In the below article, we highlight how a simple shift in mindset regarding your tax-free “savings” account can have a positive impact on your long-term wealth creation journey. In addition, we highlight the benefit of re-investing your tax refunds from Retirement Annuity contributions into your Tax-Free Savings account.

Tax-free investments – Invest for the long-term, not short-term savings

Tax-free investments, better known as “Tax-free savings accounts” were introduced in 2015, to encourage household savings. It’s actually unfortunate that it is referred to as a “savings” vehicle in shorthand speak, as it almost makes one think of it as a savings account. A “savings account” is often associated with a transactional savings account, bank account or emergency money market fund, where investors can gain quick access to their funds.

To truly reap the rewards and benefits of a Tax-free investment, it should be seen as such – an investment for the long term. In fact, the longer, the better! When treated this way, it can be an extremely powerful tool for long-term wealth creation and retirement planning.

To maximise the benefits of your tax-free investment:

• Start investing in this vehicle as early as possible and maximise your annual contributions as early as possible. (Currently, investors are allowed to invest R36 000 per tax year.)
• View this investment as a long-term investment, and don’t withdraw from this fund in the short term. In case of emergencies, rather try to build up a separate fund to dip into.

Why do we say this? Because of the Tax-free investment’s ultimate selling point – You don’t have to pay income tax, dividends tax or capital gains tax on the returns from these investments.

This makes a tax-free investment a wonderful retirement savings tool. At retirement, the growth of your investment won’t attract any capital gains tax when you withdraw funds, or dividends tax on the growth of your investment. The withdrawals made from your tax-free investment are not added to your annual income and does not attract income tax.

Lump-sum amounts taken at retirement from your retirement annuity are taxed, albeit at more favourable tax tables. Two-thirds of the retirement interest from a pension, pension preservation or retirement annuity fund is received in the form of an annuity (a regular pension). If the income from your annuity exceeds the tax threshold, tax is payable on the amount. The tax thresholds are as follows:

For the 2025 year of assessment (1 March 2024 – 28 February 2025) – No changes from last year

• R95 750 if you are younger than 65 years.
• If you are 65 years of age to below 75 years, the tax threshold (i.e. the amount above which income tax becomes payable) is R148 217.
• For taxpayers aged 75 years and older, this threshold is R165 689.

If you’re using your tax-free investment as a short-term tool, we would encourage you to think longer-term, because once you withdraw from your tax-free investment, you will decrease your lifetime limit permanently. Wouldn’t you rather enjoy a tax-free benefit on an amount of R5 000 0000 rather than R5 000?

For example:

“Investor A” invests R3000 per month into a tax-free investment, at an annual growth rate of 9% for 30 years. In 30 years, the investment could be worth an estimated R5 106 339.

Should investor A withdraw this entire amount, and it is not in a tax-free investment vehicle, the capital gains tax bill alone would look as follows:

Proceeds: R 5,066,821
Base cost: R 1,077,000
Capital gain: R 3,989,821
Annual exclusion = R 40,000.
Thus capital gain becomes R 3,949,821.
Only 40% of the gain is added to your taxable income → R 1,579,928.
Taxable income (assumed)= R 1,000,000 + R 1,579,928 = R 2,579,928
Assuming a marginal tax rate of 45%, investor A will ultimately pay approximately R 710,967 capital gains tax and get to keep R 4,355,854.

Please note – we acknowledge that the above illustration is simplified by assuming the investor withdraws the total amount, once off, in one tax year. Should the investor distribute the withdrawals over a few years, the tax burden could be lessened by the annual CGT exemption and other exclusions.

This example is simply to illustrate the long-term value of using your tax-free investment. Had investor A been invested in a tax-free investment, he/she would have an additional R 710,967 in the bank.

Keep your tax exemptions tax-free by reinvesting your retirement tax breaks into your tax-free investments

As of 1 March 2016, investors who contribute to their retirement funds (pension funds, provident funds and retirement annuities) are entitled to a tax deduction. Total contributions to retirement funds (Pension, Provident and RAF) are deductible but limited to 27.5% of the greater of remuneration or taxable income (excluding lump sums), capped at an annual limit of R350 000. Where an employee earns no other income, remuneration will be used to calculate the deduction. Contributions in excess of the annual limits will be rolled over to future years.

In the case of a contribution to a Pension or Provident via your employer, the sum of your employee and employer contributions counts towards this deduction. However, any contribution by an employer to a retirement fund for the benefit of the employee will be taxed as a fringe benefit in the hands of the employee.

You may contribute more than 27.5% of your salary to your retirement savings but you can only claim a tax deduction up to the maximum of 27.5% of your salary and limited to a maximum tax deduction of R350 000 per year. If your contributions exceed 27.5% and/or R350 000 in a tax year, you will be able to claim the balance (which you couldn’t claim in the current year) the following year(s). Any balance remaining when you retire or withdraw from service may be taken as a tax-free lump sum or be deducted from the tax payable on your annuity (pension).

The higher total of your annual retirement contributions (27.5% and/or R350 000) will be deducted from your taxable income. This may very well lead to SARS reimbursing you for the surplus.

Top tip – by re-investing the amount SARS reimburses you with (i.e. your “reward” for saving for retirement), into your tax-free investment, you will keep this amount invested, for the long-term for this tax-free amount to continue generating tax-free returns for your long-term wealth generation. Implement this every year, on repeat, and continue to contribute and grow your tax-free investment for retirement.

Each investor is unique, with distinct financial goals, time horizons, and tax considerations. It is crucial that investors carefully assess their own financial situation and seek reputable financial advice before making any investment decisions. A qualified financial advisor can help tailor your investment strategy to your specific needs, ensuring that your decisions align with your long-term objectives and risk tolerance. Remember, informed choices today can significantly impact your financial future.

________________________________

Sources:

• Source: SARS “Tax and retirement”
• Example calculated using Allan Gray Investment Value Calculator
• Example calculated using Tax Tim Capital Gains Tax calculator
• Source: SARS “FAQ: What is the impact Section 11(k) on me as a taxpayer