Tax-free savings account or retirement annuity?

Photo credit: Leah Kelly

By Lizelle Steyn

Updated 6 February 2023

We’re in the last month of this tax year, which runs from 1 March 2022 to 28 February 2023. In the financial media we're bombarded with appeals to invest in one of the two most popular ‘tax wrappers’ - either a tax-free savings account (TFSA) or a retirement annuity (RA) - before end of February.

You definitely want a tax wrapper

A ‘tax wrapper’ wraps your ETF or unit trust in a legal entity that protects it against the tax that you would normally have paid without this wrapper. Tax wrappers are a great way to pay less tax and I’ve written before on how they work in a post covering how all the different investment terms like tax-free account, retirement annuity, ETF and unit trust fit together. Before you invest, just first make sure you’ve already settled your debt and you have an emergency fund in place (a TFSA is for the long term/retirement/early retirement, so please don’t use it as your emergency fund.) More on setting up an emergency fund before you start investing in this 9-step plan to financial freedom.

Tax-free savings account or retirement annuity?

This might end up being my shortest blog post yet. Short answer: Tax-free savings account.

A TFSA has no disadvantages, except that you're allowed to invest only R36 000 in the current tax year before the 40% tax penalty kicks in. More about TFSAs in a previous blog post on how to choose the best tax-free account.

When is a retirement annuity necessary alongside a tax-free account?

• When you have more than the current annual TFSA limit of R36 000 to invest, let the rest spill over into a retirement annuity.
• When you are investing on behalf of a child and don’t want them to be able to touch the money before age 55 (youngest legal age for accessing your retirement annuity)
• When you yourself can be impulsive at times and you want to make sure you can’t touch your own investment before you turn 55
• When you run a business that you want to protect against creditors (a retirement annuity can only be touched by SARS or your ex-spouse when you owe them money)
• When you want to avoid your heirs paying estate duty (applicable to TFSA but not to an RA)

RA and TFSA comparison

If you want to dig into more detail, have a look at this RA and TFSA comparison.

I see Stealthy Wealth also has a good TFSA vs RA comparison, which I can recommend.

Invest in a TFSA and/or RA now, worry about the fund choice later

After you’ve chosen a TFSA and/or an RA as your product or tax wrapper, you would need to choose at least one fund to invest in. If you’re a first-time investor, you might feel overwhelmed by the variety of investment funds - ETFs and unit trusts – out there. There are also so many investment terms and different types of investment business. I’ve written a post to specifically help you navigate the path which your money will follow when you invest with the financial industry.

If you’re battling to choose a fund – ETF or unit trust – for your tax-free account or retirement annuity, don’t let that be the reason that you postpone your investment. You can never get a tax year back. If you don’t use this year’s R36 000 tax-free allowance, you can’t carry it over to next tax year. It’s lost forever. Choose the best TFSA before the end of February and simply put your entire contribution in the money market fund if you choose a unit trust provider, or leave it in your cash wallet if you choose an ETF provider. That's your temporary parking bay. And then take your time to do your fund research and switch into a diversified exchange traded fund (ETF) or unit trust fund with the type of asset allocation and risk that is right for you. Switching out of a money market fund into another fund within the same product or moving money from your TFSA cash wallet with Easy Equities or SatrixNow to an ETF has no tax implication or penalty with any of the TFSA providers in my blog post on the best TFSA in SA. Just start – it’s the most important step in investing.