Retirement annuities vs tax-free savings accounts: which is the wisest investment ?

Torn between investing in a retirement annuity (RA) and a tax-free savings account (TFSA)? This makes sense as both products attract generous tax treatments from the government. 

In the case of an RA, an investor’s gross contribution can be deducted from their taxable income when a tax return is completed — this is usually done in July, so don’t forget. An amount equal to 27.5% of taxable income with a maximum of R350,000 a year can be deducted.

“An RA enables individuals to save for retirement in a tax-efficient manner,” says Kelin Pottier, product development specialist at 10X Investments. “Investments held in a RA are exempt from dividends withholding tax, income tax and capital gains tax.” 

Typically share dividends are taxed at 20% whereas interest is taxed at your marginal tax rate after deducting the allowed exclusion.

On the other hand, the contributions made to a TFSA can’t be deducted from your taxable income. A taxpayer is allowed to invest R36,000 a year with a lifetime limit of R500,000 into TFSAs.

“A TFSA allows an individual to invest and grow their money tax-free,” says Pottier. “Investments held in a TFSA are exempt from dividends withholding tax, income tax and capital gains tax.”

In addition to the tax deductibility of contributions and their annual caps, the government places restrictions on the allocation (which assets you can buy) of RAs. With TFSAs, though, there are no caps as to where you can invest — even offshore if that’s your thing.

In this regard, Pottier makes an interesting sum. “If you invested R36,000 a year in a TFSA from age 25, earning a 5% net real return (after inflation and fees), up to the lifetime limit, you would have about R2.6m, tax-free, at age 65 (in today’s money terms). This would afford you a sustainable monthly tax-free retirement income of around R10,400. If you need more, your TFSA alone won’t cut it. You will need to supplement your retirement savings in other ways.”

In the end, Pottier says it boils down to what an investor’s goals are. “If the investment goal is to provide for retirement, an RA is the most suitable and has most tax advantages. If the investment goal is simply to grow your wealth tax-free and retain access to your money, a TFSA is best.”

However, he adds, it doesn't have to be a coin toss between the two. “If you're lucky enough to have sufficient cash to contribute to a RA and a TFSA, then why not choose both?”

Setting and achieving any investment goal should preferably be done in consultation with a reputable professional and registered financial service provider such as 10X Investments.

RA vs TSFA at a glance

The table below highlights how a RA and TFSA differ with respect to access to funds, investment allocation limits and withdrawals.

This article was paid for by 10X Investments.

^{The content herein is provided as general information. It is not intended as nor does it constitute financial, tax, legal, investment or other advice. 10X Investments is an authorised FSP (number 28250). 10X Index Fund Managers (RF) (Pty) Ltd is a Manager registered under the Collective Investment Schemes Control Act, 2002.}