In summary, National Treasury intends to proceed with the tax free savings account. Individuals will be allowed to open one or two accounts per year; they may invest in interest-bearing and equity instruments; total contributions may not exceed R30 000 per year with a lifetime contribution cap of R500 000. Withdrawn amounts may not be replaced.
Permitted investment products must be simple, transparent and suitable. The paper specifically prohibits direct share purchases, products with contractual periodic contributions and excessively high termination charges. The paper explores two options to enforce the annual contribution limits.
The key objective of the savings proposal is to make households less vulnerable to financial shocks and to lower the reliance on short-term debt. Although not the key objective, the increase in household savings should have broader macroeconomic benefits in terms of higher investment and export growth, which should boost the country’s growth rate.
As we have indicated before, we like this idea of a tax free individual savings account a lot. It gives savers flexibility and certainty, knowing their savings have no tax consequences, and may be withdrawn at any time. Diligent savers will be able to build up a substantial tax-protected portfolio.
However, we disagree with some of the proposed features, which appear counter-intuitive in light of the arguments used to justify the design of the product. It suggests that Treasury is ultimately more focused on the national rather than individual’s interest.
Design of the tax-free savings accountIn summary, the following design features (and justifications) apply:
- Current interest exemption: This has been retained at R23 800 but will not no longer increase from year to year (ie the real value of the interest exemption will erode over time).
- Annual contribution limit: The annual limit – Initially set at R30 000 per annum without roll-over – is intended to spur procrastinators to act, by putting an annual deadline on the savings decision. A rollover provision may tempt the individual to save another day (year). The annual limit corresponds to similar provisions in other countries such as the UK.
- Treatment of withdrawals: Withdrawals cannot be replaced – contributions will be limited to the annual and lifetime limits. This should discourage individuals to use these savings for impulse purchases, and improve self-control.
- Types of accounts: Individuals may open up to two accounts per year. Each account may hold either interest or equity products, or both.
- Lifetime limit: This is set at R500 000 for now. National Treasury does not intend to increase this cap with inflation for now as the total permitted annual contributions would then never reach the lifetime limit (i.e. there would be no purpose to the lifetime limit).
The original paper (Discussion Paper D: “Incentivising non-retirement savings”, published 4 October 2012) hoped to instil a savings culture, to reduce our stop-gap reliance on debt and retirement savings. The paper concluded that the “new accounts will provide an alternative tax-incentivised channel for short to medium term saving, to reduce the premature use of retirement saving to meet consumption needs.”
We initially argued that scrapping the interest-exemption (as proposed) prejudiced savers who were making full use of this exemption, and who would take many years to re-establish their tax position. The revised proposals, which retain the exemption (albeit at a fixed amount) addressed this problem.
However, the reality is that individuals who are marginal savers and who lack the discipline to preserve their retirement savings will not find their salvation in a tax-sheltered savings account that gives them ready access to their money.
In fact, such people will not find much use for this product at all, as long as they have not exhausted their tax-free interest exemption. They are better served saving outside this product as they can withdraw and contribute at will, without losing their tax break permanently. It may pay them to use this product to save on capital gains and dividend withholding tax, but they are also unlikely to venture into such investments.
So this product will really only serve higher income groups, who already save diligently, or those who want to save on dividend withholding tax. This is probably not Treasury’s intention.
Given this (and the current paper’s) context, we believe the product design is flawed. The flaws relate to the lifetime contribution limit and the ban on replacing withdrawals. In our view, Treasury should impose one or the other, but not both. Why?
Firstly, these restrictions effectively impose a termination penalty on early withdrawal. In discussing appropriate investment instruments for savings account, Treasury comes out strongly against products with high termination charges. But by forbidding withdrawn contributions to be replaced and setting a lifetime limit, withdrawals trigger the permanent loss of a tax benefit. This is tantamount to a termination penalty.
Secondly, these restrictions do not promote a sustainable savings culture. If Treasury wants to nurture life-long saving habits, it cannot do so with incentives that dry up after a few years. The proposed design encourages individuals to stop saving once they have exhausted their permitted contributions.
Thirdly, the restrictions encourage the use of debt to meet short-term financial emergencies, even though one of the stated objectives is to wean the public off consumer debt. But if withdrawals are permanently penalised, then it makes sense to borrow, as such loans CAN be repaid without losing the long-term tax benefit.
Fourthly, contrary to the presented argument, we believe the restrictions actually indulge procrastinators. Treasury comes out against a roll-over provision as this forces saving now, or else lose the current year tax benefit forever. That would hold if there was no lifetime limit – a missed contribution would then be lost forever. However, by imposing the life time limit, missing this year’s contribution means forsaking the tax benefit only until the lifetime limit is reached, possibly within a few years.
To overcome all these issues, we believe Treasury should either scrap the lifetime limits, or permit withdrawn contributions to be replaced (the former may be easier to administer).
Follow UK exampleTreasury’s biggest (but unstated) fear is that diligent savers will build up excessive tax-sheltered savings, invariably by people who would save anyway, or who are so well-off they do not need to save more. To overcome this, Treasury has set a life-time limit on contributions and excluded investment products that can provide exponential returns, such as individual stocks (by comparison, fixed deposits, unit trusts and exchange-traded funds have lower and more predictable long-term return prospects).
As with many of its reforms, Treasury is trying to reconcile competing objectives: incentivising sober financial habits among the masses but without further advantaging the already advantaged. This typically results in proposals that are well-meaning but not good enough.
We note that in the UK, the annual contribution cap for an individual savings account (ISA) has just been raised to GBP15 000 (that’s R270 000 at present!). Plus the ISA does not impose a lifetime limit. This makes it a viable alternative to the more traditional retirement saving products.
We don’t see excessive fund build-up as a big risk. In fact, we believe that by scrapping the lifetime limit, savers will use this product as originally intended. They will save when they can and access funds as and when needed, without fear of losing their tax breaks permanently. They will not feel compelled to build up excessive balances, or use expensive short term debt instead.
The UK authorities must believe that the benefit of instilling sober financial inhabits among the majority outweighs the cost of excessive tax breaks for the few. Why would Treasury see it differently?
