Smart moves to make the most of your tax-free investment

Question
I have a tax-free investment at the bank, but the returns seem lower than what my friends are getting from their tax-free investments at an investment company. Can I move my investment or take out another tax-free investment elsewhere?

Answer

Tax-free investments were introduced to encourage South Africans to save over the long term. They offer generous incentives to investors:

• No tax on interest;
• No tax on dividends;
• No capital gains (CGT) tax; and
• All proceeds can be withdrawn tax-free.

Tax-free investments can cause confusion. The rules are deceptively simple, but the consequences of misunderstanding them can be expensive – especially if you fall foul of contribution limits or use them for short-term saving.

To get the full benefit of a tax-free investment, you should leave your money invested for as long as possible because the bulk of the benefit comes from the capital gain, which is not taxed. The structure is not suitable for the short-term parking of money; it is specifically geared towards investors who are willing to leave their funds untouched for a decade or longer, as the capital gain needs time to grow.

There are three rules:

1. The annual contribution limit is R36,000

This limit applies across all your tax-free accounts combined, not per provider. If you contribute more than R36,000 in a tax year, even accidentally, the excess is taxed at 40%. This is a penalty, not tax.

2. The lifetime contribution limit is R500,000

Once you reach this cap, you cannot contribute another cent – ever. This is why you need to be extremely strategic about where you place your tax-free money, because you only get R500,000 of tax-free deposits for life.

3. You cannot top up what you withdraw

If you put in R36,000, withdraw R10,000 in panic during a market wobble and then try to “replace” that R10,000, the South African Revenue Service (SARS) will say that you have now contributed R46,000 this year. This is because the system records contributions, not net balances.

Because the tax benefit is most powerful over long periods, and CGT is normally the biggest tax drag on long-term portfolios, it makes sense to use your tax-free allowance for assets with high potential long-term returns, such as equities.

If the goal is long-term growth over 10, 15 or 20 years, a well-constructed equity or balanced fund is typically far more appropriate than a cash account at a bank earning 6%. The latter may be convenient, but it wastes one of the best tax shelters available.

As you can see, a tax-free investment can make a significant difference in a loved one’s life.

To answer your question, you can move your investment, but you must do it correctly. If you simply withdraw the money and reinvest it elsewhere, the reinvestment counts as a new contribution. You would instantly hit the R36,000 annual limit and risk the 40% penalty.

The correct approach is an institution-to-institution tax-free transfer. This preserves both your annual and lifetime contribution records and keeps SARS happy.

It is administration-heavy, but entirely doable. You move the whole tax-free investment to a different platform where you can access equity investments.

Alternatively, you can keep the old account at the bank and just invest new money on a platform that offers equity investments. DM

Kenny Meiring is an independent financial adviser. Contact him on 082 856 0348 or at financialwellnesscoach.co.za. Send your questions to kenny.meiring@sfpwealth.co.za

This story first appeared in our weekly DM168 newspaper, available countrywide for R35.