On the 1st of March 2015, a star was born! The tax free savings account.

 

I am sure you are asking but how will a tax free savings bring added value to my retirement value. I will provide you with information, where I will be using basic assumptions to motivate my message, just to keep things simple.

 As we know, currently, an individual can contribute R36 000 p/a or R3 000 p/m and R500 000 for a lifetime, which takes approximately 15 years, considering that full annual contributions are made.

The most valuable aspect of the tax free savings is just as it is depicted in the name, whereby all growth is tax free! No interest, dividend, or capital gains tax apply in terms of Section 12T of the Income Tax Act. You can also nominate a beneficiary, as to avoid estate tax. You can start as soon as you turn 18 years old.
 

I want to point out two simple benefits that the tax free savings brings to the retirement table:

Number 1: Boosting your tax free portion of your retirement income
Number 2: Greater flexibility on where and how to invest your money
 

Let us kick things off with the first one – boosting your tax free portion of your retirement income:

Retirement planning has evolved over the years and one of the biggest factors is that people are living longer. Considering the rise in average life expectancy. Retirement planning has become a lot more difficult and people are going to have to work longer to save enough to last them for at least 30 years. Upon reaching retirement age, the capital you have saved for retirement gets invested (most popular choice being a living annuity) to provide you with a monthly income. This income is expressed as a certain % of the fund value, this % value is referred to as your drawdown on your living annuity.
 
Ideally, a 2 – 5% drawdown would be perfect, (depending on how much capital you saved) as it would give the investment strategy the breathing space to keep up with the necessary annual growth needed, to sustain the drawdown, and to provide an increasing annual income, for at least 30 years.
 

Now, let us get to the good part…

You can earn, up to R128 650.00 p/a out of your retirement savings, without attracting income tax. Any amount above that will be subject to tax. Many people would require more than this to survive in retirement but for illustrative purposes we will work with this amount.

By utilising your tax free savings to help boost your retirement income, we can boost that tax free income even more.

For instance, let us assume you contributed the full R500 000 by the age of 45, starting at age 30. With an annual growth of 8% you would end up with R490 318 present value, in your tax free savings. Assuming the R490 318 continues its path, till age 65 with a constant 8% growth p/a, that amounts to R861 324 present value, in your tax free savings at age 65.
 

We can now tap into your tax free savings to help boost your post retirement tax free income. Based on my assumptions used, your R861 324 present value in your tax free savings could provide you with an additional R43 320 tax free income p/a which comes down to R3 610 p/m.

This means your post retirement income that can be free of tax will look like this:

  • Living Annuity: R128 650 p/a = R10 720.83 p/m
  • Tax free savings: R43 320 p/a = R3610 p/m
  • The total tax free income that could be generated = R14 330.83

Heading onto number 2 of the benefits of a tax free savings – The flexibility:

Currently with your retirement savings, you are bound to Regulation 28 of the Pensions Fund Act which limits your exposure to certain asset classes. The main limitations of Regulation 28 are as follows:
 
  • Equity 75%
  • Listed property 25%
  • Offshore Assets 30%
  • Hedge Funds 10%
One of the main concerns I have received from clients is our political and economical instability and the fact that you can only invest a maximum of 30% in offshore assets is always a worry for clients. No one wants to invest in uncertainty.
 
The TFS comes to the rescue again. Your tax free savings is not bound by regulations in terms of limits when it comes to choosing an asset class. Should your risk profile support it, you can invest 100% of your tax free savings into offshore assets which provides you with a greater diversification when it comes to your total investment portfolio.
Offshore assets can provide a greater growth opportunity.
 

To help illustrate this, let us look at a real-world scenario of one of my actual clients:

This client has both a retirement annuity and a tax free savings. The retirement annuity did take a dip in performance due to the market crashes caused by COVID-19. But I would like to focus on his tax free savings performance. He started his TFS in September of 2019. We structured the funds so that 70% is exposed to offshore assets and the remaining 30% is invested in an income fund as a form of safety net. For this client, his total contributions to date is R25 000. His current fund balance is R28 352. His total un-annualised performance currently sits at 27.84% – The power of diversification!
 
Please note that in this case, the performance figure is not the final annual performance growth figure as this investment is not 1-year old year yet.
 
Please note that retirement planning is a complex exercise. This is not a depiction of a complete retirement plan, but merely an example depicting the possibilities of smart retirement planning, and some of the ways a tax free savings could be utilised.
 

These figures are also based on certain assumptions, my assumptions used are:

  • Investment return 8%
  • Inflation 5%
  • Annual increase in tax free savings income 5%