What a tax-free investment should ideally be used for in a financial plan, and what not

By: Pierre Jean Marais, Retail Marketing at Momentum Wealth

Pierre Jean Marais

As financial planners and wealth managers, our goal is to craft effective strategies tailored to people’s unique needs. Tax-free investments (TFIs) offer valuable opportunities to address key financial planning objectives, including retirement planning and setting future generations up for financial independence. Let’s explore the most appropriate financial planning needs TFIs should be used for and provide a practical example to illustrate the long-term benefits.

  • TFIs can play a crucial role in enhancing retirement planning to build a solid retirement nest egg. The tax-free growth and the effect of compounding can significantly boost the value of a client’s retirement portfolio as they work towards maintaining their desired lifestyle during retirement.
  • By starting a TFI for a child at a young age, parents can lay the groundwork for their child’s financial independence. This investment can grow over time, providing the child with a substantial financial buffer as they reach adulthood and beyond.

Using money in a TFI to pay for shorter-term expenses like paying for holidays, weddings, home renovations, or children’s education can negate the benefits offered by this investment vehicle.

By withdrawing money from a TFI for short-term needs, people are robbing themselves of the opportunity for their money to participate in potential market growth, thus reducing the meaningful long-term benefits of the investment.

Once the money is withdrawn from a TFI, it cannot be replaced within the allowable limits, reducing the client’s ability to reach the R500 000 lifetime limit and fully capitalise on tax-free growth.

Setting future generations up for financial independence

Consider a parent who starts a TFI for their 10-year-old child, investing R1 000 a month until the child turns 18. Assuming an average yearly return of 8%, the investment will have grown to R146 716 by the time the child reaches 18.

If the child decides not to withdraw any money and lets the investment grow until age 65 without investing more, the TFI will have grown to a substantial R12 940 021*. This can provide the child with a significant financial cushion in their later years.

In financial planning, tax-free investments are ideally suited for long-term objectives such as retirement planning and fostering financial independence for future generations. By optimally utilising TFIs like this, we can help people make better decisions to optimise the benefits of tax-free growth and compounding.

Each client’s situation is unique, which makes the decision about whether to make a tax-free investment part of a financial plan a very personal decision. By offering tailored guidance and focusing on long-term strategies, tax-free investments can become a powerful instrument for wealth accumulation. If clients have the discipline to invest tax-free and stay invested, they will reap the benefits. With growth assets and time on their side, they will experience money magic and secure their financial futures on their journey to success.

Introduced in 2015, natural persons can invest in approved investment products, tax-free. These investments are subject to a lifetime investment limit of R500 000, and a yearly limit of R36 000 (2020: R33 000). The growth and the proceeds from a tax-free investment are fully exempt from South African tax, with no capital gains tax and no tax on dividends and interest. Investments of more than the yearly and lifetime limits are taxed at 40%.

Source: SARS, 1 March 2015 and 1 March 2020

*Source: Momentum Wealth, January 2024. The example merely aims to show the potential benefit of a long-term view. The effect of the cost of investing and the time value of money have not been taken into account.

Speak to your Momentum consultant or visit momentum.co.za to learn more about the Flexible Tax-free Option from Momentum Wealth.

Momentum Wealth (Pty) Ltd (FSP 657) is an authorised financial services provider and part of Momentum Metropolitan Life Limited, an authorised financial services (FSP6406) and registered credit (NCRCP173) provider.

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