By Rowan Burger from Momentum Investments
The benefits of saving your money are well known and encouraged by many financial institutions , with many advising their clients to opt for tax free savings accounts (TFSA) and/ or a retirement annuity fund (RA).Both these savings vehicles provide some form of tax exemption benefit. But the question is which one would yield better returns.
Let’s begin with an overview of the purpose of various vehicles and the investment horizons one should consider in order to ensure all your financial demands are met:
(To purchase a house, car, and other assets.)
(To meet planned or unforeseen expenses such as medical, holiday, emergencies)
(To enjoy a comfortable lifestyle in your old age)
|Investment option and horizon||- Savings
- 10 – 15 years
- Company is a separate legal entity.
- PTY Ltd / Company
|- Pension Fund
- Up to retirement and beyond
The investment horizons are only guidelines about how long one should consider saving one’s money in order to consolidate one’s debt as quickly as possible and to ensure all expected and unexpected financial demands are met.
A TFSA has tax incentives to build your savings, and a Retirement Annuity has tax benefits to enhance your retirement investments.
Let’s unpack Tax-Free Savings Accounts (TFSAs)
In 2015 the South African Government introduced TFSAs as an initiative to encourage a savings culture amongst the South African community. The tax benefits of these accounts are that investment gains including interest income, capital gains and dividends, are tax free. Furthermore, these accounts are allowed to invest in equities, fixed income accounts or both, thus significantly increasing the returns for individuals (and making them suitable as a longer term savings vehicle).
While this is a major benefit for the individual, there are various restrictions. The total contribution that will qualify for tax exemption is capped at R33 000 a year, and up to a maximum of R500 000 per lifetime. Individuals are allowed to open only two tax exempt savings accounts per year TFSAs are considered excellent savings vehicles to build a buffer to protect against unexpected financial emergencies.
A retirement annuity (RA) is a tax effective investment vehicle designed for saving for retirement and therefore is bound by the restrictions set out in the Pension Funds Act.
Ideally, an RA is purposed for individuals who:
Since 1 March 2016, RAs qualify for the same tax incentives as pension and provident funds and individuals may deduct contributions to an RA fund of up to 27.5% of taxable income or gross remuneration, whichever is the higher, for tax. There is an overall tax-deductible limit of R350 000 a year. However, contributions over the annual rand limits may be rolled over to future years, but will be subject to the limits applicable in those respective years.
The investment gains in an RA are also tax free.
Comparison between TFSA and RA
|Tax-free limits||Invest up to R36 000 and a lifetime limit of R500 000||
Invest up to 27.5% of annual income, with a maximum of R350 000 a year
Only from age 55 (or earlier if you are permanently disabled through injury or illness)
|Usage of benefit||No restrictions||
Up to a third of the lump sum upon retirement
|Investment||Simple cash and equity options||
Wide variety but subject to Prudential guidelines
Pension subject to income tax, tax relief on lump sum
So which is better? A TFSA or an RA? Well, it all depends on your savings goal. The better tool for retirement saving is the RA because it has better taxation benefits and the fact that the money is inaccessible until age 55 also gives it an opportunity to grow without interruption. TFSAs, on the other hand, are a great tool to supplement long-term savings and giving you some flexibility with regards to access of your funds. Both savings vehicles are a smart way to benefit from tax exemption.