Two things to take into consideration when choosing a fund to invest in are: 1) How long do you plan to stay invested, and 2) How can you maximise the tax benefit of the TFSA.
1. Understanding your time horizon
The fund you select will be dependent on what you are saving for. For example, if you want to use your TFSA to save for your new baby’s tertiary education your investment time horizon will be about 18 years or more. For long-term goals like this, it is recommended to invest in a fund with a high allocation of growth assets (shares and property). If, however, you feel you might need to access the funds in the event of an emergency (which is not recommended) your investment time horizon could be as little as a month, in which case you should invest in a fund with a higher allocation of defensive assets (cash and bonds).
2. Maximising the tax benefit
Thanks to a standard annual tax exemption, South African taxpayers under the age of 65 are allowed to earn interest income of R23,800 per year tax-free (more for those over 65, see below). This means a TFSA invested in a fixed deposit or interest-bearing account might not provide any tax benefit if you are earning less than R23,800 interest income per year.
To explain this further: Assuming you received an annual interest rate on your savings of 4%, you would need to have more than R595,000 in savings in order to earn more than the R23,800 interest that is already tax exempt ie to receive a cent of tax benefit by including interest-bearing investments in your TFSA.
If you are over the age of 65, this exemption increases to R34,500. In this case, assuming you receive an annual interest rate on your savings of 4%, you would need more than R862,500 in savings before you receive a cent of tax benefit by including interest-bearing investments in your TFSA. Therefore, a TFSA invested in interest-bearing investments will provide you a tax benefit only if you are already making full use of your annual interest income tax exemption.
The tax benefits of a TFSA compound over time as investors effectively ‘reinvest’ their tax saving and earn compound growth on these savings. In order to maximise the lifetime tax benefit of a TFSA, one should remain invested for a long time.
Historically, equities as an asset class has been shown to provide the highest returns over longer time horizons. As with any investment, one’s objective, time horizon and risk appetite must be considered to make investments that are appropriate and consistent with these factors.
10X Index Fund Managers (RF) Pty Ltd is a Manager registered under the Collective Investment Schemes Control Act.
