Tax-Free Savings Accounts (TFSA) are as close as we will ever come to “free money”.
The name Tax-Free Saving’s really is in itself, self-explanatory.
You pay no tax on any gains or losses incurred from saving/investing.
In this article, we are going to be unpacking the why, what, how and when questions surrounding Tax-Free Investments.
Why do TFSAs exist?
There is no better place to start than asking “why something exists”. Tax-Free Saving Accounts were initiated by the South African government on 01 March 2015, with Treasury indicating two direct reasons.
- As is the case with many tax incentives, it is used to encourage a culture of saving in a country that finds it notoriously difficult to save. In the long term, improving saving habits lead to the government spending less on health care, unemployment benefits and education. All while the overall populace is happier and more financially secure at an individual level. (A win-win for everyone except the tax man)
- Secondly, there are noticeable benefits to macroeconomic factors as the knock-on effects from the above take off (just read: the country is a lot better off when the individual saves).
As it turns out, TFSA’s genuinely exist because the government would like to help us. They want to encourage us to save more money and save for longer periods.
What are TFSAs?
Tax-Free Savings Accounts can be any financial/bank account that we are usually able to open and have been specifically designated as a Tax-Free Savings Account.
This means they could be anything from your bank account to your unit trust, as long as they are classified as a TFSA. Most predominantly TFSA are interest-bearing accounts (lets call this fixed income) – think your bank account or a similar money market account. There are however many other options that are steadily growing in popularity which include unit trusts (collective investment schemes); retail savings bonds; certain endowment policies (issued by long-term insurers); linked investment products and exchange-traded funds (ETFs) that are classified as collective investment schemes.
This probably sounds like a “long-list-of-things-I-have-never-heard-of” right?
Don’t be intimidated. It really comes down to what you would prefer. Safety in the form of capital protection (you are guaranteed to keep the money you put in) or do you want to take on risk of losing your capital and potentially earning more.
The safest option is cash/money market or what we term fixed income accounts that are available at most banks. These accounts generate a specific interest each month and you do not have to pay tax on the interest. The amount of money you put in will never decrease.
The other options we mentioned often track the performance of shares and bonds. These can be more volatile than their cash-based counterparts yet could generate a higher return. This just means that they may go up or even down significantly depending on a variety of different factors.
What you choose should be based on your risk preference and your intentions for the money, this will dictate the answer. Often a blend of different products can be a good strategy to implement.
If you are older, have fewer alternative investments and cannot afford to lose money – then you should stick to the safer products. Those who are younger or have additional/supplemental investments (Retirement Annuity, Medical Savings, Property) should consider a riskier product that may generate significantly better returns.
The benefits to having a tax-free savings account is that you do not pay any tax – including dividends tax, income tax and capital gains tax – on the money you make. To illustrate this we have included a basic example.
If you invest R33 000 into a bank account that earns 10% interest each year. At the end of the year, you would receive R3 300. In ordinary circumstances, you would need to pay SARS (depending on your tax bracket) a portion of this amount, let’s assume an approximate 30%. This means you would pay R990 to SARs and would be left with R2 310. If the account was approved as a TFSA you would pocket the entire R3 300 each year and pay no tax.
- Non-TFSA Bank Account: R2 310
- TFSA Bank Account: R3 300
The compounding effect of earning the extra amount that you would have paid in tax can be substantial over time (Read: Investing Guru: Ignoring Compounding for more information on compounding)
What are the Rules?
Before you decide who you would like to open an account with, there are some basic rules that you have to be aware of (and monitor yourself):
You may only put a maximum of R33,000 per year into TFSA’s (this amount increased from the R30,000 on the 01 March 2017). The “year” runs from 01 March to the 28 February the following year.
There is a limit over your entire life to an amount of R500,000 (you may only put in a maximum of R500,000 into TFSA’s and not R1 more)
If you break the rules and invest more money than is prescribed you will have to pay SARs a hefty 40% penalty on the excess.
For example, if you invest R36,000 in 1 year (3,000 more than you were allowed), you will be liable to pay over R1,200 (40% of the extra R3,000) to SARs.
So “Rule 3” is never break Rule 1 and Rule 2 or you will pay significantly.
Some additional points to acknowledge:
- You are allowed to have multiple Tax-Free Savings Accounts with different service providers as long as you adhere to the rules above in aggregate (the combination does not break the rules).
- You can invest in TFSA’s on behalf of your children and it will count towards their limits (but the longer the compounding effect has to work the better, so this is really a recommendation).
- Amounts reinvested (but not withdrawn) do not count towards your limits, for example, if you invest the maximum R33,000 and it earns R5,000, you can leave the R38,000 in the TFSA and it will only count as you are having put in R33,000 for the year. This is the beauty of TFSA and the advantage to letting it compound over time.
- Important to note on this though is that once you draw the money out of the account any reinvestment from there will count towards your limits. Draw means that you move funds out of a designated TFSA into a non-TFSA. With this in mind you should keep in mind there are soft limits on the liquidity. What we trying to say can be illustrated by an overstated example. If it were possible to invest all of your lifetime limit of R500,000 in the first year (you can’t because of Rule 1), and you move the R500,000 a week later back into your normal bank account, you would never be able to use a TFSA again.
- It is, however, possible to transfer money between TFSA without triggering a withdrawal, and this should be undertaken with the guidance of the service provider you choose to use.
How Do I Open TFSA’s
Tax-Free Savings may only be provided by a licenced bank, long-term insurers, a manager of registered collective schemes (with certain exceptions), the National Government, a mutual bank and a co-operative bank.
Generally, you will find most of the larger financial houses and banks including different asset managers have Tax Free Investment products available. Your bank likely offers a convenient option although there are many others on the market.
You need to consider the fee’s charged and what you would like to invest in.
Our top 10 TFSA article is coming soon but, in the meantime, we would recommend SaveTaxFree as a good source of information. Their directory lays out the vast majority of products available and will help in comparing the different products.
We personally like the Satrix product for the fact that you have a multitude of ETF’s to choose from including ETF’s that give you international exposure. Once invested into Satrix you are able to sell in and out of the different ETF’s fairly easily without it affecting the contribution limits (the Rules) or triggering a withdrawal.
In order to open an account with the service provider of your choice you would normally require at a minimum:
- Completed Application Form from the service provider (download it on the company’s website)
- Certified ID
- Proof of Residence
When should I start a TFSA?
The common saying of “sooner rather than later” could not be truer. Although you should keep in mind some key thoughts before jumping in head first.
You should only place money into a TFSA account that you will not likely need in the near future. In this sense the longer you can leave your money untouched the more chance the growth can compound. This further benefits you as you don’t pay tax on the gains. That said TFSA can also be a great way to save for a specific purpose or a “raining day”. Ideally the longer you can go without the money the more you can earn. Therefore, in this sense aim for the long term.
The choice is to go with a lump sum payment on an ad-hoc basis or put in a monthly debit order. This debit order can be up to a maximum of R2,750 (which equates to R33,000 per year).
We trust you now have a base level understanding of what Tax-Free Savings Accounts are. Look out for our future articles on TFSA to learn more. In the meantime feel free to tell us what you would like to know. Drop us a comment or a question.
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