• Editor

How to make the most of tax incentives beyond TFSAs

The media hype about tax-free savings accounts (TFSAs) may take investors’ eyes off the other tax incentives available to them. There are other ways investors can benefit, particularly if they start the new tax year with a clean slate that makes the most of available tax incentives for long-term savings products.

1. Don’t lose sight of the most important savings goal: retirement

The first, and by far the most important tax incentive, remains an investor’s contribution to a registered retirement fund (either through their employer or via a retirement annuity).

Retirement funds have been a major talking point in the advisor community over the last few years. Most of the debate focuses on whether the tax benefits of retirement funds are enough to compensate investors for the investment restrictions imposed by Regulation 28 – specifically the 30% offshore exposure limit and the three-year delay in accessing retirement assets upon emigration.

At the time, Ninety One did some modelling work to quantify the value of retirement fund tax benefits over the lifetime of a pensioner. In addition to the well-known estate duty benefits of retirement funds, we concluded that the tax savings typically accumulate to an additional investment return of 2%-2.5% p.a. over the lifetime of a retirement fund member.

This is a material performance advantage and, unless an investor is planning to emigrate soon, we believe there remains significant long-term value in contributing to a retirement fund every year.

Advisor takeaway: For most investors, contributing to their long-term retirement plan remains the priority.

2. Maintain an emergency cash fund, maximising your annual interest exemption

Investors should use their annual tax-free interest income exemption (currently R23 800 for individuals under age 65 and R34 500 for people aged 65 and older).

At expected money market rates of between 4% and 5% p.a., an investor can safely keep approximately R400 000 in fixed income investments before paying any tax on the interest earned. This can be used to set up an investor’s emergency cash fund.

Just remember to include the emergency fund in the overall portfolio asset allocation to verify that the emergency fund is not making an investor’s overall investment portfolio too conservative.

Advisor takeaway: Make sure the investor has an appropriate emergency cash reserve in place as part of their overall investment portfolio and use available annual interest exemptions.

3. Don’t forget about your annual R40 000 capital gains tax (CGT) exclusion

Due to its relatively small size, many investors forget that the first R40 000 realised capital gain in a tax year for an individual investor is excluded from the calculation of the investor’s CGT liability.

Most advised investment portfolios are rebalanced on an annual basis to keep the portfolio aligned with the investor’s risk profile. Ensuring that these annual rebalances happen in the correct tax year can save clients unnecessary CGT. Even though the maximum tax saving is only around R7 200 per year currently (R40 000 x 40% x 45%), the saving will compound to a reasonable amount of money over time. So, keep an eye on the date (relative to tax year-end) that you rebalance a long-term investment portfolio.

Advisor takeaway: An investor’s annual capital gain exclusion, whilst small, can compound to a meaningful amount over time.

4. Set up a TFSA for the long term

When TFSAs were first introduced, many investors and advisors underestimated the extent to which TFSA tax benefits need time to compound. This is because a TFSA contribution is not tax deductible upfront like a retirement fund contribution, which makes it difficult to calculate the rand value of an investor’s TFSA tax benefit in advance.

In addition, the lifetime TFSA contribution limit further delays the real tax benefit to the period when the investor has used their full lifetime contribution allowance.

These points are best illustrated by an example. In Figure 1 we project a TFSA’s fund values over a twenty-year period, based on the following assumptions:

  • An investor contributes the maximum annual amount of R36 000, and this limit is never increased by National Treasury.

  • The R500 000 lifetime limit is never increased, and contributions cease when this limit is reached.

  • Assume a 10% p.a. investment return and inflation of 6% p.a.

  • Further assume a roughly 50/50 split in investment return between interest and capital gain, resulting in an effective combined tax rate of 30% on total investment returns.

Figure 1: TFSA value projection split between contributions and investment return