Nine things to know about tax-free savings

JOHANNESBURG – Over the past six months, Moneyweb has published a number of articles about National Treasury’s proposal to introduce tax-free savings accounts from March 1 next year.

Each time we have been flooded with e-mails asking for more information. This column gives an overview of these accounts and tries to answer a couple of these questions.

The answers draw from prior discussion documents, the Taxation Laws Amendment Bill and engagements with Treasury representatives. Bear in mind that the draft regulations still have to be signed into law (this is expected to happen late this year) and that there may still be a few tweaks to the proposals before it is officially introduced.

1) What is a tax-free savings account?

This is a generic type of savings account that investors will be able to open from March 1 next year. Individuals will be allowed to hold a variety of underlying investments in these accounts. All proceeds on the investments through these accounts will be tax-free in the hands of the individual. This includes dividends, capital gains or interest.

Government hopes that this incentive will encourage consumers to save (in addition to their retirement savings). Many South Africans only save through a pension fund and often have to access these funds in the event of an emergency. National Treasury believes the tax-free savings account will reduce South Africans’ financial vulnerability.

Investors would be allowed to open multiple tax-free savings accounts annually with different underlying investments. However, investors would only be permitted to contribute up to a maximum of R30 000 per annum to these accounts (in total). The lifetime contribution limit will be capped at R500 000.

2) Who will be allowed to offer these accounts?

Several financial services providers will be permitted to offer these accounts. According to the draft explanatory memorandum on the Taxation Laws Amendment Bill, these institutions include “JSE authorised users, banks, long term insurers, collective investment scheme companies [unit trust companies], linked investment services providers and national government”.

3) What underlying investments will qualify?

Most unit trusts, bank savings accounts, fixed deposits, retail savings bonds and certain exchange-traded funds (ETFs) will be eligible for inclusion. Direct share purchases will not be allowed.

Investors would however be able to get equity exposure by investing in an equity-only unit trust in a tax-free savings account for example.

Financial services providers that already offer qualifying underlying products would not have to create a new product. They would be able to offer their existing products in a new “wrapper” – the tax-free savings account.

Regulations regarding the exact products that will be eligible for inclusion will likely be published later this year.

4) What happens to the current interest rate exemption?

While the initial proposal was for the interest rate exemption to be abolished, it has since been decided to keep this exemption in place. However, the current exemption of R23 800 for individuals below 65 and R34 500 for individuals above 65 will not be adjusted for inflation anymore and will therefore erode over time. This exemption will still be applicable to interest earned on deposits outside the tax-free savings account.

Any interest earned on deposits and investments within a tax-free savings account will be completely tax-free.

5) Will my existing unit trust investments automatically qualify as tax-free investments?

No. If you would like your current investments to qualify (and if they do indeed qualify), you would have to open a tax-free savings account with your financial services provider and transfer funds into the account (even if it has the same underlying investment).

As an example: If you currently have R30 000 invested in a Balanced Fund unit trust at Asset Manager X and would like this investment to be tax-free, you would have to open a tax-free savings account with Asset Manager X and transfer this R30 000 into the underlying investment (the Balanced Fund) in the tax-free savings account.

6) Does the scheme effectively mean that on March 1, 2015 it would be within the proposal for me to place R500 000 into 16 call accounts at R30 000 each and 1 at R20 000?

No. On March 1 next year you would be able to invest R30 000 in one or more of these accounts. The investment will be capped at R30 000 per annum and it will therefore take you around 16 years to reach the lifetime contribution limit of R500 000. In other words you will only be allowed to invest R30 000 again on 1 March 2016.

7) Is my understanding correct that the maximum balance allowable, covering all the relevant accounts, may not exceed R500 000?

No. Your capital contributions over a lifetime may not exceed R500 000. All interest, dividends and capital gains in excess of R500 000 may stay in these accounts to accrue even more interest and dividends.

8) What happens if I contribute more than the R30 000 annual limit?

According to the memorandum, the South African Revenue Service (Sars) will levy a penalty of 40% on the amount in excess of R30 000 in any year. This will also apply to contributions in excess of the lifetime contribution cap.

9) May I withdraw my money from these accounts at any time?

Yes. Investors will be allowed to withdraw money from these accounts as and when they see fit. However, in order to prevent withdrawals for impulse or unnecessary purchases amounts returned to the tax-free savings account will be subject to the annual contribution limit.

For example: If an individual invests R30 000 in one of these accounts on March 1 2015 and decides to withdraw R15 000 after six months, she has already reached the annual contribution limit for the year

(March 1, 2015 to February 29, 2016) and would only be able to “replace” the R15 000 in the next year (from March 1 2016 to February 28, 2017). If she decides to do so, she will have R15 000 of her annual cap “left” to contribute during that year (March 1, 2016 to February 28, 2017).