There are 2 advantages to creating a balanced investment portfolio with different short-, medium- and long-term investments: it balances different levels of risk across different types of investment, but also allows you to commit specific investments to specific goals. You may already have tax-free investments (TFIs) as part of your own retirement portfolio but if you also want to invest for your children, you can open a TFI account for them, too.

Starting a TFI account for your child the moment they’re born could turn out to be one of the best gifts you ever get them, ensuring that they don’t have to worry about their own retirement. Returns on their funds would accumulate steadily over the years, with compound interest causing the monthly return to increase constantly, without attracting any tax. The longer the funds stay invested, the greater the return, which is what makes a TFI such an effective tool for retirement planning.

How a TFI can allow your children to retire as multimillionaires

If you can afford to save R3,000 a month in your child’s TFI and you start the month they’re born, you’ll be investing R36,000 a year – the maximum allowed. Continue investing monthly, and the amount will reach the R500,000 lifetime limit before your child’s 14th birthday, at which point your monthly contributions stop.

By the time they turn 18, the investment will already be worth considerably more. If your child doesn’t touch that money until they turn 65, the balance will have grown to a whopping R26 million. For most, this will be enough to fund their retirement. For others, it will go a long way towards subsidising their income needs at retirement. It is important to educate your child on the benefits of staying invested over a long period, as their lifetime limit would have been used by the time they become adults.

How a TFI works

Tax-free investments were introduced in 2015 to encourage a culture of saving among South Africans. They are well suited towards saving for retirement or other long-term goals. Currently, every South African is allowed to save up to R36,000 a year tax-free, and up to R500,000 over their lifetime.

If you open a TFI for your child early in their life and the account reaches the R500,000 limit before they turn 18, they will not be able to open further TFIs in their name. They shouldn’t need to, though – their existing TFI will already be at the limit, and they need only to stay invested to benefit from the returns. 

It is also possible to transfer an existing TFI from one institution to another, or to have different TFIs with different financial institutions – provided you don’t exceed the yearly and lifetime limits. If you do break those limits, you’ll pay a tax penalty that’s currently set at 40% of any amount invested above the maximum

A TFI is attractive because investors can access funds at any time without paying tax or incurring any penalties. Your child could withdraw a portion of their funds even before they reach 65, to start a business, put down a deposit on a house or even retire earlier.

But it’s advisable to stay invested for as long as possible for 2 reasons: first, you’ll maximise the (tax-free) return on the investment, and second, you cannot replace a TFI contribution after withdrawing funds, as all contributions count towards your contribution limits.

In other words, if you have invested the lifetime maximum of R500,000, and you withdraw R100,000, you can’t ‘replace’ it later, because that means you’ll have paid R600,000 into the TFI in total, leaving you liable for the tax penalty on the R100 000 ‘replacement’ contribution.

How to set up a TFI

It’s advisable to talk to a financial planner who can help you choose the appropriate underlying unit trust funds in which to make a TFI. You can learn about the TFIs we offer at Nedgroup Investments or on the Nedbank Money app.

The earlier you start investing for your children, the longer those contributions will have to grow tax-free, and the higher their eventual return will be when they cash out that investment.