Are Tax Free Savings Accounts improving the culture of saving? There was much excitement when Treasury launched TFSAs earlier this year. We agreed wholeheartedly in the philosophy behind these accounts, which is that in order for South Africa to thrive, it’s critical that we create incentives for low income earners to save.
Yet overall, since the launch we’ve started to become disappointed, and here’s the main reason why: while these accounts can possibly offer a decent means of saving for those with middle to upper incomes – namely our client base — TFSAs don’t truly fit the needs and realities of lower income earners, who need viable savings options the most. TFSAs are essentially tax incentivized savings plans and as low income earners generally pay less tax so the benefit of a TFSA becomes less relevant to them. This could be relevant to you in relation to domestic staff you employ who might ask your advice about TSFAs. We definitely do not recommend a TFSA for anyone who doesn’t pay tax.
What do TFSAs mean to our clients?
Tax Free Saving accounts can be a very attractive option under the right circumstances. However, the attraction is not (as the adverts say) a tax saving on interest. Although interest earned in a TFSA is tax free, the attraction in our view is the long term effect of capital growth not being taxed via Capital Gains Tax. Currently you can only put R30,000 per year into a TFSA and in our view, the major detractor is that there is a lifetime contribution limit of R500,000. That means you need to think carefully when putting money into a TFSA because if you withdraw the funds, you cannot top it up again once you have reached your lifetime limit. Time is the critical factor that makes TFSAs attractive. To get the most out of a TFSA, you must leave your money invested for 20-30 years, therefore allowing for the effect of compounding to take hold.
So then why not use it for children or grandchildren?
Here’s a personal example to set the scene. When my children were very young (and I could afford it), I set up debit orders into unit trusts that are invested in their names. Their nest egg has been growing as they get older. The money is currently not taxable in their hands and it is unlikely they will have a tax issue by the time they are 20 years of age.
If rather than unit trusts, I had set up TFSAs for them, when we reached the time to withdraw the money to say buy a first car or deposit on a home, I would have prejudiced their right to use a TFSA as a planning tool in their lifetimes. The point is debatable but we believe that a TFSA should not be used to save for minor children as it reduces their once off lifetime allowance without them having a choice in the matter.
For Adults Only
TFSA’s would suit people in their thirties who have got into the property market and can afford to save after paying down their bond and their car. However, this is generally a small group: those with children are most likely elbow deep in school fees and bigger bonds, with little left to put towards a TFSA. The accounts probably work best for 35 -50 year olds, who are largely on top of their debts (bond and car), contributing the maximum to their retirement savings, living within their means and have some savings capacity.
Here’s what we think works best for our clients:
Bottom line, in order to get the maximum out of a TFSA, you should consider putting in long term savings that you may only need in 20-30 years. You want to invest for maximum capital growth, so we don’t recommend holding cash in a TFSA. Rather invest in growth assets like equity either locally or offshore, or both. While equity is more volatile, it offers the most capital growth over the long term.
In general, we recommend that you keep saving into your retirement fund (be that your work pension or provident scheme or your retirement annuity) throughout your working life, concentrate on reducing your debt over time, hold an emergency fund that is liquid, and only once you are on your way to achieving these goals, consider starting a TFSA for long term discretionary savings.
When the Hype Clears
There is currently much hype in the market about TFSAs, with lots of product providers advertising their offerings. In time this buzz will fade once people and advisers work out that TFSAs are not for everyone.
However, if Treasury adjusted the rules by increasing the annual amounts depositors can put in and waiving the lifetime capped amount, these savings devices would become much more user friendly and attractive. By eliminating the cap, savers would be able to liquidate and restart the product again without long term implications.
You can rest assured that we’ll be keeping our eyes on the evolution of the TFSA, and how it can best serve our clients.