South Africa has one of the lowest household savings rates in the world, notes Hugo Malherbe: executive product development at PPS Investments.<\/p>\n
To encourage the culture of savings, the government introduced tax-free investment and tax-free savings accounts in 2015 to incentivise good savings habits. Today, tax-free investments appear to be a popular choice but still remains an underutilised opportunity, he said.<\/p>\n
Malherbe unpacks the ways in which tax-free investments can benefit an investor portfolio.<\/p>\n
Contribute wisely and within the limits<\/strong><\/p>\n With tax-free investments, an individual can contribute up to R36,000 per tax year and up to R500,000 over their lifetime, where the interest, dividends; and capital gains are earned tax free.<\/p>\n It\u2019s important to note that any amount exceeding the annual or lifetime contribution limit will be subject to significant tax penalties (taxed at 40%), that could erode the value of your investment. The contribution limit applies to all the tax-free accounts held in the individual\u2019s name.<\/p>\n Even though one can access their tax-free investment at any time, withdrawals cannot be replenished. Tax-free investments are best-positioned for building wealth over the long-term.<\/p>\n Using tax-free investments as part of a retirement savings plan<\/strong><\/p>\n Due to the long-term nature of tax-free savings, the tax benefits, accessibility and flexibility, it is often considered as part of a retirement savings plan.<\/p>\n While a tax-free investment is not designed to be your sole source of retirement savings, when coupled with retirement fund savings, it presents an opportunity to boost your nest egg with a tax-free lump sum at retirement along with the retirement fund savings that secures a regular annuity income.<\/p>\n The tax-free investment is also not subject to Regulation 28 (part of the Pension Funds Act) which limits the percentage allocated to certain asset classes.<\/p>\n Thus, the tax-free investment offers more freedom around choosing investment options that align to an individual\u2019s retirement savings goals and plan. With no restrictions in terms of asset allocation on tax-free investments, one could invest 100% in any asset class, for example: global or SA equity depending on one\u2019s needs and ensuring adequate diversification across one\u2019s portfolio.<\/p>\n Even though the contributions into the tax-free investment account are not tax deductible like retirement savings contributions, what makes the tax-free investment account a powerful investment vehicle is the compounding effect of the tax savings over time, coupled with the investment growth.<\/p>\n With retirement savings contributions into a retirement annuity fund, a pension fund or a provident fund, you can claim back up to 27.5% of remuneration, or taxable income up to R350,000, in a tax year.<\/p>\n While both options present tax-efficient ways to save towards retirement, it is essential to view your investments within the context of your holistic financial plan.<\/p>\n Invest early and stay the course<\/strong><\/p>\n When investing, it\u2019s best to start early and remain invested for the long-term, as it offers more potential of boosting one\u2019s wealth in the future. Even though the tax-free investment limits the contribution to R36\u202f000 per year, the principle of a little can go a long way applies here.<\/p>\n To demonstrate this, consider the example below that illustrates the net worth of two people after 40 years with one in a tax-free investment account and one in an investment account:<\/p>\n (Assumptions: annual growth of 8%, marginal tax rate of 30%, investor B used CGT exemption)<\/p>\n\n