Asset allocation crucial in your tax-free savings accounts
With tax season around the corner, it's a great time to dot your i's and cross your t's, making sure that you have contributed the maximum possible to your tax-free savings account (TFSA).
However, I have found that many investors focus on the amount they are contributing without giving much thought to the asset allocation within the funds.
Using a TFSA to make the most of the tax breaks is just the first step. Once you have an investment in place, you must make sure that it is performing optimally to achieve your long-term savings goals, the key to which lies in your asset allocation strategy.
The asset allocation within your TFSA should ideally be tailored in line with your investment goal, your risk profile as an investor and your time in the market.
Let's look at some of the appropriate asset allocations for various goals:
Optimising for retirement
One of the drawbacks of contributing towards retirement funds such as retirement annuities (RAs) and pension funds is that they need to be compliant with regulation 28 of the Pension Funds Act, which restricts the asset allocation you can make to offshore equities to 30%.
Relatively speaking, SA is a small emerging market.
Using a TFSA as part of your retirement savings strategy means you can increase your exposure to offshore and equity investments, since a TFSA does not have to comply with regulation 28.
A learning curve
As a parent, you can open tax-free savings accounts for your children.
This means a family of four can save up to R132,000 a year in tax-free savings accounts, making them an ideal savings vehicle for education. It can be a long-term goal of 15 to 20 years, depending on the age of your child.
A balanced asset allocation can help minimise risk and promote growth within your portfolio. For example, you can use a higher allocation to equities and listed property at the beginning of your investment term and gradually move into less risky assets or more conservative allocations, such as cash and fixed income towards the end of the investment term.
Maximise your cash allocation
You can choose to have a 100% cash asset allocation within your TFSA.
If you are an older investor and you prefer to have a significant amount of cash, for example, for medical costs and emergencies, you may find that you end up paying punitive taxes on the interest income you earn.
The interest exemption in SA has not increased since 2014.
Using a 100% cash allocation in a TFSA is a great way to counteract this and reduce the tax you pay on interest earned.
Do remember that it's essential to select cash instruments from reputable institutions, which have consistently outperformed inflation in the long term.
Benefits of tax-free savings
The main benefit of using TFSAs is that there is no tax on the growth within the fund, which essentially accelerates the growth. There are also no taxes on the withdrawal amounts.
You can contribute R33,000 per year to a TFSA, with a lifetime limit of R500,000.
It is important to note that TFSAs are not restricted to bank accounts as their name implies, but include savings vehicles such as exchange-traded funds and unit trusts.
You can open a tax-free savings account with various financial service providers, including banks, life assurers such as Old Mutual and asset managers such as Allan Gray.
A TFSA gives you all the benefits of significant tax savings while also offering you a flexible investment that can be adjusted according to your investment timeline.
However, it is vital that you ensure the allocations within your TFSA are appropriate to maximise your lifetime tax benefit and to achieve your savings goals.
Remember, your savings goals, your profile and your timelines are unique to you, so the asset allocation within your portfolio should also be tailored to your needs.
If you need help optimising the asset allocation in your TFSA, speak to an adviser - ideally one who holds the certified financial planner (CFP®) qualification.
Swart is a director of Autus Private Clients and Financial Planner of the Year 2019
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