The difference between a Tax Free Savings Account and a Retirement Annuity

Carl van der Berg of Alexander Forbes Financial Planning Consultants.

Many people don’t understand which tax is being referred to when discussing Tax Free Savings Accounts (TFSA), says financial consultant Carl van der Berg of Alexander Forbes Financial Planning Consultants.

Potential tax advantages

Both interest tax and capital gains tax have annual exemptions which form part of the taxation of discretionary investments.

“A working individual pays both income tax and tax on any growth. So you pay tax when your discretionary funds (anything outside of a retirement fund structure) grow at a rate that exceeds any exemption in a year of assessment.”

TFSA is an initiative from government to encourage a culture of saving, and South Africans can now save up to R30 000 a year knowing that the interest, capital gains and dividends they earn are completely tax free.

“When you contribute to a Retirement Annuity (RA), you are taking money already taxed as income and putting it back into a vehicle you can invest in, and then you pay tax on it when you draw on those funds later. Your contributions are tax deductible against your income in that year of assessment.” A TFSA offers greater flexibility for those who are retiring. “With a RA, one third of your capital, up to a maximum of R500 000, can be withdrawn tax-free as a cash lump sum at retirement.”

Van der Berg says that for an individual paying a high rate of tax, who also has a high level of discretionary investments, there is a chance that because the growth on the discretionary investments will add additional income to the individual in the current year of assessment, they would run the risk of possibly owing money to the taxman when submitting their tax return.

“Contributions to an RA will help to mitigate this problem as you would be taking already taxed funds and contributing them to an investment where you will be paying income tax on coming out, however these contributions are deductible against taxable income in the current year of assessment.”

Access to capital

TFSA allows clients to have 100% access to capital, whereas with an RA, no funds can be accessed until the age of 55. “At this age you are restricted to withdrawing one third of your investment, with the remaining two thirds used to purchase an annuity to receive a monthly income..”

Portfolio choice

With a TFSA you have the right to invest funds however you want. However, with a RA, asset allocation is prescribed to the investor, so this is one of the disadvantages of this type of investment vehicle.

Estate duty

In most situations, your RA investment will fall outside the estate as opposed to a TFSA. Funds existing in a RA will fall outside of your estate insofar as they have qualified for tax deductibility. TFSA falls within, meaning you will pay tax at death and nominate a beneficiary via your will.

Costs

“RA fees, which include administration, advice and management fees, could be as high as 2.5% of your investment per annum, while a TFSA is probably be less than half of that,” says Van den Berg. This means that a TFSA is relatively cheaper than an RA investment. “If you are considering a TFSA you should shop around to see what fees you would incur. Some platforms offering TFSA have no admin fees and very competitively priced management fees. TFSA are often cheaper since fund managers are prevented from charging performance fees.”

Tax payers have until February 29, 2016 to take advantage of these opportunities – the deadline for provisional tax payments.