A tax free savings account (TFSA) and retirement annuity has its unique benefits and drawbacks, it is pivotal for potential investors to consider their individual financial goals, tax situations, and retirement plans.
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Considering your retirement planning options while your new-year good intentions are still intact can put you in a good position, according to Linda Kleynscheldt: head of Actuarial and Product, PSG Wealth.
A tax-free savings account (TFSA) and retirement annuity (RA) are two options that are available to people, but you need decide if either (or indeed both) of these products might be right for your needs.
Here is a closer at the differences between TFSAs and RAs.
Kleynscheldt said that both TFSAs and RAs are open to all individuals.
"For TFSAs there are no age restrictions for making contributions and on RAs contributions may be made up to the maximum retirement age stipulated by the product provider," Kleynscheldt said.
According to Old Mutual, a TSFA lets investors grow their money without paying tax on the growth of their investment, the interest or dividends while a RA is a long-term investment that is designed to help people save for their retirement.
TFSAs and RAs offer people tax-free growth while their money remains invested which means there is no tax on the interest, dividends or capital gains for either of these investment vehicles.
Contributions to TFSA, have already been subject to income tax.
On the other hand, contributions to RAs effectively lower your taxable income as the South African Revenue Service (Sars) will deduct RA contributions up to 27.50% of your taxable income (capped at R350,000) each tax year when a tax return is submitted.
Kleynscheldt said that this means that you can actually save on your tax liability by contributing to an RA.
Contributions to TFSAs are limited to R36,000 per tax year and R500,000 in your lifetime. For RAs there are no annual or lifetime contribution limits on contributions, and excess contributions can be rolled over to future years.
Before the implementation of the two-pot retirement system on September 1, 2024, members of retirement annuities could only access their retirement savings funds at the age of retirement of 55, however, there were a few exceptions to the rule such as emigrating to a different country or becoming permanently disabled.
The introduction of the two-pot system has resulted in changes that give members greater access to their retirement savings before retirement.
"Members can now make one withdrawal per tax year from the part of their retirement fund known as the savings pot subject to a minimum withdrawal amount of R2,000.
"However, they should also be aware that they could be liable for additional taxes if they withdraw funds from this pot, as these will be taxed at their marginal tax rate."
Fund members can make one lump-sum withdrawal from their vested pot in their lifetime, which is taxed according to the withdrawal tax tables but members are not allowed to make withdrawals from the retirement pot portion of their RA before retirement.
"In contrast to RAs, TFSAs allow investors to access their funds at any time, tax free, making these products a flexible choice for both emergency needs and long-term investment goals," Kleynscheldt explained.
"However, withdrawals from TFSAs cannot be added back to your annual or lifetime limits. Withdrawals from these products will thus reduce the capital amount available to compound over time, resulting in lower returns over the long term."
For a TFSA, the funds become part of your estate if you pass away, but it can incur estate duty and executor fees.
RAs are not a part of your estate, so the proceeds of these investment vehicles are transferred to beneficiaries without executor fees being incurred.
RAs can also offer creditor protection which mean that your retirement savings are safe from potential claims if you face debt issues unlike TFSAs which do not offer this protection.
Both products offer access to a wide range of asset classes to suit different risk levels, however, RAs are subject to Regulation 28, limiting exposure to high-risk asset classes to ensure safe retirement savings.
TFSAs aren’t bound by these limits which give investors more freedom in their investment choices.
A TFSA offers investors flexible, tax-free growth and easy access to funds, which could be ideal for medium- to long-term goals while RAs provide upfront tax benefits, estate planning advantages and creditor protection which makes them a strong choice for longer-term retirement savings.
"It is always important to consider your goals, tax situation and retirement plans when deciding which product to invest in. Speaking with a trusted financial adviser can help you build a savings strategy tailored to your specific needs," Kleynscheldt said.
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