Tax-free savings accounts or different life stages: Young professionals, mid-career investors, and pre-retirees

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A tax-free savings account (TFSA) is a long-term investment savings vehicle introduced in 2015 by the National Treasury. The rationale behind this introduction was to incentivise more South Africans to save, due to the tax advantages on offer. There are, however, limits in place when it comes to the contributions allowed, so these need to be kept in mind. The maximum annual contribution amount is R36,000 (R3,000 per month), and the maximum lifetime allowance is R500,000.

Growth within a tax-free savings account is tax-free, meaning there is no capital gains tax, interest or dividends tax. As such, there are more available returns to potentially grow and compound over time. Crucially, there is no tax on withdrawals either, so if you have been saving diligently for 30 or 40 years, your TFSA has the potential to be a great source of tax-free income for you on an ongoing basis.

A tax-free savings account is a long-term investment product that can be used for a variety of end goals, depending on what stage of life you are at. For example, you may wish to use this product to save for retirement or as a source of income during retirement. It’s important, when making use of a tax-free savings account, that you avoid early withdrawals and pay close attention to fund selection. In this article, we look at how to best align your TFSA with your life stage in order to maximise its potential, while making use of 10X’s cost-effective, transparent and well-diversified approach to investing.

Why a tax-free savings account is a long-term investment vehicle

A tax-free savings account is not a savings account in the traditional sense; it is a long-term investment vehicle with greater potential for strong capital growth over the long term. If at all possible, you should look to avoid any withdrawals from your tax-free savings account, as you are not able to add those withdrawals back in; the contribution room has been lost, and this may ultimately impact the potential growth of your TFSA.

Your TFSA has the potential to maximise growth over time due to the compounding of the tax-free returns. This can be further emphasised by ensuring that you are paying low fees to your service provider.

Let’s look at an example which helps to highlight the effect of fees on the growth of your TFSA over time:

Let’s look at an example of 1% in fees vs 3% in fees. We will assume the following information:

• Monthly contribution: R3,000
• TFSA lifetime limit: R500,000
• Investment term: 30 years
• Annual return: 12%
• Annual inflation: 6%

The contributions will stop after reaching the limit, to avoid any penalties, but the money stays invested for the full 30 years. The returns are compounded monthly and adjusted for inflation to determine the final investment values.

Example 1 (1% in fees): After 30 years, the final investment value is approximately R1,438,627

Example 2 (3% in fees): After 30 years, the final investment value is approximately R901,248

As this example shows, a difference of only 2% in fees can significantly impact the final investment value of your TFSA. This example is for illustrative purposes only, and actual results may vary. You can learn more about fees here.

At 10X, we offer a cost-effective TFSA enabled by an index-tracking and buy-to-hold investment strategy. This strategy involves fewer trading costs and research overheads which means fewer costs passed onto you, the investor, in the form of fees.

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Stage 1 – The young professional (Ages 20–35)

In your early years as a professional, your mindset surrounding your tax-free savings account should be about building a long-term growth engine early. Even though retirement is far off, now is the time to start saving and taking advantage of the power of compound growth.

As a younger investor, you would generally be more risk-tolerant and have longer time horizons on hand. Therefore, you might consider incorporating a higher percentage of growth assets, such as equities, into your portfolio. You may also prefer to diversify your portfolio offshore. Diversifying offshore can provide a good hedge against local market instability and any depreciation of the Rand.

Taking advantage of the maximum annual allowance is advised. You could either do a monthly debit order of R3000 or a lump sum contribution of R36 000 per annum. As always, with any long-term investment, you should try to avoid any early withdrawals and keep the capital invested for the long term.

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At 10X, our online platform is simple and easy to use, making it a breeze for new investors to navigate. We also offer a TFSA that can be invested 100% offshore, which may appeal to many investors. This is an offering that not all service providers have due to their own internal investment limitations.

Consider using our TFSA calculator, a free online tool which allows you to forecast the potential growth of your TFSA over time.

Stage 2 – The mid-career investor (Ages 35–50)

At this stage, it’s time to consolidate, diversify, and prepare for flexibility. As an investor who is mid-career, it is possible that you may have other retirement investments, such as a retirement annuity, pension or provident fund. A TFSA can be a great investment to round off your retirement savings plan. It also allows for more liquidity, if needed in times of emergency.

At this point, growth assets can potentially still make up the majority of your asset allocation, as equities are most likely to provide the best returns in the long term. Equities have historically produced returns above inflation, by around 7% annually, over the long term (based on JSE All Share Index performance versus CPI from 1960-2020). It’s important to note, though, that past performance does not guarantee future results.

If possible, maximising contributions to your TFSA is still a good idea, as this allows you to take full advantage of compound growth, key to getting the most out of your TFSA. Remember, a TFSA should not be used as a short-term savings vehicle. Your savings should be invested for the long term, in order to maximise the growth benefits that come with a TFSA.

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Asset allocation should be carefully selected in order to help meet the full potential of the TFSA. This should be aligned with your investor profile, taking into account your risk tolerance levels, investment timelines and financial goals. At 10X, you have the freedom to adjust your underlying investment portfolio by choosing from a selection of carefully curated funds, each with a different asset allocation and geared towards different investor profiles.

We offer a variety of curated funds that would suit a variety of different investor profiles. These well-diversified funds offer exposure to a range of different asset classes, thus ensuring that there is an appropriate balance between risk and return. 10X takes a long-term approach when it comes to investing, focusing on a five-year outlook with a buy-to-hold mentality. We understand the importance of asset allocation in the potential overall growth of your TFSA. These are the range of funds that investors have access to when investing with 10X.

Stage 3 – The pre-retiree (Ages 50–65)

A TFSA allows for more flexibility than other savings and investment vehicles, such as an RA or a provident fund. There is no tax on withdrawals, and no annuitisation rules apply. At the pre-retiree stage, you might consider opting for a more conservative asset allocation, as your time horizon is, in all likelihood, shorter, and you have less time to rebound from market dips. You would, of course, still want to contribute to your TFSA until you reach the lifetime limit of R500 000, if you have not already done so.

Even though you’re looking to retire imminently, you may want to consider keeping a percentage of your capital invested in growth assets, in addition to looking to incorporate some more defensive assets. For example, bonds might add stability to a portfolio, which may be suited to older investors who are less risk-tolerant, perhaps seeking more capital preservation, and also looking at shorter investment timelines.

As a pre-retiree, there is a need to strike a balance between growth, on the one hand, and buying power protection on the other. Our well-diversified, low-cost funds are designed to support you during this transition period, so more of your returns stay invested and continue to potentially compound as you move closer to retirement.

Stage 4 – Post-retirement strategy (Ages 65+)

A TFSA can still play a role for investors who are already in retirement. You can take advantage of tax-free growth, and if the need arises for an emergency withdrawal, then the capital can be accessed without paying any tax.

Ideally, you would want to keep as much of the capital invested as possible. Withdrawing from your TFSA may, however, be preferable to accessing capital from your living annuity, at least in the initial stages of retirement, to protect you from sequence of returns risk if the market isn’t strong at that stage. Note that unlike a living annuity, tax-free savings accounts form part of your estate, which means your beneficiaries may have to pay estate duty on those funds. H2: Common pitfalls across all stages There are some common errors that you would look to avoid as an investor. Let’s take a further look at some of these:

• Withdrawing early: Your capital should remain invested so you can take advantage of the compounding tax-free growth. Any capital that is withdrawn cannot be reinvested, as this contribution room has already been used.
• Investing too heavily in defensive assets: Some investors may invest too heavily in bonds and/or cash. While more stable, defensive assets typically don’t give you the growth you might be looking for over the long term. You might look at incorporating equities in your asset allocation to take advantage of potential compound growth, provided that this is well-aligned with your investor profile.
• High fees: As an investor, you should always review fees and the Effective Annual Cost (EAC) of your investment annually. The EAC is the total fees and costs of owning an investment, such as a TFSA, over a one-year period of time. All factors being equal, a higher EAC may mean that there are fewer returns to be reinvested and allowed to potentially grow over time. A lower EAC may mean that there are more returns to be reinvested and allowed to compound over the long term. The EAC would be just one factor to consider when comparing service providers. You can evaluate and compare the EAC of your TFSA by making use of this free calculator, offered by 10X as a part of our online suite of tools available on our website.
• Exceeding the TFSA limits: If you exceed the TFSA limits, there may be a penalty imposed by SARS. This penalty is 40% on the excess contribution amount.

How to choose the right TFSA provider

Choosing the right TFSA provider can have a major impact on your long-term investment outcomes. The quality of the underlying investments, the fee structure and the level of service you receive can make a measurable difference over time. When choosing the right TFSA service provider for you, there are some key criteria that you would need to consider.

• Access to a range of well-diversified funds: Find a provider that offers exposure to multiple asset classes, including equities, bonds and offshore investments. A diversified portfolio helps spread risk and provides the opportunity for more stable long-term growth.
• Low and transparent fees: Low fees allow for more potential growth of your funds when compounded over time, and high fees can significantly reduce your overall returns. In general, you should aim for a provider with low and transparent fees.
• Strong investment philosophy and performance record: Review whether the provider’s investment approach aligns with your investor profile and financial goals. For example, index-tracking strategies have been shown to deliver consistent market-related returns at lower costs.
• Simple and intuitive platform: A user-friendly and easy-to-navigate platform that allows you to access TFSA investment statements, tax certificates, and similar information can make managing your TFSA much easier.
• Excellent client service and support: A responsive and knowledgeable support team can make a major difference when you need a query answered. Find a provider that offers easy access to investment consultants, fast response times, and clear, transparent communication.

10X ticks all of these boxes:

• We are able to offer a wide variety of funds that are well-diversified and include global exposure.
• Our fees are low and transparent; fees charged are usually 1% or less for most products.
• Our online platform is intuitive and easy to navigate, making it simple for all investors to use.
• We use an index-tracking investment strategy alongside a more active approach to asset allocation to achieve the returns our clients deserve
• 10X investment consultants are helpful and knowledgeable. If you need any assistance, don’t hesitate to get in touch, and they will be more than happy to help you.

Conclusion on tax-free savings accounts at different life stages

A tax-free savings account is a versatile investment vehicle, suited to investors who are at any stage of life. Your TFSA can be structured to suit the young investor, those who are mid-career, those who are close to retirement age or even those who are in retirement already. You would look to ensure that your TFSA strategy is well-aligned to your financial goals, risk-tolerance levels and investment timelines.

If you haven’t started your TFSA yet, now is the time. Take advantage of the tax-free investment growth on offer with the TFSA and the potential long-term compounding growth. The 10X TFSA is a great option. Our superior track record of low fees and high returns means you can retain tax advantages and grow your savings while maintaining full control. The 10X TFSA is designed to protect your future. Get in touch today to learn more!