Savvy savings: Helping your clients master Tax-Free Investments in South Africa

Planning a Tax-Free Investment (TFI) in South Africa can be a bit daunting with so many options available. Should investors opt for an interest-heavy product offered by the bank, or a unit trust with more growth potential? And if they choose a unit trust, which one of the hundreds of funds in the market is the most suitable solution? Is it better to invest the full annual allocation limit of R36 000 on the first day of the tax year each year (1 March), or to do a monthly debit order of the maximum allowed R3 000 per month? Or is it better to just invest according to their own unique budget constraints? This is where the expertise of a financial advisor becomes invaluable.

As a financial advisor, your role is to guide clients through these choices and help them understand the benefits and risks associated with each option. By taking the time to assess their financial goals, risk tolerance, and current portfolio, you can tailor a strategy that fits their unique needs. Making them feel comfortable on every step of their TFI journey is also a great opportunity to build trust and establish a long-term relationship with a client.

Another important consideration for financial advisors, is the fact that TFI accounts represent "sticky money" that can steadily earn a monthly income through ongoing advice fees. The predictable income stream from these accounts ensure that financial advisors can focus on delivering high-quality service without the constant pressure of acquiring new clients.

Choosing the right fund

When it comes to choosing the right fund, it's essential to consider each client’s overall investment portfolio and tax thresholds. There is no one-size-fits-all solution. Some clients might be at their annual interest exemption already and, therefore, need to use their TFI for their remaining interest needs. Other clients might be purely focused on capital gain because their TFI forms part of their retirement savings, making it very long-term in nature.

The first step should always be determining the appropriate risk bucket, or the most suitable balance between growth and income assets, largely driven by a client’s planned investment horizon. For a client’s TFI, it also involves considering the investment goal of the TFI, the client’s risk appetite, and what they are already invested in, in their existing portfolio. Diversification is also key to ensure the TFI complements the client’s existing portfolio, rather than increasing concentration in similar assets.

For example, a multi-asset fund may be the most applicable for a client. The Nedgroup Investments Best of Breed™ Flagship Fund Range consists of five multi-asset funds spread across the risk-return profile and designed to provide clients with diversified exposure to local and global asset classes.

Source: Morningstar

The graph above shows the performance of an investor who picked an average fund in the ASISA multi-asset high equity category. This category includes balanced funds with up to 75% in stocks or equity exposure and up to 45% in offshore exposure. The investor also made the maximum monthly contributions allowed since the beginning.

At Nedgroup Investment, we're proud to manage R1.1 billion in Tax-Free Investment accounts (TFI) for 9 200 clients. On average, each client has around R120 000 in their TFI, with some clients already exceeding R600 000. It's also noteworthy that 60% of our annual contributions come from existing clients topping up and only 40% from new TFI accounts being opened. Many of our clients who have unit trust or retirement product investments with us, still have the opportunity to benefit from the amazing advantages of our TFI.

Timing your contributions

Deciding between annual and monthly contributions depends on each client’s financial situation, and again, there is no one-size-fits-all answer. Monthly contributions can be easier to manage and help instill a disciplined saving habit. It also allows clients to take advantage of rand-cost averaging, which can mitigate the impact of market volatility. On the other hand, if clients have a lump sum available, investing it at the beginning of the year can maximise their tax-free growth potential. However, this requires careful planning to ensure they can invest the full amount upfront, as any withdrawals they make cannot be replaced. Most importantly, however, is to motivate clients to start contributing what they can afford, even if they under-contribute relative to what they are allowed every year. Every bit they invest, especially free of tax, brings them closer to their financial goals and builds a habit of saving for the future.

Lessons from the last decade

As we approach the ten-year milestone of Tax-Free Investment accounts in South Africa, it's an opportune moment to reflect on the actual outcomes and gather insights from hindsight. The charts below illustrate the growth achieved by investing annually versus monthly in the various major fund types as categorised by the Association for Savings and Investment South Africa (ASISA).

Source: Morningstar

Source: Morningstar

Several valuable lessons emerge from this historical analysis:

Proven investment opportunity: TFIs have demonstrated their potential as an excellent investment vehicle, with all reviewed fund choices growing investments from as little as R3 000 per month to nearly R500 000, or in most cases to more than that.

Contribution timing: There is minimal difference between contributing monthly versus annually. The crucial factor is to contribute in a manner that suits clients’ financial situation, as the true benefit lies in the power of compounding.

Fund performance: While global equity has outperformed other fund types over the past decade when viewed at a specific point in time, this does not guarantee it will continue to do so in the future.

Additionally, it may not be the most suitable option for every client. The graph below clearly illustrates the differences in short-term volatility among the various fund choices, which must be considered alongside clients’ risk appetites. Finding an investment solution that clients can comfortably stick with, something that won’t trigger clients to sell from at the bottom, is critical.

Source: Morningstar

Let’s recap the T’s & C’s of Tax-Free Investing

Tax-Free Investment accounts offer South African taxpayers a unique opportunity to grow their savings without the burden of taxes on interest, dividends, or capital gains. This means clients won't pay a single cent of tax on their TFI, regardless of the fund or product they choose. Clients can invest up to R36 000 per year in a fund of their choice and a total of R500 000 over their lifetime. While withdrawals are allowed, they cannot be replaced, and any contributions exceeding the annual limit will incur a 40% tax penalty. This structure encourages consistent saving and long-term investment.

Additionally, clients may open a Tax-Free Investment account for their children, allowing them to benefit from tax-free growth and the power of compounding from an early age. Children or minors can access the funds when they turn 18, providing them with a solid financial foundation for their future.

Don’t delay, invest today

Tax-Free Investments are most beneficial when viewed as long-term investments. The tax benefits become more significant over time, making these investments ideal for long-term goals like retirement or saving for children’s education. It is also important to avoid common pitfalls such as over-contribution, which can lead to penalties. Ultimately, the best approach to TFIs is one that fits a client’s financial situation and long-term goals. Consulting with a financial advisor can provide personalised guidance tailored to a client’s needs.