Last year the government introduced tax-free savings accounts to boost South Africa’s savings rate.
TFSAs are ideal because account holders are exempt from paying capital gains tax , tax on interest and tax on dividends.
TFSAs are useful as long-term investments and parents can open them for their children. If you want a TFSA for each of your children you can save up to R30,000 a year per child. A family of five can save up to R150,000 a year.
When it comes to the type of investment vehicle, you can either invest in a tax-free cash deposit-type account, a unit trust or exchange traded fund.
Fixed-deposit accounts are traditionally offered by banks. These are low-risk and low-return accounts that are better suited for short- to medium-term investments. Interest rates rarely compete effectively with inflation rates, thus making them inefficient for the investor looking at the long term.
Each bank has variable interest rates, differing according to the length of investment and the amount invested. Withdrawal notice periods vary from institution to institution. Consult the bank for the latest rates and monthly costs before you pick an account.
For those looking for slightly riskier products, you can choose between unit trusts and ETFs.
Unit trusts are collective investments made up of a portfolio of assets that include (but are not limited to) equities, bonds and listed property.
Unit trusts are one way that investors can spread their exposure to different asset classes. Unit trust funds are usually actively managed and you must bear in mind that you will be charged a management fee when you go with this option.
An example of a unit trust would be the Satrix Alsi Index Fund. This tracks the performance of the JSE All Share index – 160 of the largest companies, ranked by market capitalisation, that are listed on the JSE .
Much like unit trusts, ETFs are securities that track the performance of an index, commodity or bond. The main difference between the two is that unit trusts are priced once a day whereas ETFs trade like shares and the price depends on the time of the trade. ETFs are also passively managed funds, which means they are slightly cheaper than an actively managed unit trust.
The Satrix 40 ETF is an ETF that tracks the performance of the FTSE/JSE Top 40 index. This means the investor is invested in the top 40 companies on the JSE (valued by market capitalisation) with the benefit of a diversified investment in one security.
If you’re more interested in an actively managed fund, a unit trust might be a better option. However, if you want to go with a cheaper investment with low fees, you might want to look at ETFs.
The benefit of a tax-free unit trust or ETF tax-free investment is that, depending on which asset class you are invested in, you can expect higher returns as you are exposed to different asset classes. The downside is that your capital is not guaranteed.
Speak to a financial adviser so you can understand the risk versus reward trade-off and your risk profile in order to make an informed investment decision.
You also need to be aware of the following restrictions that come with a TFSA:
You can deposit only a maximum of R30,000 a year into your account, with the lifetime contribution capped at R500,000;
You cannot reinvest any funds withdrawn from your TFSA. For instance, if you contribute R30,000 to your TFSA in the current tax year, and decide to withdraw R5,000, you have to wait for the next tax year to reinvest that sum; and
You cannot transfer funds from one TFSA to another, although this is likely to change on November 1.