Tax savings add significant value over long term

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Staff reporter, 4 May

The tax-saving element in an investment portfolio run through a tax-free savings account (TFSA) could add about a quarter of the value of the investment over the long term, says Mark Humphreys, who heads up Standard Bank Online Share Trading’s TFSA offering.

“One can run models assuming different rates of return,” he says. “If we plug in the JSE’s historical rates of return, we’re typically talking of returns of 18% a year compounded. That becomes significant in terms of capital gains tax over 10 to 20 years.

“The saving from the absence of capital gains tax and dividends tax probably makes up a quarter of the value of the investment.”

He says the beauty of the structure of the tax-free account is that it is suitable for savings – for people who need to tap into their funds within one or two years. But, he says, National Treasury has shown foresight in allowing users to take on higher risk in the TFSA scheme. That enables investors to use the TFSA as a long-term retirement savings vehicle.

“History has shown that time spent in the market – of more than three years, five years, 10 years, even 30 years out – is where you really get to extract value from it.”

With the tax-saving element, that value multiplies. “In the In long term you get a lot of value from not paying dividends and capital gains tax – that’s where those investing for the long term will gain significant value.”

For context from the JSE, Humphreys points out that an investor who entered at the top of the market in 2008 before the sub-prime crash would probably have lost 50% or more of their money. “That’s quite scary to an individual who might need the money at any point in time.”

However, if the person had remained in the market, not only would all the funds have been recovered by now but the return would be about 105%.

What’s important to first-time investors, he says, is to understand the trade-off – the risk that they may lose money at some point in the process. “But historically speaking and in terms of how markets function, equities do tend to outperform the other asset classes, so if you’re willing and able to give that investment time, it’s very likely it will outperform all other options that you have.

“Coupled with eliminating capital gains tax and that becomes significant over 10 to 20 years.”

Humphreys believes the R500 000 limit – the amount you’re allowed to invest tax free in your lifetime – will be raised and ultimately done away with. “We think it’s there in case people find ways to abuse the product – then Treasury will find ways to rein it in. But if the TFSA process goes smoothly I think they’ll raise it.”

Asked if he believed TFSA investors would be allowed to start trading individual stocks, he said it would be considered “but I doubt we’ll be having the conversation within five years. It took considerably longer for the UK to introduce regular shares into their tax-free offering.”

While people needed time to get comfortable with the product, “we’re comfortable with what’s on offer now as there is much available already”.

Through cash investments or ETFs, which are listed entities invested in specific portfolios of assets (for example, financial stocks or the JSE top 40 index) he points out that investors can have market-linked returns, interest rate-linked returns, offshore exposure and exposure to government bonds. Asset managers are also offering various unit trusts that are approved under the tax-free legislation and that carry varying degrees of risk.

“There’s more than enough on offer – we’re certainly not cracking the whip to hurry the process along. We also need to get comfortable with how this works and time to see if the thing plays out according to now National Treasury wants.”