It’s nearly the end of the tax year and across the industry investors are urged to max out their tax-free savings account (TFSA) and retirement annuity (RA) before 29 February 2020, notes Gielie de Swardt, head of Retail Distribution at Sanlam Investments.
Before 2015 there was only one product offering significant tax relief to private individuals, the RA. Then arrived the TFSA with its unique rules and tax treatment.
While it’s great to have more options, it could also lead to ‘analysis paralysis’, non-action because there never seems to be enough time to figure out which one of these products is better. We compare an RA and TFSA here to make it easier for you to choose one – or both, De Swart said.
How is an RA similar to a TFSA?
Both investments attract no income tax on interest, dividends or capital gains tax while you remain invested in the product (it’s when you withdraw your money that tax kicks in on the RA).
“In other words, in all the years that you remain invested, you should not be paying any tax on the income or growth on either of these products – they are essentially both tax-free for as long as you remain invested,” De Swart said.
How does the tax on an RA differ from that on a TFSA?
- Tax relief on your contributions:
With an RA you can contribute up to 27.5% (capped at R350,000) of your total annual income and deduct it from your taxable income to enjoy tax relief on it; with a TFSA there’s no such deduction from your taxable income to lower the amount of income on which you pay tax.
- On your withdrawals:
When the day arrives to withdraw your money (only possible after age 55 for an RA) no tax applies to the TFSA – not on any of your withdrawals.
However, with the RA, the first R500,000 of your lump sum withdrawal attracts 0% tax; the rest is taxed according to a sliding scale, De Swart said. The income that you have to buy with the compulsory two-thirds of your RA value is taxed on the same basis as your salary or normal annual income.
“Essentially the TFSA is always tax-free (with the exception of the 40% tax penalty mentioned below); the RA is tax-deferred but with additional tax relief in the years that you are making contributions.”
Can I access my money at any time?
With an RA, the earliest date that you may retire and withdraw money is age 55, De Swart pointed out, and on that date your withdrawal is limited to a lump sum of one-third of the value of your RA.
“If you’re planning to be financially free before 55, because of the ‘age restriction’ an RA may not appeal to you, but don’t dismiss it completely. It’s possible to use both a TFSA and an RA as long-term savings products,” De Swart said.
“Once you’ve reached your financial freedom goal you could use your TFSA to withdraw the money needed for your living expenses up to age 55. After age 55 you can officially retire from your RA and use the one-third lump on retirement and subsequent annuity income to live from.”
With a TFSA, there are no withdrawal restrictions – you can access your money at any time, Sanlam Investments said.
What if I invest more than the annual allowance?
With a TFSA, the taxman will penalise you once you contribute more than the TFSA R33,000 annual allowance – a penalty of 40% of everything you put into your TFSA accounts (combined) that exceeds R33,000 per tax year. “So, make sure you monitor all your contributions to your TFSA accounts closely,” De Swart said.
With an RA, there is no penalty for ‘overcontributing’. “Yes, there is the annual tax-deductible limit on RAs. But you are welcome to contribute more than 27.5% of your income. Any excess amount is carried over to the next tax year. In other words, it has the potential to provide tax relief in coming years.”
Can I invest in any asset class I want?
With a TFSA, the restrictions are less limiting that with an RA. “TFSAs are not allowed to invest in single commodities (for example gold) or funds that have a performance fee structure,” De Swart said.
In contrast, RAs are subject to various limits on all major asset classes and geographies, for example you may invest no more than 75% in shares and no more than 30% in international assets, he said.
“This can be frustrating for investors who want more exposure to these high growth, but riskier asset classes. Generally, the good diversification enforced on an RA does create a smoother return experience, though.”
And the verdict: TFSA or RA?
So, should you go for an RA or a TFSA?
“That will entirely depend on your unique tax bracket – now and once you are ‘retired’. It will also depend on whether you would need access to your savings before age 55, whether you want to invest 100% in shares, property or offshore assets (not allowed with an RA) and whether you need protection against potential future claims from creditors,” De Swart said.
Your needs are unique and therefore how much you need to allocate to your RA compared to your TFSA will vary from person to person.
If you decide to prioritise a TFSA, first do a few checks before you top up
February is a good time to log into all your tax-free savings accounts and double-check how much you’ve contributed in total since 1 March last year.
Are you still under the R33,000 annual contribution limit across all accounts? Do you have spare cash to invest? If not, do you have any investments in taxable products, such as standard (pre-TFSA) unit trusts?
“You may want to consider converting some of that investment (if no penalties apply) and investing the money in a TFSA version of the same unit trust instead. To do that, you would need to withdraw money from your existing taxable unit trust to reinvest into your TFSA.
“Remember that the withdrawal would trigger a capital gain with SARS, but the first R40,000 of your taxable gains every tax year is currently exempt from capital gains tax,” De Swart said.