Tax-free accounts are almost ten years old and I want to look into the actual impact of paying no tax on a long-term investment.
My favourite is if you deposit R36,000 (the current annual limit) into a tax-free account on the day a child is born it will generate +R117,000 in today’s money when they retire at age 65. This assumes a 7% growth after inflation (so this is in today’s spending power) and using the 4% rule of retirement.
R36k deposited into a tex-free account at birth. Age 65 +R117k a year
While R117,000 per year (even in today’s money) is not living the high life, all you did is make a single R36,000 investment. If you added another R36,000 every year until you reach the lifetime limit of R500,000, that number would be a lot higher and make a fundamental difference to their adult life. It would remove the pressure of saving for them.
Here are some more numbers using the following assumptions:
- 7% real growth (so after inflation resulting in the final values being in today’s money)
- 40 years of investing
- Maxing out your tax-free as quickly as possible (about 15 years)
Forty years of tax-free
The tax-free account grows to some ±R5m (today’s spending power).
Using the 4% rule, the tax-free account you’ll be able to draw ±R200k a year and when you die you’ll leave a giant pile of money to your kids (or partner). You could draw faster and leave nothing :).
Your mileage may vary depending on age or returns. The spreadsheet is here so you can fiddle to your heart’s content to find out what your own situation would be.
The reality remains, tax-free accounts have serious benefits and we need to be taking advantage of them as much as we can every year.
Wealthy Maths blog
Many of us avoid making financial decisions because we worry that we can’t do the maths. Luckily, there are only a few formulas you need to understand to make a good financial choices. This series of articles is dedicated to helping you understand how to do the calculations for yourself. Once you grasp these simple formulas, you can make better financial choices on the fly.
