The psychology of tax free savings

Why are tax free savings accounts so popular? The answer seems obvious. South Africans are feeling squeezed by our tax burden and tax free accounts offer welcome relief.  But there’s more to the story. South Africans are notoriously poor savers, which meant that government had to get creative in order to create a culture of saving. Inspired by the science of financial decision-making, the planning team at National Treasury devised a policy of subtle psychological cues to motivate us to become better at saving.

It all started in 2013 when Trevor Manuel, at the time Minister in The Presidency, announced an ambitious long-term programme for inclusive growth in South Africa. The National Development Plan 2030 set out to end poverty and reduce inequality by 2030.

The plan emphasised evidence-based monitoring and policy coordination across departments, with National Treasury taking a lead role in policy development. In line with the plan’s recognition that “sustainable growth and development will require higher savings, investment and export growth”, Treasury set out to devise new policy acknowledging that saving is a fundamental pillar of sustainable economic growth and that the rate of saving in South Africa is much too low.

Treasury’s challenge was now to motivate South Africans to save more. In a country with a robust culture of saving, the solution is straightforward: simply increase the financial incentives for saving. However, South Africans are resistant to saving and frequently make financial planning decisions that go against our best financial interests. To understand why, Treasury planners took a close look at behavioural economics, the study of the psychological factors guiding economic choices.

Policymakers identified two all-too-human traits that affect people’s savings decisions: procrastination and self-control.

Most of us recognise the need to start saving more effectively, but we keep putting off crucial savings decisions. One striking study found that employees were much more likely to invest in a pension fund when they were automatically enrolled in the fund, compared to when they were required to opt into the same fund, even though the economic incentives were identical in each case.

And when we do start to save, we are often tempted to make impulse purchases that eat into our savings.

Treasury set to work designing a savings incentive informed by these psychological insights. An effective incentive would have to motivate people not to waste time before starting their investment and to encourage South Africans to make ongoing contributions to their savings.

Evidence also suggests that potential savers are put off by overly complex financial products, so the new policy would have to make provision for simple to understand products with clear-cut benefits.

Putting these insights together produced an elegant solution. A savings vehicle with a compelling and straightforward benefit: any returns earned from a tax free account are exempt from tax. But there’s a twist: in order to overcome savings inertia, a strict limit is placed on the annual contribution. Currently that amount is fixed at R33 000. If you miss your annual deadline, you miss out on tax free returns for that year.

There is also a lifetime tax free contribution limit (currently R500 000). However, there is no cap on the returns you are entitled to earn from your investment.

What’s the practical takeaway from from a personal finance perspective? Invest in a tax free savings account as soon and possible and contribute as consistently as possible. Finding the optimum tax free savings account will depend on your particular savings requirements. But whatever tax free investment you choose, the time to start saving is now.