National Treasury is set to introduce tax-free savings on 1 March 2015. New draft regulations were released last month in a bid to make the tax free savings accounts more transparent and easy to use.
But will the new tax-free savings accounts be a better mechanism for saving for retirement than a retirement annuity (RA)?
Tax free vs. Ra's
Danelle van Heerde, head of advice process and tools at Sanlam Personal Finance, believes that RA's are still the best vehicle when it comes to saving for retirement.
"For your retirement savings it will still be better to take out a RA, because the tax saving in the end is going to be more. This is because you can also deduct your contributions from your taxable income, and then you get your investment returns tax free, so you get that same benefit as you would with a tax-free account," said van Heerde.
When you are in retirement you will still pay tax on your earnings, but it will be a lot less. "Although you do pay tax on your income when you are in retirement, you can either take your lump sum tax free, or pay lower tax on the monthly payments. You delay your tax, but then you typically don't pay the same tax on the income as when you earned it, when in retirement," explained van Heerde.
Therefore, van Heerde believes that a RA is still the best way to save for retirement, but a tax-free savings account should not be over looked.
However, Paul Roelofse, a certified financial planner, believes that if you are earning less money then a tax-free savings account is best for you.
"When it comes to accumulating funds for retirement […] the advantage of a RA is that you can claim the contributions on your tax return up to a certain limit. However, it probably only appeals to people who have high margins of tax applied to their income. The savings account approach would be more appropriate for someone who pays a lower tax rate," said Roelofse.
He added that people should have a mixture of both, but that it depends on how much money you have to put away after you pay all your expenses.
Tax-free for savings
"If you want to save for something else, or if you want to save for your retirement but still have access to your money, then a tax-free account is a very good vehicle. You should definitely start putting any savings into a tax-free account," said van Heerde.
Roelofse added that there is a lot of life between now and retirement, for many people, and that tying up money in a RA is not always the best option.
"There are a lot of other things which will happen on the way to retirement, such as life changing events, and so tax-free savings accounts are better because people can access the money when they need to," said Roelofse.
Roelofse explained that it's important to balance your portfolio and try and plan for all the other events in life. A tax-free savings account is a good vehicle in which to help you with 'life changing' events.
Van Heerde advises people to start saving earlier so that interest can play a bigger role. "Once you start earning compound returns, on returns the tax that you don't pay on those are therefore quite a bit higher and the accounts are much more valuable. Therefore, for savings it is a very good vehicle, but for retirement a RA is still much better," said van Heerde.
Contributions
You are allowed to contribute up to R30 000 per year in a tax-free savings account but the contributions for yourlifetime is R500 000.
You will also be allowed to open one or two accounts per year, where you may invest in either interest bearing or equity instruments or both types of investments in each account, but total contributions for the tax year may not exceed the annual limit of R30 000.
If you invest R30 000 ever year, it would take you 16.6 years to reach your lifetime limit. Once you have reached the R500 000 limit, you can leave the money in the account and just let it earn interest.
The key thing to remember with tax free savings accounts, is that all gains earned on the account are tax free. You just cannot go over your yearly, or lifetime limit, otherwise whatever amount is over the limit will be fined at 40%.
In order to get to the R30 000 a year (and thus the R500 000 over 17 years) you would need to invest R2 500 a month.
Another benefit (and perhaps also a down fall of the tax-free savings accounts) as mentioned before by van Heerde, is that the money can be accessed at any time. The reason why it can be a negative is that easy access means that there may be a temptation to dip into the account unnecessarily to pay for something frivolous.
With tax free savings accounts the beauty is that if you need the money for an emergency, it is there. But you also have to be disciplined as not to dip into the funds over the years, and then end up with a smaller pot when you need the money for your retirement.