Overview on Tax Free Savings versus Retirement Annuity

Posted 21 February 2020 under TaxTim's Blog
Overview on Tax Free Savings versus Retirement Annuity

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:

 

Debt

(To purchase a house, car, and other assets.)

Savings

(To meet planned or unforeseen expenses such as medical, holiday, emergencies)

Retirement

(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.

Retirement Annuity

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:

  • are self-employed;
  • don’t have access to a work-place pension or provident fund through their employer;
  • want to supplement their pension or provident fund savings; or
  • earn significant amounts of non-pensionable income (i.e. interest and rental income).

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

 Comparison 

 TFSA

 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

Money access Anytime 

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

Growth Tax-free 

Tax-free

Payment  Tax-free

Pension subject to income tax, tax relief on lump sum


Summary

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.   



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