The great Tax Free Savings Account con!
Am I the only one who dislikes Tax Free Savings Accounts (TFSA) and all the hype that goes with them?
Let’s take a step back before getting all excited about TFSA’s. They were introduced (by Government) to encourage non-savers to save and unfortunately, government did not want to be seen to be favoring the wealthy (that’s you and me) with these investments. That’s why the contribution rate is so low!
The reality is that on R33k (it was R30k when introduced) and with a life-time amount of R500k you are NOT going to be able to draw any meaningful income in the near (or possibly even distant) future!
Let’s look at the mathematics:
For the purposes of this exercise, if we assume that from here on you start with R33k per year and that the annual contribution amount is increased by 6% per annum (CPI) then you would have reached your life-time threshold limit in ±11 years (it’s currently R500k and has not been increased since they started). If we assume a real return on the funds of 5% (which is probably way too generous for most TFSA’s) then your capital should be worth ±R900k in 11 years time (that’s less than R500k in today’s terms) and you wont even be able to generate an income of R2000 in today’s terms.
If you leave the investment to grow for a further 10 years you should have ±R2.7million (less than R800k in today’s terms) and you could draw an income of ±R3500 per month (in today’s terms). Push it out a further 5 years (that’s 25 years of saving) and it does not look that much better – your income draw would be ±R4000 pm (in today’s terms). No one is going to retire on that!
Add to this the following realities:
- If you take any money out during the period, you cant put it back i.e. if you withdraw from the TFSA account it is gone forever…and you cant put it back without eating into the R500k life-time limit (this is crazy but it’s an admin nightmare to track it).
- Most unit trust TFSA accounts have minimum investments that are way out of reach of the “non-savers”.
- The result of the high minimum contributions is that the good old life insurance companies and banks have stepped in to fill this void.
- The life insurance companies have low minimums but VERY high fees and we know what that does to returns.
- The banks, on the other hand, have low minimums but most investors will sit in cash for the full term so there is no way you will even get close to an inflation beating return and that’s pointless.
The truth is that TFSA accounts are actually highly specialized investments – they are not simply to be used for your children – failing to consider the consequences of using up your offspring’s life time limits could result in some interesting legal cases in the future and contributions to TFSA’s for your kids could be breaching tax exempt donations limits.
In my opinion, if you are going to use a TFSA then you need to have at least a 30-year time horizon in mind (before you are even going to think about drawing the funds). You should be investing in a fund where you are going to get maximum growth and maximum tax benefits (such as a property fund). On top of this you should have made the maximum contribution to your retirement funds, topped-up your offshore investments and then, and only then, if you have spare cash to invest, consider using a TFSA. Just make sure that you are using a low cost, high growth option!