By Amanda Visser

It will come as no surprise to most that the South African Household Saving Ratio is projected to remain well below 1% (0,60%) in 2022. The saving ratio is based on the econometric models of Trading Economics.

This dismal savings culture is despite a plethora of tax efficient and tax free savings products available on the market. South Africans can save tax free through tax free investment accounts (TFIs) or obtain generous tax deductions by saving in retirement funds and retirement annuities.

Tax free investment accounts

In an effort to address the lack of savings in the country, government introduced tax free investment accounts (TFIs) in 2015. They are mainly directed at the middle-income market.

The TFI has an annual limit of R36 000 and a lifetime investment limit of R500 000. These accounts cannot be used as transactional accounts. Fixed deposits, retail savings bonds, certain endowment policies, linked investment products and exchange traded funds that are classified as collective investment schemes qualify as a TFI.

People are being discouraged from withdrawing from the investment, says Ronald King, head of policy and regulatory affairs at PSG. The intention is to save for the long term.

He says there is certainly a space for tax free investment plans in one’s investment portfolio. However, there is a risk that people will focus on the tax benefit without putting sufficient effort into the investment decision – in other words which underlying assets to choose. “Therefor they may be investing far to conservatively,” says King.

Charl Horn from FirstRand Group Tax says investors should consider a product provider that offers a tax free investment wrapper which is essentially a single product, but are allowing flexibility to invest in different underlying asset classes. This include cash, property, equity and bonds.

One of the big advantages of a TFI is that investors are able to transfer between products – in order to optimize returns – without any tax consequence, says Horn.

King advises that since it is a long term investment vehicle, the asset allocation towards higher risk assets such as property and equities should carry much more weight.

“A bank deposit may be the cheapest option, but that limits the investor to cash and for long term investments that is not the best option.”

He says when investors consider a 10-year investment the rule of thumb is to consider a balanced moderate fund. When considering a 15-year or longer investment horizon, the risk profile of an equity investment drops significantly and becomes an attractive option.

Horn says investing in a TFI for your children in effect means that you are giving your child a golden handshake at the start of their adult life, instead of them starting on their own and only reaping the same benefits 20 years down the line.

He also notes that in terms of the Income Tax Act minors are taxed in their own name on income which is received by or accrues to them, unless section 7 of the act deems the income to be received by the child’s parent.

Horn says in the context of TFIs, it could be interpreted that where a parent contributes funds into a minor’s TFI, any income flowing from that investment will be deemed to be that of the parent.

“However, given that the income from the TFI would be (tax) exempt, it would not have any adverse tax consequences for the parent. The parent would, however, need to disclose it in their tax return,” he adds.

Keith Engel, CEO of the South African Institute of Taxation, says given SARS’s new skills in obtaining third party data, particularly in terms of the financial sector, it is nice to have a tax-free option.

“Many use this option for intermediate savings that is somewhat flexible on withdrawal; whereas pension funds require a longer term savings horizon.  Sometimes, intermediate flexibility can be crucial in savings for education,” says Engel.

Tax efficient investments

According to King the tax deductibility of the contributions to pension, provident and retirement annuity funds does outweigh the benefits of the non-taxable withdrawal from the tax free investment plan.

Investors are permitted to invest up to 27.5% of their annual taxable incomes, subject to a R350 000 per year ceiling. On retirement the first R500 000 lump sum withdrawal is tax free.

The contributions to a tax free investment are not tax deductible, but the return is tax free and there is no tax payable on the withdrawal from the fund.

Another option is an endowment policy where interest, dividend income or capital gain earned in the fund is taxed in the fund. Income is taxed at 30% (even if the individual’s marginal tax rate is 41%) and capital gain is taxed at 12% (even if the individual’s effective capital gains rate is 16.4%). However, accessing funds before the end of the term could result in a penalty.

King and Horn emphasise that investors should always consider their risk appetite and their investment goals when making their decisions.