How to pay less tax when saving for retirement

Sygnia Group CEO Magda Wierzycka said a tax-free savings account is the most important tool afforded to South Africans by law to put away as much money as possible for retirement.

Speaking to Bruce Whitfield on The Money Show, Wierzycka said tax-efficient savings strategies, such as a tax-free savings account (TFSA), exist to incentivise South Africans to save and protect themselves from the corrosion of taxes.

“When saving for retirement, many people don’t release or forget that the returns derived from their retirement annuity and living annuity are treated as income and are taxed quite heavily,” said Wierzycka.

“The growth and returns in a TFSA, on the other hand, is completely tax-free and becomes a lump sum of capital for you to use as you wish,” she added.

Wierzycka noted that people’s misconception is that your living expenses will be much lower after you retire. But in many cases, medical expenses start climbing, and you can’t discount those in the calculations.

When you factor in future energy and food inflation concerns, adding a TFSA to your retirement portfolio becomes even more important to maximise financial stability for retirement.

Understanding a tax-free savings account

Tax-free savings accounts (TFSA) were introduced in 2015 to help maximise tax relief. All proceeds, which include interest income, capital gains and dividends from these accounts, are completely tax-free.

Tax-free savings accounts offer different investment options to suit your objectives and risk profile, and individuals can invest in equities, fixed income accounts, or both.

There is a cap on the amount investors can put into a TFSA, in that the total contribution that will qualify for tax exemption is R36,000 per annum and up to a maximum of R500,000 per lifetime.

However, the account balance, including the growth and interest earned, can exceed R500,000 in a lifetime.

It is important to note that Treasury is not allowing the conversion of existing savings accounts into a TFSA. It needs to be a new account.

However, TFSAs are easy to open, and most financial service providers will offer a tax-free savings account.

Wierzycka suggests that investors shop around and select a TFSA with the lowest possible fees.

She added that, while there is a small cost to opening up a TFSA with a financial service provider, the comparable tax investors would have to pay if they opted to invest outside of a TFSA would be much greater.

An example of the benefits of a TFSA

The longer you invest in a TFSA, the higher the returns on your investment and the bigger the tax saving you get.

The example is based on a monthly payment of R2 500 for 16 years and eight months – when the lifetime limit of R500 000 is reached.

It assumes an investment in a balanced fund with a return of inflation plus 4% per year before fees and a personal tax rate of 40%. These values are not guaranteed and are for illustrative purposes only.

Using the criteria above, if you were to have invested in a plan where the return was taxed, the amount available to you at the end would be R1,563,500.

In the TFSA, under the same conditions, the end amount available to you would be R2,058,600 – meaning you made a tax saving of R495,100 on your investment return in a tax-free savings account.

Sanlam (webpage)