Well, fortunately there is a wonderful website which has been created called savetaxfree.co.za. I really would suggest and recommend to people that they go to that website because it’s a completely independent website that really just shares with you all the different options and possibilities that there are available in the South African market. And it allows you, with a fairly simple interface, to maybe specify things like your investment horizon, your risk tolerance, what you are looking to achieve with that, and then help you to narrow down the range of options that are available in terms of the tax-free savings and investment accounts.

SIKI MGABADELI: What sort of fees can you be charged?

NERINA VISSER: There is no limit in terms of that, but clearly this is a product which government has made available, or an opportunity, a dispensation, that is really designed to encourage people to start saving and investing more for their own retirement and not make them as dependent on government. So as an industry I do think we have a responsibly to really do this at as affordable a level as possible.

But I want to just put things into context for people. Because it’s limited to R30 000 a year, if you are looking, for example, at a 1% cost on such an investment, that translates to only R300 for the whole year. So think – what can you get for R300 in a year? So as investors, we also need to appreciate what we can expect to get in terms of this. Either it’s going to be a higher cost, or, if companies are offering this at a lower rate like a 1% rate, they are really doing this as a contribution to facilitate and to grow the industry, because it doesn’t even begin to cover the costs of the financial services providers.

SIKI MGABADELI: All right, let’s take some questions. We’ve got three on SMS, One is: what type of tax-free savings accounts are available for children?

NERINA VISSER: Oh, this is a wonderful question. I’m so pleased to hear that, because it doesn’t have to be a special account. The tax-free savings and investment accounts are equally available to every single South African citizen. So it’s a wonderful way for a family, for parents, to save for each person in the family who qualifies for the R30 000 annual limit. So if there is a mom and a dad and two kids, it means that as a family you can save R120 000 per annum on a tax-free basis.

I strongly recommend to people that, rather than take out something like an education policy which often comes with expensive add-ons that you don’t necessarily need, just save for your children in a tax-free investment account. It’s going to take 17 to 18 years to build up to the R500 000 annual limit that we currently have. That’s the perfect time horizon, from birth, to save for your child. And by the time they are in matric or finishing school, there is a wonderful capital lump sum waiting for them for their adult life.

SIKI MGABADELI: Another one. Are charges the same on TFSA unit trusts compared to normal unit trusts with the same provider?

NERINA VISSER: Theoretically speaking, yes, although I can’t guarantee that it will necessarily be the case. So for the actual unit trust itself the charges would be the same, but there might be differences in the administration costs on top of the unit trust price itself.

SIKI MGABADELI: All right, a final one. I have invested in the Beta Betta and the db x-tracker world in my TFSA [tax-free savings account]. What else would you recommend I buy next?

NERINA VISSER: It’s great to hear this question, because I think a lot of people have been very keen to put all of their tax-free allowance into the db x-trackers or offshore products. And of course, with the rand having done what it has, it’s been a brilliant investment.

But I want to caution people against after the fact – there is that wonderful saying, don’t shut the stable door after the horse has bolted. So many people are now wanting to rush to take money offshore or to invest it in the db x-tracker products, so I just want to caution against not basing you investment on the experience that we’ve had in the last few months with the rand depreciating. What I definitely would focus on for the next year is to try and look at something that’s not going to only give you good capital gains but also a high level of interest.

So something like your property ETFs are a really good choice for a tax-free account because you are getting both the capital gains tax free as well as all the distributions also tax-free.