When tax-free savings accounts (TFSAs) were were first introduced in South Africa in 2015, many criticised the small annual contribution limit of R30 000 (which was increased to R33 000 for the 2018 tax year and R36 000 for the 2021 tax year) and whether it would ever grow into a meaningful investment for investors. Unfortunately, as a result it has taken investors and advisors some time to embrace the material benefits of TFSAs.
However, seven years later an investor who had maximised their annual investment limit would have contributed R231 000 by the end of February 2022. Interestingly, the largest TFSA account value at 28 February 2022 on the Ninety One Investment Platform (Ninety One IP) was approximately R509 000, i.e. tax-free growth of R278 000! And in aggregate, TFSA investors at Ninety One IP now have a total of approximately R2.3 billion invested, of which more than 90% is advised; this was built up by a combination of the smallish annual contributions and tax-free market growth.
The UK experience1
It is interesting to look to the more mature UK tax-exempt Individual Savings Account (ISA) market for insights into the longer-term potential of the South African TFSA market. ISAs were introduced as long ago as 1999 to incentivise individuals to invest. Much like our TFSAs, ISAs are tax-exempt investment vehicles, under which any interest or dividend income received is free of tax and on which any capital growth is free of capital gains tax.
In the most recent reported period (2019-20) approximately 13 million adults invested around £75 billion into an Adult ISA, up from 11.2 million the prior year (£67.5 billion). This increase was driven by the rise in cash ISA subscriptions, which increased by £4.8 billion. The amount subscribed to stocks and shares ISAs increased by £1.6 billion over the prior year. This is materially different to our experience on the Ninety One IP platform where 95% of TFSA investments are growth-focused. While the maximum annual limit is £20 000, the average investment amount was only £5 740, which is down from the prior year's £6 049. Unlike TFSAs, there is no lifetime limit applicable to ISAs.
Delving into the statistics over the now more than 20-year history of ISAs in the UK, it seems clear that as the tax benefits became better understood, so the take-up has accelerated. At the end of 2019-20 there were 20 million Adult ISA accounts with a staggering combined market value of £620 billion (2018-19: £584 billion), illustrating the significant potential for SA’s fledgling TFSA industry.
Some further observations
- As you would expect, the larger the ISA investor’s annual income, the larger their accumulated ISA value and the amount they invest each year. However, what is interesting is the extent to which lower income earners have embraced ISAs where, on average, their accumulated ISA value exceeds their annual income, which is not the case for high income earners.
- The median ISA holder (by income) has an annual income of between £20 000 and £29 999, with average ISA savings of £28 530.
- For ISA holders earning £150 000 or more, the average ISA value is £88 970.
- In aggregate, 18% of the 13 million subscribers invested the maximum £20 000; this increased to 61% for those earning £150 000 or more.
- Higher income earners have a strong preference for stocks and shares over cash ISAs, while lower income earners favour cash ISAs.
- The greatest number of ISA holders are in the 65 and over age group, and they also have the highest average accumulated value. Unsurprisingly though, a large portion (61%) of this group made no investment into their ISA in the most recent reported year, suggesting that they are now using their ISA to supplement their retirement income. A South African TFSA can help a retiree who has chosen a living annuity reduce their marginal tax rate and thereby maximise their after-tax income.2
Maximising the long-term tax benefits of a TFSA
A key insight when setting up a TFSA is that the underlying investment portfolio should be consistent with the long-term nature of the investment. Based on the current annual limit, it will take 14 years to reach the lifetime contribution limit of R500 000. And while TFSAs allow for withdrawals at any time, doing so should only be as a last resort. This is because the amount taken cannot be replaced and therefore that allowance is lost forever.
Importantly, the tax benefits of TFSAs compound exponentially over time. Therefore, it appears to make no sense for an investor to use a TFSA for an investment horizon of less than five years. Jaco van Tonder, Advisor Services Director at Ninety One, has shown that after twenty years the tax saving represents over 20% of the investor’s total accumulated value.3 With short-term money market rates of between 4% and 5%, an investor can keep up to R400 000 in a fixed income fund before paying any tax on the interest. This makes a money market investment (with low/no volatility), and not a TFSA, the ideal vehicle for an emergency fund, a key component of any well‑constructed financial plan.
An analysis of the Ninety One IP TFSA book shows that investors and their advisors agree; 93% of the TFSA assets on our platform are invested in offshore, equity or multi-asset (balanced or flexible) funds. And at 21%, the most supported fund by some margin on Ninety One IP is the Ninety One Global Franchise Feeder Fund, which reflects investors’ appetite for increased offshore diversification. As Figure 1 shows, this has also provided investors with a good investment outcome.
In this example, on 1 March of each year an investor invests the maximum annual contribution into the Ninety One Global Franchise Feeder Fund via their Ninety One IP TFSA. The green area of the chart represents the sum of the investor’s annual contributions, i.e. R30 000 for the period 1 March 2015 to 28 February 2016, R60 000 for the following year, etc. Over the full period (1 March 2015 to 28 February 2022), the total invested amount is R231 000. The orange area of the chart represents the growing total value of the TFSA investment over time. As at 28 February 2022, the accumulated value is R410 915, resulting in a tax-free annualised return of 15%.
Figure 1: Illustrating the growth on your annual TFSA contribution
Source: Ninety One and Morningstar.
The investment performance is for illustrative purposes only. It is calculated by taking the actual initial fees and all ongoing fees into
account for the amount shown and income is reinvested on the reinvestment date.
Conclusion
In seven short years, early adopters are already reaping the material benefits offered by TFSAs. However, it is critical that investors stay the course and whenever possible invest the maximum allowable amount at the beginning of each tax year. If this is not possible, it is preferable to initiate a monthly debit order rather than wait until the end of the tax year to contribute.4 The earlier you start earning investment returns, the earlier those investment returns start compounding, tax free!
1 Source: HMRC, https://www.gov.uk/government/collections/individual-savings-accounts-isa-statistics.
2 TFSAs – helping to maximise your retirement income and minimise your estate duty liability.
3 Making the most of your TFSA.
4 Don't delay, invest today.
