Understanding Tax-Free Savings Accounts

Understanding the best use for your TFSA

Imagine paying no taxes on an investment and your money can be accessed when you need it. If this is something you are interested in, continue reading. This ideal investment scenario is available to South Africans but there is one caveat, you can only invest a certain limit into this structure per year.

Rules of Tax-Free Savings Account 

No tax: When I said no tax, I meant no tax, Tax free saving accounts don't pay any income, dividend, or capital gains tax on the returns from this investment.

Annual limit: The current annual limit is R36 000. This amounts to a R3000 per month contribution. There is also an R500 000 lifetime limit set on contributions. You could have invested R195 000 to date if you add up all the annual limits since inception of Tax Free Saving Accounts in 2015.

No carryover: Unlike the game pool where you get two shots and it carries over, a tax-free savings account does not carry over. Meaning if you did not invest the full R36 000 per year, you lose out on it going forward. So maximizing it is important. Withdrawing from your fund does not allow you to contribute it back again. Example: you invest R36 000, then a month later withdraw R30000. You can't invest for that year again as you have used your limit for the year. 

Penalties: If you contribute more than R36 000 to your tax-free savings account, then a penalty of 40% of the amount over R36 000, will be added to your normal tax payable for that year.

Accessibility: Any person, even minor children can have multiple tax-free savings accounts. The annual limit of R36000 aggregates across all accounts, meaning you can't contribute more than the annual limit to all your accounts combined. If you desperately need some of your funds, any withdrawals are tax-free on your account. 

Where can I get my hand on a Tax-Free Savings Account?

All banks, long-term insurance, and unit trust managers provide these accounts. I found the easiest way to use EasyEquities. Click here to open your account with EasyEquities and receive a FREE R50 to start your investment journey. 

What can I use it for?

Having normal annual interest tax exemption limits of R23 800 for people under 65, and R34 500 for people over 65, means you need quite an investment to outperform these exemptions. Here's an example: The below table shows the year of assessment and the annual limit that was applicable for that year including the interest exemptions that applied each year. I assumed that the investor contributed the annual limit at the beginning of each year and then applied a growth rate of 9%. In the growth column, the amount within the brackets is the investment amount and outside the brackets shows the interest payable for the year. As you can see in the column furthest to the right, this investor would have paid no interest tax yet even if he invested outside of a Tax-Free Savings Account.

That being said, using your Tax-Free Savings Account to save for a holiday, car or home deposit might have little tax benefits for you. And might become more admin to figure out what you have contributed during a specific year of assessment. 

As we can see that in the short term these accounts don't add many tax-free savings, but in the long run, these will be tax-saving machines. Using your Tax-Free Savings Account for long-term goals such as children's education, and supplementing your retirement savings will have the biggest tax savings and benefits. You want to maximise your growth and leave the investment to grow for a long period to not only start getting tax-free benefits but continue to do so in the future. We wrote an article on how much you need to save and which funds are recommended for long-term growth. Using a Tax-Free Savings Account for this goal will give your child a headstart in life. 

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