The value of a tax-free savings account (TFSA) is seen in the long term. Once the investment is sizeable enough, the tax-free aspect becomes noticeable on the growth. It may not make sense for you to open a tax-free investment for yourself, but starting one for your child could be a fantastic idea.
In terms of the current regulations you are limited to a lifetime contribution of R500,000, and an annual contribution of R33,000. It will take roughly 15 years to reach your lifetime limit provided you’re contributing the maximum amount each year. The tax-free benefits in the first five years are negligible, and even up to the 10-year mark they are not that impressive. After 20 years, though, you’ll really start to see a major difference as the compounding growth kicks in.
Assuming an annual growth of 9% and an effective tax rate on returns of 25%, you can clearly see the benefits over a long term. The graph does not take inflation into account, and it is assumed that the lifetime limits as well as annual contribution limits remain unchanged.
It is also true that a minor who is not earning any income will fall well below the taxable rates; this serves as illustration only as to the long-term effect of the tax-free benefit.
The graph shows the comparison of growth over 30 years, but keeping the investment untouched for a further 30 years would have an incredible tax benefit, and may serve your child very well in their retirement. That is, of course, if they can resist withdrawing the money earlier.
Opening such an investment in your child’s name has a risk that they may wish to access the money as soon as they become an adult, and are financially active. It’s important to provide your kids with financial education, knowledge of investing, how compounding growth works, and the value of saving for the future.
Withdrawing the funds early would be detrimental to the overall plan but they would still benefit from an investment that you started for them, so all is not lost.
A tax-free investment is not the only option available for you to save for your child’s future. Knowing the purpose of the investment can help you decide on what is best – is it for education, a 21st birthday present, or to buy a first car? Each investment should be treated separately.
It’s also important to remember that a tax-free investment is only available to individuals, and cannot be held in a trust or other legal entity.
Tax-free investments offer a great opportunity for long-term wealth creation and, although many scoff at the lifetime limit and don’t see value in it for themselves, using this for a future generation can make a lot of sense.
Looking to the new decade it’s worth revising your investment strategy to ensure that your money is working for you – and your descendants – in the best way possible.