Ho Ho Ho: Santa and your tax-free savings account
In an article recently published by Moneyweb, Rosebank Wealth Group’s Trevor Lee wrote about Tax Free Savings Accounts and proposed that this type of investment invested in your child’s or grandchild’s name would have multiple benefits. You can either carry on reading here, or switch to the Moneyweb version of the article by clicking here.
If you are a value-conscious shopper, a wander through a children’s toy shop can be quite a challenge. At Christmas time it becomes nauseating. There are mountains of ‘buy me now’ goods made of flimsy plastic that are unlikely to hold the attention of proposed recipients’ interest longer than the sell-by date of yoghurt. And they are so expensive.
What is the alternative?
A gift of an investment in your child’s or grandchild’s name has multiple benefits. Firstly, it should increase in value and in due course be spent on something really life-changing like education or a deposit on a car. Secondly, tracking the progress of the investment might offer an early and valuable insight into the world of investments to the lucky recipient.
Background on donations tax
For many years National Treasury was mindful of the need to create a tax-efficient savings vehicle and yet had to find ways of creating a vehicle that prevented high tax-paying donor-parents diverting part of their income or capital gains to their children to reduce their own tax. The complicated Income Tax Act, therefore, aims to close loopholes which enable parents in particular from paying less tax.
The most important rules to remember are the following:
All taxpayers are permitted to donate a maximum of R100 000 per year, tax-free.
Donations over this amount are liable for donations tax, which is currently levied at a flat rate of 20% of the value of the donated asset. In the event that the donor fails to pay the donations tax, both the donee and donor are jointly and severally liable for the tax.
The proceeds of the investments made on behalf of minor children or grandchildren are taxable depending on the identity of the donor. If the donation is made by the parent, the income resulting from the donation, (the dividends and interest) must be added to the parent’s tax return. If a minor receives a donation or lump sum from a person other than a parent, then the minor is directly liable for any tax on any applicable interest, dividends and capital gains. In the event that a minor child is liable for tax, the parent must register the child for income tax and submit a return on the child’s behalf. *
However, a tax return is only necessary if the child has tax deductions to claim and the gross income consists solely of South African-sourced income more than R23 800. In the case of withholding tax on interest and dividends, the asset manager deducts the relevant tax and pays it to Sars. *
Importantly, the last two points do not apply to tax-free savings accounts. For more on the tax rules, click here.
What is the best way to invest on behalf of a minor?
Giving an investment as a gift has become a lot easier since the National Treasury launched tax-free savings accounts (TFSAs) in 2015. At Rosebank Wealth Group we would suggest that parents/ grandparents take advantage of the tax free savings option on behalf of children or grandchildren.
There is no age restriction on having a TFSA, so a grandmother, for example, could start one for each grandchild as long as the parent or guardian takes responsibility for the account until the child turns 18. Each person can invest up to R33 000 (or have R33 000 invested on their behalf) per year up to a maximum of R500 000 over a lifetime in a TFSA. Crucially, there are no regulated minimums; if you don’t invest the permissible R33 000 this year, you can’t investment more next year, but you can take longer to achieve the maximum allowance of R500 000 per individual per lifetime.
Technically, if she had the funding, a grandmother could invest up to R33 000 in a TFSA for each grandchild, (subject to the R100 000 donations rule above). The earlier the investment starts, the longer the compounding period and the higher the end tax-free lump sum. The rules for investing in a TFSA can be accessed by visiting the Sars website or clicking here.
What are the rules for ‘qualifying TFSAs’?
TFSAs can be designed and offered by traditional asset managers, insurance companies, stockbrokers, banks and the government; (retail bonds are available via a TFSA from National Treasury, Pick and Pay or the post office). The underlying holdings range from low-risk assets like fixed deposits to higher risk equity portfolios.
Regulations stipulate that qualifying TFSAs:
May not have performance fees;
Must enable investors to withdraw their money at seven days’ notice;
In the case of fixed deposits or fixed-term policies, early withdrawal penalties may be levied but penalties are restricted by the regulations;
Derivatives can be used but only to reduce risk of loss or to reduce costs; they cannot be used to gear the investment; and
If investors choose to switch from one TFSA to another, providers must agree to do the switch at no cost.
What are the consequences of an investment in your child’s name?
When minors turn 18 they become the legal owner of their investments. At this time, parents or grandparents lose transactional rights to their child’s investment.
Is there a publically available list of TFSAs?
The best directory of TFSAs is published on a website called savetaxfree.co.za, developed by financial research and media firm Intellidex. The company also publishes the annual Financial Mail Guide to Tax-Free Savings, listing all TFSAs with relevant information for potential investors.
Which type of investment should you choose?
TFSAs have been designed with a wide range of applications in mind. An investor investing on behalf of a new baby, with a 25-year time horizon, would have a completely different investment strategy, risk tolerance and choice of underlying holdings to an investor investing on behalf of a 15-year-old with a specific saving objective.
It is important to look at the different options available to you and we would recommend you consult an independent financial advisor at the outset.