TFSA vs RA

I know, you've heard it all before — you need to save for retirement, pay yourself first, and look after your future so you don't have to leech off your kids in your old age. And it's true. One day you won't be able to earn an income, and you'll have to have an investment big enough to pay the bills and hopefully leave you with a little extra.

Everybody knows the theory, and many have every intention of putting it into practice, then — bam! The industry hits you with some abbreviations: 'To start investing for your retirement, consider an RA and/or a TFSA because there are some really great tax benefits.' Those who make it past finding out that RA stands for 'retirement annuity' and TFSA stands for 'tax-free savings account' are hit with something even worse — having to choose. And this is where many potential investors end up freezing and doing nothing. But the great news is that there's no right or wrong choice here. It's a choice between great and awesome.

How an RA works: An RA is basically an investment account that holds some investments. You can put unit trusts, exchange-traded funds (ETFs) or even cash in your RA, and they will be protected from tax while they are inside the RA. The money you allocate to an RA can be deducted from your annual income before you pay tax — contributions to an RA are 'tax deductible'. SARS caps the amount of RA contributions you're allowed to deduct from your income. The maximum you may deduct is 27.5% of your annual income or R350 000, whichever is lower.

Tax on RA investments: A really great feature of RAs is that you don't pay any tax on the investments inside. This means no tax on interest earned, dividends or income and no capital gains tax on sales. That's a lot of 'no tax', which means your investments work harder for you because you keep more of your returns. There are some rules around what you can and can't put inside an RA — no more than 30% of your investments can be outside of South Africa (with an additional 10% into Africa, making the offshore maximum 40%). You're also not allowed to have more than 75% in equities or 25% in listed property.

When can you access your RA? RAs were specifically designed to help people save for retirement. You cannot access the money inside an RA until you're 55. But this might actually be a good thing — no access before 55 forces you to be disciplined and to stay invested until you're retired. Once you reach age 55, you're only allowed to take a maximum of one third of the value as cash (unless the total value of the RA is less than R247 500, in which case you can take it all out as cash). The remaining two-thirds must be used to buy either a living or a guaranteed annuity.

How does a TFSA work? A tax-free savings account is also an investment account that holds some investments. You can put unit trusts, ETFs or even cash inside a TFSA, and these investments will be protected from tax while inside the TFSA. The money you put into a TFSA cannot be deducted from your income for tax purposes — the money you invest will be after-tax money. As it stands, you aren't allowed to contribute more than R33 000 in a tax year to a TFSA (or R2 750 a month). There's also a lifetime limit of R500 000. If you invest more than the annual limit, you'll be taxed at 40% of the amount by which you exceeded the limit.

When can you access your TFSA? The hinges of the door to your TFSA money are pretty loose — you can take money out at any time. This is great for those pursuing early retirement because it means you can access your money at whatever age you need it. Note: any money taken out of a TFSA cannot be 'replaced' without affecting your limits. Unlike an RA, there are no restrictions about how much you can take out as cash, or what you have to use that cash for. There's no tax payable when accessing the money inside a TFSA.

So, which way to go? They're both excellent ways to save for retirement and the tax breaks are awesome. A few game-changers may make one better suited for your goals: If you plan to retire early, you may prefer a TFSA since you won't be allowed to access any money in an RA until you're 55. If you have a work pension fund, you may already have an RA-type product through your employer and may want to consider a TFSA to diversify your tax treatment. If you're a high income earner in one of the higher tax brackets, the tax deductions on RA contributions can really super-charge your investments. The combo option: there's nothing wrong with doing a combination of an RA and a TFSA. Because RA contributions are tax-deductible, you get a tax refund after you submit your tax return — take this refund and plug it straight into your TFSA, and let SARS fund your TFSA for you.