Tax-free investments: An attractive option, within limits

The deadline for tax-free contributions for the 2017/18 tax year is coming up, so make sure you’ve maximised your R33,000 annual limit. The benefits can be considerable over time.

Tax-free investments, launched in March 2015, are products that any investor should consider as part of their overall investment portfolio, given that they offer the opportunity to invest tax-free over time. They are a valuable part of a portfolio, but you should consider their benefits and limitations very carefully to determine how best to use them.

What are the benefits?

• All growth in the underlying investment is fully exempt from any tax on interest, rental income, dividends or capital gains;
• Investors can withdraw their money at any time (although at Prudential we would encourage our clients to invest for the long term);
• Contributions are flexible – either via a lump sum or debit order;
• Tax-free investments are not subject to retirement investment limits; and
• Parents can open separate accounts for their children.

Look after your RA contribution first

A consideration when deciding whether to invest or not is that contributions to tax-free savings products can only be made from after-income-tax money. If you are investing tax-free for retirement, this leaves you less to invest and to grow compared to retirement annuities (RAs), where all contributions are exempt from income tax (up to a limit of 27.5%), as well as underlying growth being exempt from all taxes. This means that, from a maximum return perspective, it would probably be better to exhaust your RA contribution limit every year before investing in a tax-free savings product.

However, if you are investing for a shorter time, or require more accessibility, RA’s do not allow you to withdraw your accumulated savings until age 55, whereas tax-free savings products are accessible at any time. RA’s are also subject to retirement investment restrictions (limits to how much you can invest per asset class, etc.) governed by Regulation 28, while tax-free investments are not. We would suggest that you consult a financial adviser to ensure you make the most efficient decisions for your unique personal circumstances.  

Be aware of the limits

Another consideration is that the government has imposed strict contribution limits of R500,000 per individual over a lifetime and R33,000 per year for tax-free savings products. If you exceed these limits, SARS will levy a penalty of 40% of the amount in excess of the limits, so it’s important to keep track of your total contributions. And if you withdraw a sum from your tax-free investment, it still counts towards your lifetime limit. Because parents are allowed to open tax-free savings products for each child, the R500,000 limit becomes less restrictive: a family of four will have an aggregate limit of R132,000 per year and R2 million over their lifetime, which starts to become a substantial amount. This makes tax-free savings products very suitable vehicles for saving towards a child’s tertiary education, for example.

Prudential offers a range of five tax-free unit trusts to suit a variety of risk and return requirements.

To invest in our tax-free unit trusts, complete an online application form now. Alternatively, for more information, contact our Client Services team on 0860 105 775 or at query@prudential.co.za.

This article was originally published on 31 January 2017 and was updated on 24 January 2018 to reflect the changes to annual contribution limit.