Tax-free savings account: a crucial investment vehicle

Despite what the name suggests, a Tax-Free Savings Account (TFSA) makes for a better investment account as opposed to a savings account. It is an apt choice for investors with a long-term investment horizon and wanting to maximise tax efficient strategies. With either an annual lump sum investment of R36,000 or a series of regular investments into a TFSA, an investor exposes their capital to a tax-free environment – no tax on interest or dividends and no capital gains tax. These tax benefits offered by SARS, when compounded over time, significantly enhance investment gains.

The earlier you start the better the outcome

The best time to invest was 30 years ago, the second-best time is now. The tax year, along with an investor’s R36,000 annual tax-free allowance, comes to an end on 28 February 2022. Investors are likely reviewing the key question of where best to allocate their remaining annual tax-free allowance. Moreover, the plans regarding the allocation of the subsequent year’s tax-free allowance are likely in motion. Anyone can easily open a TFSA. Many investors use Easy Equites’ platform to do so, or they contact their financial advisor and direct them to open one.

Where to allocate the funds in a TFSA

Within a TFSA, capital can be allocated to different asset classes. Listed property, equity, cash or bonds are some of the available options. However, to maximise your tax-saving and generate higher returns, some options are better suited to a TFSA – an account in which investments can grow uninterrupted by tax. 

The best options

A TFSA is most advantageous for equity and listed property investments as these asset classes deliver higher real (after inflation) returns than cash and bonds. In addition, interest on cash and bonds already benefit from income tax exemptions (the amount depending on the individual’s age). There is no inherent underlying growth in income from these investments either. Equity and listed property’s income (in the form of dividends or REIT distributions) and capital gains are usually taxable. Hence, these investments generate high tax savings in a TFSA.

It is also pertinent to remember that although listed property in a TFSA delivers large tax savings, these tax savings do not apply to global listed property investments. On most of these global listed property investments, foreign dividends tax still needs to be paid.

Why invest in property?

South African listed property performed well in 2021 as it recovered from deeply discounted levels and negative sentiment related to Covid-19 and the SA economy. Looking ahead, the forward income yields, taking into account the continued recovery and stabilisation of yields, indicate that listed property valuations are still attractive. Long-term investors who exercise patience still have an opportunity to gain property exposure at an attractive entry price, which reflects a discount to NAV. Although investors have made good returns over the last year, there is an expectation for double digit returns this year on the basis of a good income yield and modest capital growth. Investors also need to bear in mind that South Africa has a diversified property market with many companies having offshore assets. Therefore, they receive SA property at attractive prices and some offshore diversification too.

In addition, there are significant benefits of compounding total returns when re- investing the income yield generated by listed property over a long-term horizon.

Maximising tax efficient strategies

Traditional retirement savings in the form of pension funds and RAs are bound by Regulation 28 rules, which allow a maximum of 75% in equity and 25% in listed property. For those investors who are early in their retirement savings and can tolerate the additional volatility associated with equities and listed property, a TFSA in listed property can be a great way to increase exposure to the sector and supplement retirement savings. Better yet, one can use the tax refund on RA contributions and invest those directly into a TFSA.