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Tax-free savings account or retirement annuity?

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Tax-free savings account or retirement annuity?

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We’re entering the last two months of this tax year*, which runs from 1 March 2020 to 28 February 2021. Soon you’ll be bombarded with appeals to invest in one of the two most popular ‘tax wrappers’ – either a tax-free savings account (TFSA) or a retirement annuity (RA) – before end of February.

You definitely want a tax wrapper

A ‘tax wrapper’ wraps your ETF or unit trust in a legal entity that protects it against the tax that you would normally have paid without this wrapper. Tax wrappers are a great way to pay less tax and I’ve written before on how they work in a post covering how all the different investment terms like tax-free account, retirement annuity, ETF and unit trust fit together. Before you invest, just first make sure you’ve already settled your debt and you have an emergency fund in place (a TFSA is for the long term/retirement/early retirement, so please don’t use it as your emergency fund.)

Tax-free savings account or retirement annuity?

This might end up being my shortest blog post yet. Short answer: Tax-free savings account.

A TFSA has no disadvantages, except that you are allowed to invest only R36 000 in the current tax year (it was R33 000 last year) before the 40% tax penalty kicks in. More about TFSAs in a previous blog post on how to choose the best tax-free account.

When is a retirement annuity necessary alongside a tax-free account?

  • When you have more than the current annual TFSA limit of R36 000 to invest, let the rest spill over into a retirement annuity.
  • When you are investing on behalf of a child and don’t want them to be able to touch the money before age 55 (youngest legal age for accessing your retirement annuity)
  • When you yourself can be impulsive at times and you want to make sure you can’t touch your own investment before you turn 55
  • When you run a business that you want to protect against creditors (a retirement annuity can only be touched by SARS or your ex-spouse when you owe them money)
  • When you want to avoid your heirs paying estate duty (applicable to TFSA but not to an RA)

RA and TFSA comparison

If you want to dig into more detail, our graphic designer and I did an RA and TFSA comparison with infographic for my current employer.

I see Stealthy Wealth also has a good TFSA vs RA comparison, which I can recommend.

Invest in a TFSA and/or RA now, worry about the fund choice later

After you’ve chosen a TFSA and/or an RA as your product or tax wrapper, you would need to choose at least one fund to invest in. If you’re a first-time investor, you might feel overwhelmed by the variety of investment funds – ETFs and unit trusts – out there. There are also so many investment terms and different types of investment business. I’ve written a post to specifically help you navigate the path which your money will follow when you invest with the financial industry.

If you’re battling to choose a fund – ETF or unit trust – for your tax-free account or retirement annuity, don’t let that be the reason that you postpone your investment. You can never get a tax year back. If you don’t use this year’s R36 000 tax-free allowance, you can’t carry it over to next tax year. It’s lost forever. Choose the best TFSA before the end of February and simply put your entire contribution in the money market fund option as a parking bay. And then use next year to do your fund research and switch into a diversified exchange traded fund (ETF) or unit trust fund with the type of asset allocation and risk that is right for you. Switching out of a money market fund into another fund within the same product has no tax implication or penalty with any of the TFSA providers in my blog post on the best TFSA in SA. Just start – it’s the most important step in investing.

*Article originally published 21 December 2020.

Article reposted with permission from  Go Freedom.

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I’m Lizelle and I have no intention to retire from a working life. Only from my corporate life. I’ve been down many paths over the past 25 years: actuarial technician; investment performance analyst; product manager; hedge fund manager; client experience designer; finance forum owner; communication specialist; coffee stall owner; and Nia teacher (much fun). And I've been on a few sabbaticals, being a strong believer in proper breaks. I’ve been a salaried worker and a freelancer, and definitely prefer the latter. So, my next goal is to up-skill, cross-skill, invest in how I see my future self and save up some reserves, so I can return to the freedom of flexible work – for good. To me, financial freedom is a process; it's not an absolute destination.

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