Taking stock of your client’s finances during February can make or break their tax plan for the year ending 28 February. Now is the ideal time to spot the gaps where they haven’t yet fully used all of their tax-free allowances, whether it’s via a retirement annuity (RA) or a tax-free savings account (TFSA).
Option 1 – max out their TFSA
February is a good time for your client to log into all their tax-free savings accounts and double-check how much they’ve contributed in total since 1 March last year. Currently they may invest up to R33 000 per tax year in a TFSA. Any additional contributions are taxed at a hefty 40% of the excess above the R33 000 limit.
It’s important to check that they’re still under the R33 000 annual contribution limit across all accounts. If so, great, there’s a gap. Do they have spare cash to invest? If not, do they have any investments in taxable products, such as standard (pre-TFSA) unit trusts?
They may want to consider converting some of that investment (if no penalties apply) and investing the money in a TFSA version of the same unit trust instead. To do that, they’d need to withdraw money from their existing taxable unit trust to reinvest into their TFSA. Remember that the withdrawal triggers a capital gain with SARS, but the first R40 000 of their taxable gains every tax year is currently exempt from capital gains tax.
Option 2 – top up their RA
By February they should have a fairly good idea of what their total income will be – salary, business income, interest, rental income, bonus and included capital gain for the current tax year. Unlike the TFSA, there’s no limit on contributions to a retirement product, such as an RA, pension or provident fund. They can invest as much of their income as they please, although only the first 27,5% – capped at R350 000 – is tax-deductible. Like many South Africans, your client may, however, only have enough cash for one of the above options, not both.
Tax-free growth and income for both
A great benefit of both a tax-free investment account and an RA is that all the growth and income on the investment are tax-free while your client remains invested. This includes tax on interest, dividends and capital growth.
Tax on withdrawals
However, an important difference between a TFSA and an RA is that with a TFSA your client pays no tax on withdrawals. With an RA, only the first R500 000 of your client’s lump sum taken at retirement is tax-free.
When your client starts withdrawing an annuity income, that income is taxable as per the normal SARS income tax tables. However, for most high-income investors, the income tax rate in active employment is higher than when drawing a retirement income in the future, so deferring tax by contributing to an RA in higher-earning years may be worth it.
TFSA vs RA – an easy comparison
The main differences between a TFSA and an RA are highlighted above. There are many other differences – relating to the types of funds they may invest in, rules around protection from creditors, estate duty, and parents’ rights on an RA or TFSA held in a minor’s name – but for the main differences, read the infographic here.