Tax-free investments: An attractive option, within limits

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31 August 2016| Pieter Hugo, MD Prudential Unit Trusts

In a case of look before you leap, check out the limitations before you invest.

Tax-free investments, launched in March 2015,  are products that any investor should consider as part of their overall investment portfolio, given that they offer the opportunity to invest tax-free over time. However, you should consider their benefits and limitations very carefully to determine whether they would be an appropriate investment for you.

What are the benefits?

• All growth in the underlying investment is fully exempt from any tax on interest, rental income, dividends or capital gains;
• Investors can withdraw their money at any time (although at Prudential we would encourage our clients to invest for the long term);
• Contributions are flexible – either via a lump sum or debit order; and
• Parents can open separate accounts for their children.

Look after your RA first

A consideration when deciding whether to invest or not is that contributions to tax-free savings products can only be made from after-income-tax money. If you are investing for retirement, this leaves you less to invest and to grow compared to Retirement Annuities (RAs), where all contributions are exempt from income tax (up to a limit of 27.5%), as well as underlying growth being exempt from all taxes. This means that, from a maximum return perspective, it would probably be better to exhaust your RA contribution limit every year before investing in a tax-free savings product.

However, if you are investing for a shorter time, or require more accessibility, RA’s do not allow you to withdraw your accumulated savings until age 55, whereas tax-free savings products are accessible at any time. We would suggest that you consult a financial adviser to ensure you make the most efficient decisions for your unique personal circumstances.

Beware the penalties

Another consideration is that the government has imposed strict contribution limits of R500,000 per individual over a lifetime and R30,000 per year for tax-free savings products. If you exceed these limits, SARS will levy a penalty of 40% of the amount in excess of the limits, so it’s important to keep track of your total contributions. Because parents are allowed to open tax-free savings products for each child, the R500,000 limit becomes less restrictive: a family of four will have an aggregate limit of R120,000 per year and R2 million over their lifetime, which starts to become a substantial amount. This makes tax-free savings products very suitable vehicles for saving towards a child’s tertiary education, for example.