My favourite is if you deposit R33,000 (the current annual limit) into a tax-free account on the day a child is born it will generate R100,000 in today’s money when they retire at age 65. This assumes a 7% growth after inflation and using the 4% rule of retirement.
While R100,000 per year (even in today’s money) is not living the high life, all you did is make a single R33,000 investment. If you added another R33,000 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:
- 2.5% annual dividend
- 6% 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)
The tax-free account grows to some R7.7m (today’s spending power) while the taxed account grows to R6.6m.
The mind-blowing detail is that the difference of R1.1m is only because of a 20% dividend withholding tax which on a 2.5% dividend yield is a very modest 0.5%. Staggering.
Using the 4% rule, the tax-free account which has no capital gains tax (CGT) would pay out R310,000 a year, whereas the taxed account (which starts lower at R6.6m) pays R217,000 per year after CGT (assuming top tax bracket). That’s a difference of almost R100,000 per year.
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, the 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.