By Liliane Barnard, CEO and Portfolio Manager, Metope Investment Managers, and Aimee Glisson, Performance and Risk Analyst, Metope Investment Managers
The end of February marks the start of the new tax year and it’s time for investors in a Tax Free Savings Account (TFSA) to either make their lump sum investment of R33 000 or a series of regular investments in order to take full advantage of the tax benefits offered by SARS for these type of savings vehicles. The annual contribution limit in a TFSA may not exceed R33 000.
It’s likely that investors are reviewing the key question of where best to allocate their R33 000 annual tax free allowance, and lifetime limit of R500 000 in order to make the most of their TFSA.
They may also be asking how do the returns generated from a TFSA compare to a normal unit trust, or RA over time, and whether it makes more sense to choose a tax-free investment or a RA?
LONG-TERM TIME HORIZON
A TFSA is best suited as a long-term savings product as the compounding effect of the tax saving is most powerful over a longer period. It is also most advantageous for equity and listed property investments, as these asset classes deliver higher real (after inflation) returns than cash and bonds. In addition, interest on cash and bonds benefit from income tax exemptions (the amount depending on the individual’s age), while equity and listed property’s income (in the form of dividends or REIT distributions) and capital gains are taxable.
WHY INVEST IN THE METOPE PROPERTY INCOME PRESCIENT FUND?
Given the downturn in the economy which has seen listed property underperform other asset classes for two consecutive years, the income yields on listed property companies are extremely attractive. At the end of 2017, the SA REIT index (the index comprising SA’s largest income-producing REITs) was trading on a forward yield of 7.2%. Following the sell-off, yields are now around 11.8%, and for the first time in 10 years, listed property is offering a yield greater than the government bond, with the prospect of growth in income in the medium- to long-term.
The Metope Property Income Prescient Fund focuses on high yielding REITs and aims to generate a yield higher than that of the SA REIT index after fees. For those investors looking to generate an income from their investments, and who can maximise their TFSA allocations for the next 15 years, this fund can be used to provide an attractive income in the future. This is ideal for those investors who do not have a pension fund or whose pensions may not be sufficient.
By way of illustration (see chart below), an investor who maximises their TFSA contributions for the next 15 years into a product offering the same yield as the SA REIT index, and who reinvests all income, will be able to draw an income of R160,000 per annum at the end of 15 years (at which point they have maximised their lifetime TFSA contributions). Adjusting for an expected long-term inflation rate of 4.5%, this equates to a monthly income of R6,877 in today’s money. The income on the portfolio can then be drawn into perpetuity without drawing down on the portfolio, thus preserving the capital.
This scenario assumes zero growth in income or capital in the portfolio, which is very conservative. Due to the contractual lease escalations inherent in listed property, we expect growth at least in line with inflation through the cycle. While the sector is currently in a downturn and some companies are expected to decrease distributions over the short term, a long-term investor should see a return to real growth in distributions and capital, as we have seen in previous cycles. If we assume 3.5% growth in income (still below inflation and below historic levels) and a stable yield, that investor’s monthly income could increase to R9,428 per month (in today’s money)
Source: Metope Investment Managers
TFSA’S COMPLEMENT TRADITIONAL RETIREMENT SAVINGS
Traditional retirement savings in the form of pension funds and RA’s are bound by Regulation 28 rules, which allow a maximum of 75% in equity and 25% in listed property. For those investors who are early in their retirement savings and can tolerate the additional volatility associated with equities and listed property, a TFSA in listed property can be a great way to increase exposure to the sector and supplement retirement savings. Better yet, one can use the tax refund on RA contributions and invest those directly into a TFSA!