Looking to get your client started on their investment journey? Why not consider a tax-free savings account (TFSA)? They are an ideal entry into the investment market, the low fees appeal to new as well as younger investors, and because growth is not taxed, TFSAs can earn higher returns faster!
Better investment outcomes
Contributions to a TFSA, dividends and interest earned, as well as capital gains and any withdrawals are all tax free - a unique and very appealing benefit of these investments. This ultimately means returns should be higher than a similar investment where taxes, including CGT (capital gains tax) and Dividends Tax, apply. Fees and costs are also regulated to make sure they are as low as possible, again a contributor to better returns.
These benefits come with a small drawback - there is a limit on total contributions. As of July 2022, an investor may invest a maximum of R36 000 per year, with a lifetime limit of R500 000. Invest more and a tax penalty, payable to SARS, of 40% applies. These limits are per investor and not per account. Very importantly, they apply to total contributions not net contributions. If an investor contributes R36 000 at the start of the year, withdraws R10 000 during the year and invests R10 000 at the end of the year, the total contributions for the year are R46 000. R10 000 (R46 000 less the annual allowed limit of R36 000) will attract a penalty payable to SARS at 40% (R10 000 x 40% = R4 000). This penalty is added to normal tax payable on the notice of assessment.
More than a savings account
There are many TFSAs available, from pure cash saving accounts at banks to collective investment schemes and ETFs with equity components. Although the name may suggest these are savings accounts, there are many TFSAs that are suitable as long-term investments. It is, in fact, as a long-term investment that TFSAs’ advantages are greatest because of the “no tax on growth” rule.
A great way to start out
Over the past two decades, clients have become more aware of the impact investment costs have on returns. Some of the more vocal investors are millennials, who are savvy investors, read more and are perhaps more distrusting of age-old institutions and industries, including financial services.
Financial services responded to this change with better and more customer friendly regulation, for example, TCF (treating customers fairly) as well as cost and fee disclosures, and more customer-friendly products. None is more customer friendly than the TFSA. The TFSA caters directly to the need for better returns, uncompromised by high fees and aided by tax incentives. They are the ideal starter investment and give investors benefits over and above investment options where growth is taxed.
Starting early will grow wealth more
The earlier a TFSA is taken out the better. Think of this as a compound interest growth story.
If an investor takes out a TFSA at age 30 and contributes the maximum R36 000 per year, they will reach their lifetime limit total contribution of R500 000 in year 14. Assuming a growth rate of 8% per annum, excluding costs, this investment will already be worth just over R1 000 000 after 15 years.
The investor is age 45 at this stage and can choose to remain invested in their TFSA. At an 8% growth rate, the TFSA investment would earn an additional return, giving the client a tax-free investment worth over R2 million in less than 10 years. They can withdraw this money as and when they choose or leave it invested.
Clients should carefully consider the need to withdraw funds early as these investments will keep on earning tax free returns, and the higher the balance in the account the higher the returns. Clients’ personal needs and unique circumstances should be carefully assessed with a qualified adviser before withdrawing funds to ensure their investments achieve the optimal outcomes.
If your client wants to grow their wealth, TFSAs may allow them to do this at a faster pace than investments where tax applies, such as Dividends Tax and CGT, and sometimes personal tax.
This is perhaps one of the most challenging aspects of selling TFSAs to your clients because there is so much choice. Many TFSAs are portfolios of different investments, offering diversification and ensuring clients are not overexposed to a particular investment.
Advising on TFSAs is advising on an investment. Assess your clients’ needs and affordability in line with FAIS regulations and take their circumstances (age, goals, affordability, and more) into account. Importantly, fully disclose all relevant information, including costs and underlying investments.
According to regulations, TFSAs must charge “reasonable” costs – there is no one set or standard fee as there are many different kinds of TFSAs from savings accounts to investment accounts. Clients need to know which costs apply and how they impact the investment. They should also be told about the services they receive, such as regular reporting, professional management and compliance with regulations to protect their investment. Comparing costs can give an indication of where the TFSAs’ costs fall in relation to other investments and a range of TFSAs.
Clients also need to know what type of investments are in the TFSA, what potential they offer for returns and their risk. Low-risk investments, such as cash or money market TFSAs, may appeal, but may also not offer the best investment outcome if a client has long-term goals that require capital growth. A slightly higher risk TFSA, for example one with underlying investments in equities, could deliver the capital growth required. Clients should be aware that TFSAs can be transferred with no tax implications if they are wanting to change accounts or providers.
Clients can contribute monthly, or in lump sum amounts. However, it is critical to remind them that there is the contribution limit and that it is a limit on total contributions. They cannot make a withdrawal from their TFSA, and then pay back the amount and assume the payback is not a contribution. SARS regards this as two contributions (initial contribution plus the payback), adds them to form a total contribution, and will levy any penalties due on amounts over the annual and/or lifetime limits of R36 000 and R500 000 .
The 1Life Tax Free Savings Account, available on 1Life Vantage, offers a range of investment options at low costs to suit your clients’ needs. Debit orders start at R500 a month, with lump sum contributions starting at R5 000. Quotations can be generated on 1Life Vantage.
Grow an investment faster
TFSAs punch above their weight. Their advantages outweigh any limitations, and they have the added benefit of transparency and low costs – which makes them a competitive investment that should be the first port of call for every investor.