By Caroline Naylor-Renn
“I don’t want my kids to go through the same struggles as I did.” That’s the mantra most parents have for their children. They may also be aware that their children will face financial challenges that they never did. Many jobs, for example, require significantly higher levels of educational attainment than was the case 20 or 30 years ago. Those parents may also know that it will take their children longer to save up for a deposit on their first home, leaving them living at home or renting for longer.
Knowing this, many parents try to give their children as big a financial leg up as possible when they start adulthood. That may mean paying for university, buying their child’s first car, or even helping with a deposit on a home. And unless a parent is in an extremely fortunate position themselves, they’ll need to save and invest to have any hope of providing them with those things.
You could use education investment policies; however, many parents have opened their child’s education policy when they reach 18 only to find that it’s barely enough to cover their first year of studies, never mind a full degree and postgraduate studies.
As such, parents should take advantage of the full range of savings and investment tools available to them when it comes to securing their children’s futures. One of the most powerful, and potentially underutilised, of these tools is the tax-free savings account (TFSA).
Maximising savings
For those who may not be familiar with TFSAs, they were first introduced to South Africa in 2015. The idea behind these accounts is to try and encourage a culture of saving among South Africans, something which has been a major issue in the country for several years now. In fact, the household saving rate in South Africa currently sits at -1.10%. That means that the vast majority of households are spending more money than their current income allows for.
With TFSAs, contributions are not tax-deductible, but any interest, dividends, or capital gains earned within the account are tax-free. TFSA contributions are subject to annual limits set by the South African Revenue Service (SARS). At present, those limits are around R36 000 annually and R500 000 over your lifetime.
Both the growth and income you receive on your investment are tax-free. The value of the fund can, however, grow indefinitely. That means you can enjoy all of the upsides of growth without having to worry about any tax pitfalls. In other words, any gains made on the money you’re putting towards your child’s education or first property goes towards those things and only those things.
Timing matters
That sounds great, right? And in many ways, it is. There are, however, a few factors you should consider before opening up a TFSA for your child. Key among those considerations is timing.
Remember, children generally have very few tax liabilities. So, if you had another better-performing investment vehicle in their name, they generally wouldn’t be liable for the capital gains and income tax anyway. On the other hand, if you open a TFSA when they’re one or two and start withdrawing when they’re 18 or 19, they could easily end up exhausting their child’s lifetime tax-free allowance.
A better option may be to start using a TFSA later so that your child accrues most of the tax benefits early on in their career when they’re earning the least. This is also a time when saving can be challenging, meaning that it may have a bigger impact. And if they reach the threshold of the tax-free allowance by the time they’re in their late 20s, they may be in a better position to use it for something truly meaningful, like a deposit on a home.
One tool among many
Ultimately, parents need to remember that TFSAs are just one among the many tools available to them when it comes to investing in their children’s future. And part of getting the most out of those tools means knowing when they’re most effective. It is important to diversify investments for your child’s future. A TFSA can be an incredibly powerful tool but it’s most powerful and most effective when used at the right time.
* Naylor-Renn is a COO at 10X Investments.
PERSONAL FINANCE