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Thursday 7 May 2020

Could You Retire Comfortably Using Just A TFSA?

TFSA - the coolest account by far? 
In a pretty unexpected move back in February, Government decided to up the annual contribution limits on Tax Free Savings Accounts (TFSAs) from R33,000 a year (R2750/month if you want to invest monthly) to R36,000 a year (or R3000/month if you want to do it monthly). 

People celebrated everywhere because now it meant that you had a nice round number as a monthly amount :-P. 

But more importantly it meant you could get your money in faster before you hit the lifetime limit which remains at R500k (it previously would have taken you a little over 15 years to hit the limit, it will now take you less than 14).

Just a super quick recap on TFSAs – they are AWESOME because everything inside a TFSA remains tax free – that means you won’t owe SARS any tax on Capital Gains, Dividends or interest you accumulate inside your TFSA. (More details on TFSAs in this post – just scroll down to the TFSA section)

What Your TFSA Could Be Worth

I first tackled this question back in this blog post in 2018, but now with the new contribution limits announced in Feb this year it needs another look.

So, if you were able to cut out some expenses and free up R3,000 a month (that will allow you to hit the TFSA annual contribution limit of R36,000), what kind of future investment value could you looking at? (Now before I get slaughtered, I know that R3,000 a month is a LOT of money for many people. But please don't let this article discourage you, because the principles remain the same, and will apply to smaller monthly investments as well.)

Okay, first, a few assumptions…

Right, very important - TFSAs should not be used as a normal savings account. They really start showing their value when they are used as a long term investment account. (I really wish they would change the name from Tax Free Savings Account to Tax Free Investment Account, but anyways…) And by long term I am talking more than a decade, so a generous helping of equities (and maybe a little sprinkling of listed property) is going to give you the best shot of the best returns.

So based on some scratching around I did, historically it has been possible to squeeze out equity returns of 15% over the very long term. So I am going to run with that for now. Many people feel that 15% might be too high based on other figures they have seen, but keep in mind the stock market returns quoted often exclude dividends and their reinvestment. And yes, even with dividends reinvested, there are many which feel I am being way too optimistic (and maybe I am) - so I will also run the numbers using lower return figures later on. But let’s go with 15% p.a. for now.

Okay the next assumption is that you keep making an uninterrupted contribution of R3000/month. This means that after 13 years and 11 months you add your final money to your TFSA and hit your lifetime limit. 

The investment balance?
R 1,551,877.88


Important to keep in mind thought, is that this ~R1.5 Million is what we call “future money” and while it is very much R1.5 Million, what it can buy in ~14 years time will not be the same as what R1.5 Million buys you today (damn you inflation!)

So adjusting the investment value for inflation (historically around 6%) I calculated you will have around R690k in today's money. Tax free!

Could You Retire Comfortably Using Just A TFSA?

Now I think we can all agree that no one is retiring on R690k. But something to remember, is that the above calculation is for the case where you contributed until you reached the lifetime limit and then stopped and attempted retirement.

However, for those of you who still have time (i.e. more than the almost 14 years it takes you to reach the lifetime limit) you find yourself in a pretty awesome position. Because even though you would be unable to make any additional contributions, you can continue to let the investment run and by doing so, the compounding machine will continue doing what it does best – multiply your money like bunnies.

For example, let’s consider a 21 year old at the very start of their working career. They happen to stumble upon a blog post encouraging them to open a TFSA and start investing immediately (I have no idea where they would find such a blog post…) and so that’s what they do. Now I can fully appreciate that there are very (very) few 21 year olds who would be able to come up with R3,000 a month, but for the sake of this example, let’s assume that this 21 year old could.

This person would hit their lifetime limit just before their 35th Birthday. Since they are no longer allowed to contribute anything further, they stop adding money and just leave the investment to carry on compounding until they are 55 years old.

Their investment balance at age 55?

R3.54 Million! (And that’s inflation adjusted, and Tax free!)

Using the 4% Rule this investment balance would allow for an income of R11,800/month.

While that would leave them better off than the huge majority of South Africans at age 55, it is maybe still not enough for a comfortable retirement (even for a single person). So let's take this one step further and assume that this person found their soul mate - immediately obvious by the fact that they too had started contributing to their TFSA the month they started working. (What a great first date question btw :-P)

So now If we combine their TFSA values at age 55 – the investment balance is R7.08 Million.

And, using the 4%Rule again, this would give them a combined monthly income of R23,600 (inflation adjusted) until the day they die. And I think you would have a difficult time arguing that that is not enough for (a modest) retirement (especially if you factor in a likely scenario of having a paid off house by then). And when you consider the pretty awful retirement stats in South Africa, I think most 55 year old couples would take R23,600 a month with open arms!

Okay, and what would happen if this couple decided to delay their retirement by another 5 years (taking them to age 60)?

In other words this is what they each did:
  1. Age 21-35: Contributed R3000/month to a TFSA 
  2. Married someone doing the same 
  3. Age 35-60: No more investing, blew all their cash on cars, houses & travelling 
  4. Age 60: Retire

They would then have a combined investment balance of more than R10.6 Million (in today’s money). That would be enough for a tax free, inflation matching income of R35,333 a month. I think that would make for a pretty sweet retirement!

And isn’t that amazing - despite only investing for a little under 14 years over a career of more than 40 years, a couple maxing out their TFSA’s from an early age, and without any contributions to anything else (RA’s, company pension plans, discretionary investments etc.) would have enough to get by in retirement.

So can you retire using just a TFSA? Well, it's definitely possible.

And imagine the type of retirement (or even the possibility of an early retirement) if they added just a little something extra into some other investments? (For example, once they hit the TFSA lifetime limit if they redirected that R3000/month TFSA contribution somewhere else for a few years).

It's Never Too Late To Start

Okay, and what about us old farts (remember, to a 21 year old, anyone above 21 is considered very old). Have we missed the boat?

Definitely not!

There are still some solid (and remember totally tax free) gains to be made by investing in TFSA.

The table below (click for a larger image) shows the investment balance for a TFSA according to how long you are able to invest R3000/month (up until you hit the lifetime limit if you get there) and the return you get (for those who feel that my 15% assumption is way too high). These values are all inflation adjusted using an inflation rate of 6%. (Again, I can fully appreciate that not everyone is able to come up with R3000/month, but you can still use this table to figure out what your outcome could be - for example if you can only do R1,000 a month, then divide the number in the table by 3. Just remember though, that by contributing less you would not hit the lifetime limit and you could continue contributing past 14 years and achieve an even better outcome).

But most importantly, regardless of the amount you have:
  • Start today
  • Invest consistently
  • Be patient while compounding does it's thing

Till next time, Stay Stealthy!
 - ~ - ~

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