Should you open a tax-free account for your child?

JUST as the government is trying in various ways to incentivise positive financial behaviour, such as saving, you could do this within your own family. Your children have time on their side; an appropriate savings vehicle could show them the power of compounding – and more so when these funds are not eroded by taxes.

Enter the tax-free savings account (TFSA). TFSAs, introduced in 2015, are a government initiative to encourage South Africans to save for the long term. But can you open one for your child?

“Yes,” says the South African Revenue Service (Sars), “parents can invest on behalf of their minor children.” And this applies to other adults, including grandparents. “Any person can open a tax-free account for a minor child.”

With a TFSA, none of the regular taxes on investments (capital gains, interest and dividend taxes) applies.

But you can incur donations tax by contributing to an account for your children or grandchildren. The normal rules apply here, says Sars: there is no donations tax on total annual donations up to R100 000.

So, if you can afford it, is opening a TFSA for your child in his or her best interests? On the face of it, it seems like a great idea. However, this rider appears on the Sars website, after the statement that parents can invest on behalf of their child: “The minor child will use his/her own annual or lifetime limits.” For this reason, Palesa Tlholoe, a certified financial planner and wealth manager at Imvelo Wealth

Solutions, does not recommend TFSAs for children. “An individual is only allowed to contribute up to R36 000 a year into a tax-free savings account, and R500 000 in their lifetime. Using your child’s tax-free allowance depletes this amount,” says Tlholoe.

In other words, if your child wants to open a TFSA of his or her own later in life as an adult, the lifetime limit is reduced by whatever you have already contributed.

If you contribute less than R36 000 a year, you cannot roll over the difference to a subsequent year and use it to contribute more than R36 000 in that year. The point of this rule is “to address the problem of procrastination”. The Sars document elaborates: “If individuals were allowed to roll over any unused amount … [they] would most likely put off actually saving the money until later.” The no-rollover rule is thus intended to encourage individuals to save “today”.

It takes 13 years and nine months to reach the lifetime limit at current annual limits, says Sisandile Cikido, head of retail investments at Nedbank. If you contribute less a year, it will take longer.

Another salient question is whether opening a TFSA for your child is in your best interests. “Make sure you maximise every opportunity to improve your own financial situation,” says Tlholoe.

“Use it as a tax-free supplement

NEWS 24/7 IOL.CO.ZA to your retirement savings. While you are likely to have to pay tax on your pension or retirement annuity withdrawals, a TFSA allows for a nice tax-free nest egg.”

FURTHER POINTS YOU NEED TO KNOW

◆ Investments are aggregated over the tax year, not the calendar year. If you contributed R10 000 in March last year, then R30 000 in February this year, you would have exceeded the limit for the 2021 tax year, incurring a tax penalty of 40% on the R4 000 excess contribution.

◆ Returns on investments don’t count towards annual or lifetime limits. If you invested R36 000 in the 2021 tax year and earned interest of R5 000, which is capitalised, the total in the account would be R41 000, but the R5 000 interest is not regarded as a contribution, says Sars.

◆ Tax-free savings accounts are not just savings vehicles. Investment vehicles such as unit trusts and exchange traded funds, if offered as tax-free investments, are also an option. Although tax-free bank savings accounts are low risk, they tend to generate lower returns, so Tlholoe does not favour them. If you accept greater risk, products such as tax-free unit trusts may provide higher returns.

◆ Transfers between products are allowed. If you intend to make a transfer, Cikido cautions it is important not to withdraw the investment. Disinvesting, then reinvesting, instead of transferring, negatively affects your lifetime contribution limit.

◆ Replacement of withdrawn funds is seen as a new contribution. This affects annual and lifetime limits. The intention behind this rule was to help prevent rash decisions but allow access if necessary. “Don’t view a tax-free investment as an emergency fund,” says Cikido, “but rather as a long-term investment.”

Tax-free does not mean fee-free. Performance fees aren’t permitted, but, depending on the type of account, you may have to pay advice fees, asset management fees, and administration charges.