An initiative by National Treasury to encourage household saving will see financial service providers gearing to launch tax-free savings (TFS) products on 1 March 2015.
Treasury proposes that increased saving will assist households in reducing financial vulnerabilities. “The household saving rate in South Africa is extremely low,” says Rene Grobler, head of Investec Cash Investments. In the past, savings accounted for 25% of GDP, the average has settled at 15% which is low according to international standards, she says.
FinScope Survey of 2013 shows 42% of adults save. A 2014 report by Treasury states that South Africans do not save sufficiently due to low levels of employment, low household income and easy access to credit which spurs on impulse purchases for instant gratification.
Current tax incentives for savings include the annual interest tax exemption of R23 800 and R34 500 for retirees over 65. This incentive only applies to interest earned. It is limited and lacks transparency, says Grobler. TFS will replace the existing interest tax exemption, which will be gradually phased out as it won’t be adjusted with inflation.
How TFS works
Individuals can invest in multiple products, provided investment contributions do not exceed the annual limit of R30 000. The lifetime limit is R500 000 and will take 16 years and eight months to reach. After approximately 17 years, an investment of R30 000 a year (assuming 7% return) could be worth over R1m, explains Grobler.
Contributions of more than R30 000 will incur a tax penalty of 40% from SARS. In the first year, transfers between product providers are not allowed but transfers between products from one service provider are permitted, explains Grobler.
Products include retail savings bonds, collective investments, ETFs and bank deposits. Products should be transparent, simple and suitable for the market. The use of derivatives is restricted and performance fees are not allowed. Direct share portfolios are excluded. Product providers include banks, long-term insurers, unit trusts and government.
It’s a virtuous circle. Savings create investment, investment creates growth and growth creates income.
TFS work as investment accounts only, debit orders and the issuing of guarantees are not permitted. Accounts are ideal for medium to long-term savings. The returns are greater if left for a longer time for compound interest to grow, says Grobler.
Funds are accessible within seven days in emergency cases. However, to discourage erratic withdrawals, withdrawn amounts are not allowed to be replaced immediately. The maximum allowed for exit penalties charged by providers (for premature withdrawals) set by Treasury is R300. The accessibility of funds makes TFS accounts more attractive than Retirement Annuities (RA). RA funds are only accessible at retirement, contributions are tax-free but returns are taxed. As for TFS, after-tax money is invested and returns are tax-free.
A report by Daniel R. Wessels states that RAs are exempt from estate duties and are protected from creditors’ claims. TFS accounts have no creditor protection and will form part of the deceased’s estate. Amounts within TFS can’t be transferred directly to an heir’s TFS. Transfers are deemed as contributions and are “subject to the annual and lifetime contribution limits of the recipient”.
Grobler advises individuals to consider the first-mover advantage. At a rate of 7%, waiting a year to invest translates into a loss of R150 000 that could have been earned over 17 years.
It is still to be determined if TFS will change savings culture. Considering similar TFS products adopted in the UK, the initiative didn’t incentivise new savings; it only moved money around the market. “It’s hard to say what impact it will have in SA,” says Grobler.
Incentivising household saving benefits economic growth. By increasing fixed investment, there is less reliance on foreign capital and government debt, says Grobler. “It’s a virtuous circle. Savings create investment, investment creates growth and growth creates income.”
*This article was featured in Finweek magazine.