The benefits of a tax-free savings account

A tax-free savings account (TFSA) exempts you from paying tax on any interest, local dividends, or capital gains your savings may attract, provided you don’t exceed the contribution limits of R36,000 annually, or R500,000 in your lifetime.

This article examines whether you qualify for a tax-free investment, what the benefits are, and how you can invest.

Tip: Did you know that unit trusts also offer tax exemptions on interest income and capital gains? Find out more here.

Anyone can open a TFSA

The National Treasury rolled out TFSAs in 2015 to encourage South Africans to save. 

Wayne Mostert, director of financial service provider ASI BestSure, notes, “Anyone can open a TFSA at a bank, insurance company, or similar financial service provider with a South African ID or passport, proof of residence, and bank account details.”

The advantages of a TFSA

Aside from being tax-free, TFSAs are very accessible, which means you can take out your money at any time, says Paul Leonard, advisory partner at Citadel Wealth Management.

“However, withdrawals do not replenish your lifetime contribution limit of R500,000, which works according to what you deposit cumulatively.

“For instance, if you deposit R50,000 in your TFSA and withdraw R20,000, that R20,000 still forms part of your deposited lifetime limit.”

Mostert adds that there are no penalties for withdrawing from your investment, and you can change, stop and restart your contributions at any time, at no additional cost.

Leonard lists some further benefits, as follows.

• Offsetting job insecurity: There is talk of the two-pot retirement system limiting South Africans’ ability to access their retirement savings. While we await the outcome, the accessibility of a TFSA may offer a solution, should your job security be compromised. While saving for the long term, you can access some of your money immediately if needed.
• Early emigration access: If you emigrate and can prove you have been out of the country for more than three years, you can access your retirement savings. If, however, you need to access your savings earlier than this, a TFSA is a good option.
• Couples benefit: A couple saving together can put away double the money in a TFSA - that is, R72,000 per year, or R1 million in their lifetime.
• Mini tax haven: For disciplined savers who earn below the tax threshold, TFSAs present a mini tax haven when saving for retirement. You can store money in your TFSA and never be taxed. Compare this to a retirement annuity (RA). The money you keep in an RA has not been taxed, and your money will not be taxed on interest, capital gains or dividends while you are in South Africa. However, you will be taxed on the entire amount when you withdraw your money after the age of 55.
• Supplementing your retirement savings: Suppose you get to a point where you have maxed out your tax-free retirement contributions. The maximum you can put into a retirement annuity per year to attract tax exemption is 27.5% of your taxable annual income, or R350,000 – whichever is the lowest. If you have extra to save, you can invest in a TFSA.

Be sure to stick to the limit

Mostert says you should keep an eye on the total amount you deposit, as exceeding TFSA limits will attract 40% taxation on the excess.

This doesn’t mean that you can’t have more than R500,000 in your account – only that you can’t deposit more than that in your lifetime, or more than R36,000 per year.

When a TFSA is inappropriate

Leonard and Mostert agree that TFSAs are inappropriate for short- or medium-term savings.

They are also unsuitable for children or adolescents, as they don’t earn an income and are thus below the tax threshold, and so will not benefit.

Instead of saving on tax, TFSAs for non-earners eat into that person’s lifetime limit of R500,000, cautions Leonard. Anyone who contributes on behalf of a child is taking away from the amount the child could have saved tax-free later, he notes.

Tip: The younger you start preparing for your retirement, the better. Find out more here.