In an effort to improve household savings which have declined over the last fifty years from over 6% to a negative 0.05%, National Treasury has made proposals which will allow investors to invest in a range of investment products tax-free.

These products will include access to equity and property unit trusts and although the savings will be made with after-tax income, all interest and capital gains in these investments will be tax-free. Individuals will be allowed to invest up to a maximum of R500 000 in these funds.

In addition to the tax benefits provided by retirement vehicles, National Treasury hopes that the use of further tax incentives will encourage South Africans to save for shorter and medium term goals to bolster household financial stability and lower the dependency on credit.

“An increase in household saving aimed at managing shocks to income and expenditure and promoting household welfare should also work to reduce reliance on credit for consumption purposes, further strengthening the resilience of households over time,” says National Treasury in its discussion document, Incentivising non-retirement savings.

This paper forms part of a series of discussion documents aimed at improving household savings and retirement funding and suggests that the decline in our savings rate may be a result of the easy access to credit. Today there is less incentive for people to save towards a goal as credit allows them to have what they want today and to pay later, even though at a much greater cost.

“The high levels of indebtedness increase the vulnerability of households to income and credit shocks, debt traps and the emergence of exploitative lending practices” says National Treasury who adds that research shows that most people tend to be myopic and present-biased. People place a very large premium on current consumption and will, in most instances, not save enough for the future.

National Treasury hopes that “tax incentives will, in the long term, facilitate a positive savings culture, laying the foundation for increased household and national savings”.

Currently individuals who save into interest bearing accounts receive a tax exemption on the first R22 800 of interest earned.

National Treasury argues that the current tax free interest income thresholds are not effective in increasing savings as these tax free interest income thresholds are not visible enough and do not allow for the marketing of a product as being tax effective. It also does not provide tax incentives to save into growth assets such as equities.

In light of the estimated cost of approximately R3 billion estimated for the 2008/09 fiscal year National Treasury says it is even possible that the current tax free interest income thresholds have had a negative impact on national savings on a net basis through increased government dissaving.

Based on current interest rates an individual does not pay interest income tax on lump sums up to around R500 000.  Although the proposed changes would not necessarily further benefit these investors at current interest rates, should interest rates increase their additional interest earned would remain exempt from tax and they would be able to move their funds to equity type investments and enjoy the same tax benefits.

Pensioners currently enjoy a higher tax-free threshold of R33 000 and at current interest rates can invest over R600 000 before paying tax on interest earned. This new proposal could negatively impact their current tax benefits; however National Treasury says the interest income tax exemption thresholds will be phased out during the transition period. “Such phasing will take account of the needs of pensioners who are currently dependent on interest income, and will only be implemented after the consultation process has been completed”.

The paper does not directly address how government will promote savings among lower income workers where tax benefits are not an incentive. The paper does however suggest that it will look at products similar to the current Fundisa unit trust initiative which is specifically designed for tertiary education.

In the Fundisa product government contributes to investors’ savings by paying an annual 25% bonus to investors to a maximum of R600 per year. Despite Fundisa providing an excellent savings vehicle with an effective guaranteed return of over 30%, it has not been widely taken up by the market mostly as few potential investors are aware of the product which is not actively sold by financial advisors due to the low commission structure. Its limitation to education savings only could also be responsible for the low take up and National Treasury has stated that its policy for any savings initiative will be to allow individuals to save into any approved savings vehicle without restriction on what the funds must be used for.

How it will work

Individuals will be able to save up to R30 000 a year with a lifetime limit of R500 000 per individual. These limits will be adjusted over time to take account of inflation. The cap on the amount invested is to limit the tax benefits for high income earners who may shift a large portion of their savings into these vehicles thereby reducing the taxes government receives from their current investments.

National Treasury says it will take consideration of the current age of investors and allow older individuals to accelerate their annual savings during a transition period. For example taxpayers aged 45 to 49 could invest up to one quarter of their lifetime limit, 50 to 59 years to invest up to half of their lifetime limit and for those aged 60 years and older to invest the maximum of their lifetime limit during the transition period.

An investor will also be able to withdraw savings at any time but will not be able to “top up” these withdrawals. In other words withdrawn funds cannot be replaced. This will discourage “casual withdrawals driven by problems of self-control”.

Investors will be encouraged to maximize their annual savings allowance and will not be able to roll over the unused portion of the allowance at the end of the tax year which will ensure individuals commit to a regular savings plan.

The proposed tax-favoured accounts will be available for saving towards any purpose and will provide both a low risk interest bearing account and an equity account which would include collective investment schemes (unit trusts).

An investor will be able to invest in both types of accounts and will be able to move between service providers in order to support a competitive environment.

The savings vehicles will have to be registered with the South African Revenue Service and National Treasury aims to ensure that the financial industry offers these products at reasonable costs and that appropriate information on charges, access, risks and returns is provided. A set of criteria will be formulated and service providers will be able to market their products as compliant with these officially-endorsed standards.