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Investment Strategy
Wednesday, April 8, 2015 - 02:16
Magic formula

The introduction of tax-free savings accounts is part of Government’s drive to create a culture of savings in South African households.

Clients may now invest up to R30 000 a year in a variety of products covering a wide range of asset classes, with a lifetime investment cap of R500 000. All dividends, interest and capital gains generated by these savings accounts are tax-free.
Explains Johan Gouws, Head of Investments: Momentum Employee Benefits, “These accounts tie in with themes underpinning Government’s proposed Retirement Reforms such as simpler, cost-effective products as well as fund preservation. Government hopes to reduce the temptation to dip into retirement savings by encouraging South Africans to save for medium-term goals and emergency funding. This will make households less vulnerable to financial shocks and lower reliance on short-term debt.”
Tax-free savings accounts are also suitable for long-term savings like retirement, he says. Yet, despite the simple concept underlying this investment, one needs to take a holistic view on all available tax incentives. “For instance, withdrawals from tax-free savings accounts are non-taxable, but contributions made to these accounts are from post-tax earnings. In comparison, contributions to retirement funds are tax-deductible, but withdrawals are taxable. Products like retirement annuities and employer retirement funds may still offer more tax-efficient retirement savings,” he points out.
“If one considers individual tax rates, it may be more beneficial to increase retirement fund contributions in years where your tax rate is high and rather contribute to a tax-free savings account in years when your tax rate is lower.” This is specifically relevant in the light of the life-time contribution limit specified. Use your tax-free savings contribution wisely.
Consequently, investors should seek professional financial advice before opening a tax-free savings account. Unique individual circumstances will determine whether to invest in tax-free savings, when to do it, how much to invest and how this investment fits into an overall financial plan.
Tax-free savings accounts are extremely liquid, allowing investors to access funds with seven days’ notice. However, Government penalises unnecessary withdrawals by prohibiting investors from reinvesting these amounts into the savings account. “This is because the benefits of investing in a tax-free savings account are low in the first few years,” says Gouws. “It takes a while for the magic of compound interest to set in. The longer investors can avoid withdrawals, the more tax-free interest will accumulate.” Tax-free savings accounts are exempt from capital gains tax, giving them an added boost, as these amounts saved also benefit from compound interest.
The challenge to the financial services industry is to find innovative ways to package, market and sell tax-free savings, particularly through existing distribution channels. For instance, companies should consider offering tax-free savings as part of their employee benefit programmes to encourage employees to save or alternatively supplement retirement savings.
Employers and institutions can play a valuable role in offering financial education around tax-free savings so investors can benefit optimally from this “gift” from Government. A good understanding of the basics such as budgeting, regular saving, and the benefits of delayed gratification, are all essential disciplines to win in the compound interest game.

Copyright © Insurance Times and Investments® Vol:28.4 1st April, 2015
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