Lets talk about TFSA, baby: Part2/2

In this article, we discuss the ins and outs of TFSA accounts. Part2.

Part1 recap:

What is a TFSA? Accounts that allow users to invest without paying taxes on the returns from these investments.

Types of incomes not taxed in TFSA: Interest income from cash and bonds, dividend income from stocks, and capital gains.

What can you hold in TFSA? Investors are only allowed to invest in collective investment schemes, such as unit trusts and ETFs.

Part2 discusses the specifics around contributions and withdrawals. Lets dive in. 

Contribution:

• Contribution to TFSA is limited to an annual contribution of R36,000 (or R3,000 per month) and a lifetime contribution of R500,000.
• Investors are allowed to make any monthly contribution, subject to the asset manager and specific fund in which they invest. For example, client debit orders at Allan Gray may not exceed R3 000 per month, but they are allowed to make ad-hoc top-up contributions throughout the year to the maximum allowance of R36,000 per year.
• Investing less than the maximum allowance does not carry over to the following years allowance. For example, if you contributed 30K this year, you cannot contribute R42,000 next year.
• You may have more than one TFSA account, however, the combined total contributions are still limited to R36,000 per year. For example, you can invest R16,000 (Old Mutual), R12,000 (Investec) and R8,000 (Absa). 
• Cash flows generated within the fund that are reinvested/rolled up into the fund are capitalised and do not affect the annual or lifetime limit. For example, if a person invested R36 000 for the 2021 year of assessment and the return on investment is interest of R5 000, which is capitalised, the total amount in the account will be R41,000. The interest amount of R5000 is not regarded as a contribution.

Be careful! If you exceed the annual and lifetime limits, SARS will tax you at 40% on the excess contributions. E.g., if invest R38,000 this year, the additional R2,000 contributed will be taxed at 40%. (R2,000 x 40% = R800 owed to SARS)  

Celebrate! The R500,000 limit is strictly contributions, not overall value. By the time you max out your TFSA, the overall value will be much higher. Once you have reached your lifetime contribution limit, you can sit back and let the magic of compound interest work away at growing your nest egg.

Lets crunch some numbers:

The S&P and JSE have returned roughly 10% per year in the last 30 years. 

• If you contribute R36,000 per year (R3,000 p.m), you will reach R500,000 contributions after roughly 14 years. Total value = R1,050,000. Leave it untouched for 10 years = R2,720,000, 20 years = R7,064,000, 30 years = R18,320,000
• If you contribute R18,000 per year (R1,500 p.m), you will reach R500,000 contributions after roughly 28 years. Total value = R5,050,000. Leave it untouched for 10 years = R13,100,000, 20 years = R34,000,000.
• If you contribute R12,000 per year (R1,000 p.m), you will reach R500,000 contributions after roughly 42 years. Total value = 20,220,000. Leave it untouched for 10 years = R52,400,000.

Withdrawal rules

• You can withdraw any available amount at any time.
• Overall contributions remain R500,000, regardless of what you withdraw. Thus, withdrawals do not net off against contributions. For example, Contribute R200,000, and withdraw R50,000. Allowed remaining contribution equals R300,000 (R500,000 - R200,000), not R350,000 (R500, 000 R200,000 + R50,000)

Part 2 Summary:

• Maximum contributions capped at R36 000 per year up to a total of R500 000.
• Can have multiple accounts, but the total is still limited to R36 000 per year.
• Returns generated within the fund do not count as part of contributions.
• Tax-free withdrawals are allowed at any time, but withdrawing does not net off against contributions. Maximum contributions will always remain R36,000 per year and R500,000 in total.