How to invest safely (and smartly) for your child’s future

Wondering what strategy is best for safely investing in your child’s future? Wonder no more:
Wessel Brand, Portfolio Manager at Sygnia Asset Management, has crunched the numbers and has the answer.

Parenting is tough. In between the day-to-day commitments, you make important long-term
decisions that will have a major impact on your child’s future. From what school your child should attend and what extra-murals to sign up for to how much screen time should be allowed, the pressure to make the right choice is relentless.

I understand this, which is partly what motivated me to spend a good portion of my December holidays doing an exercise aimed at helping parents make one of the most important decisions of all: determining the best investment strategy and the best investment vehicle to secure your child’s future.

Because while I can’t help parents decide whether to go private or Model C or whether to allow TikTok access or not, as a “numbers guy” with a solid background in tax I can
give parents the information they need to make a sound investment choice for their kids’ future. Here’s what I did and what I found out…

The exercise

I wanted to see how a tax-free savings strategy performed in comparison with two other common non-tax-free savings strategies.

I applied the same amount of money that can be invested tax-free for any South African citizen from birth onwards (R36 000 per annum up to the maximum of R500 000 per lifetime) over the same period (30 years) to the same baseline assumptions* for three different investor strategies. I categorised these as Investor A, Investor B and Investor C, and I found wildly varying results.

Investor A: TFSA all the way

Investor A is a parent investing their child’s full annual tax-free allocation of R36 000 into
a tax-free savings account (TFSA). On this basis, the lifetime contribution limit of R500 000 will be met by year 14 of this long-term investment.

Investor A can place the full investment in a TFSA in their child’s name and will never pay
taxes on profits realised when switching between underlying investments in the TFSA. The investment will also never lose out to dividend withholding tax, which is 20% on all dividends received from underlying investments.

Investor B: Playing the market long term

Investor B is a parent who also wants to invest long term for their child, but they choose to
switch the underlying investments once every five years to take advantage of market opportunities.

While some gains may be made, Investor B will have to pay capital gains tax on their realised gains. Investor B will also be liable for dividend withholding tax (20% on all dividends received).

Investor C: Playing the market short term

Investor C is a parent who chooses to invest short term for their child, trying to time the
market and gain high growth from market trends. As a result, this investor switches the allocation of their child’s underlying investments at least once a year.

Again, Investor C’s child must submit all realised gains to the South African Revenue Service (SARS) annually with their income for personal income tax. For my calculation purposes I used the lowest tax bracket for a natural person (18%), which becomes effective once a natural person has annual taxable income over R87 300. To be 100% accurate, I included the primary tax rebate for natural persons (R15 714 for the 2022 financial year).

The results

According to the baseline assumptions used for my calculations,* after 30 years Investor A has an investment growth 22.5% more than Investor B and 41.9% more than Investor C.

For parents investing long term for their kids, it’s a no-brainer: a TFSA delivers the best
growth, with none of the tax deductions associated with investing in non-TFSA funds.

The beauty of paying zero tax is that it allows your investment to achieve its fullest
potential over time due to the positive effect of compounding interest year after year (there’s a reason Albert Einstein is said to have described compound interest as the “eighth wonder of the world”, saying, “he who understands it, earns it; he who doesn't, pays for it.”)

While R36 000 a year may not seem like a huge amount, if you start from year one of their life you will have invested a total of R500 000 by the time they are 14. Even after you hit the half-a-million cap, their investment will continue to grow in line with the fund’s growth. Add in the positive effects of compounding interest and your child should have a solid nest egg by the time they are 18, which can be used for tertiary education, seed money for an entrepreneurial idea or simply to invest in their own financial security for years to come.

Whatever the usage, if invested wisely this small investment (minimum R500 per month) can be your child’s springboard to success. And with Sygnia’s recently launched Stargazer product, investing in a TFSA for your child has never been simpler, or easier.