Four issues to consider when opening a tax-rree savings account, says Standard Bank

Tax-free savings accounts are ideal tools for long term investment strategies, but a huge amount of education is needed to ensure that customers use the products in the most effective manner and avoid becoming victims of the law of unintended consequences, says Standard Bank.

“Anyone in South Africa who has money to save should be taking advantage of a tax-free savings account,” says Ms Takumi Daling, Product Manager: Savings and Investments at Standard Bank. “However, there are several factors that are unique to tax-free products that one needs to be aware of to avoid making an inadvertent error in judgement. Probably the four biggest issues to be aware of are over-contributions, withdrawals from a tax free account, transfers between tax free accounts and saving in the name of a minor.”

Over-contributions

South Africans are allowed to contribute up to R33 000, per tax year, towards a tax-free savings or investment account (the limit was raised from R30,000 in March 2017) and the interest earned, will be tax free. It is important to note that there’s no limit on the number of tax free accounts that an individual may have, however the annual contribution limit of R33 000 still applies to the sum of all the contributions to all tax free accounts. Nevertheless, individuals frequently overshoot this limit, either through carelessness or ignorance, with the result being that they inadvertently incur a penalty from the South African Revenue Service (SARS).

“The onus is on the consumer to be aware of the annual contribution limit of R33,000 that one can contribute to tax-free accounts, otherwise you risk being penalised on the over-contributed amount,” says Daling. “If, for example, you end up paying R43,000 into your tax-free savings account in any one tax year, SARS will levy a penalty of 40% on the capital that was over-contributed, which in this case would amount to a R4,000 penalty (R10 000 x 40% = R4 000).”

Daling says customers must also be aware of the fact that there is a lifetime limit of R500,000 that one can contribute to a tax free savings or investment product and that overshooting this threshold will trigger a similar penalty, which will be levied by SARS. While it is possible that this lifetime limit of R500,000 might be increased in future to ease the burden of inflation on newer contributors, at present this has not yet happened.

The impact of withdrawing funds from a tax free account

Customers will see the real benefit of investing in a tax free product, if they adopt a long term investment strategy. Daling notes that many people are not aware of the implications if they withdraw a portion of their funds in a tax free investment, to fund a sudden unexpected expenditure, for example.

“Once you have exhausted the annual contribution limit and you withdraw money from your tax-free account, you should not pay it back into the tax free account again, in the same tax year” says Daling. “For example, if you contribute a lump sum of R33,000 at the beginning of the tax year you cannot cash out, say R20,000 half way through the year with the intention of paying it back again during the same tax year, as this over-contribution will attract a penalty.Once you’ve used up your contribution for the year you can’t top it up again.

Tax free transfers

In 2015 when tax free savings accounts were first introduced to the market, customers were not allowed to transfer funds between tax free accounts, as it was viewed as a withdrawal from one tax free account and contribution to another tax free account, which may result in an over-contribution and attract a subsequent penalty. However, as of 1 March 2018, customers are able to transfer seamlessly between tax free accounts without the risk of being penalised.

Nevertheless, it is essential to adhere to the formal procedures necessary to effect the transfer. As with transferring your retirement savings from one unit trust to another, clients should start the process by first opening a tax free savings account at the receiving institution, obtaining and complete a ‘Request for Transfer’ form and hand it in at the sending institution. The sending institution will then initiate an inter-bank transfer to transfer the tax free funds and issue a ‘Transfer certificate’. The customer will also get a copy of this certificate.“The ability to transfer funds between tax free savings accounts promote competition and gives the customer the ability to seek out the solution that offers them the best possible returns,” says Daling. “Customers must just ensure that they follow the inter-institution process and not try do it themselves. If you transfer the funds from one tax free account to another, without following the outlined process, it will be viewed as a ‘withdrawal’ from one account and a ‘contribution’ to another tax free account, which may cause you to over-contribute and attract a penalty.

Saving for a minor

A tax free account also provide parents or grandparents with an opportunity to open accounts in the name of a minor in order to save for their education or simply to provide them with a future nest egg, which they can access when they come of age.

However, one of the snags that you need to be aware of is that if you open up a tax-free account in the name of a minor and exhaust their R500,000 lifetime contribution allowance threshold by the time they reach, say 18 years of age, they will not be able to contribute further to a tax free account. Similarly, should the child in question decide to cash out of the tax-free savings account handed to them by their parents to fund their university education, or perhaps make a down payment on a house, they will not be able to contribute to a tax-free vehicle again in their own name as they would’ve already utilised their lifetime allowance.

“Some people may view that as contentious because someone might not be able to contribute to their own tax-free savings account on account of their parents having already done so in their name,” says Daling. “However, would you rather inherit a large lump sum at age 18 or 21 or would you rather start savings yourself at that age? I think it’s fair to say most people would take the lump sum.”