What are the advantages of tax-free savings accounts?

With a notoriously low savings rate in South Africa, the government attempted to remedy this by introducing tax free investments from March, 2015.

The National Treasury published its final amendments to these regulations in March, 2017 and tax free savings accounts (TFSA) can now amount to R3 000 annually, instead of only R30 000. 

TFSA’s offer a tax-free account with a lifetime maximum of up to R500 000, where users are not taxed on their interest or dividends earned. 

Similar to pension funds

Lisa Linfield, certified financial planner and founder of Southern Pride Wealth, describes TFSA’s as a tax-free wrapper in which you can save and invest. 

“Imagine a present wrapped in paper. The TFSA is the wrapping paper and the saving and investing is the present. You can use many different types of savings and investment products in the wrapper – unit trusts, tracker funds, money market funds, and savings accounts. And each of these are wrapped in a tax-free status – that is, you don’t pay dividend tax or tax on interest,” she explains. 

“So you get an extra 20% from dividend income, and your tax rate (18-45%) on your interest income, which means more money for you at the end. They are similar to retirement annuities and pension and provident funds, but they are different in that the payments into your TFSA are after tax, and not before tax,” she adds.

Linfield believes that TFSA’s will continue to increase in popularity as people become aware of them, and with further education, people will be able to take advantage of this “fantastic tax break”.  

Greater growth with TFSA's

Jean Minnaar, general manager at Old Mutual, explains that without being taxed, you will be able to enjoy greater growth.

“If you save R1 000 a month for ten years, your investment could grow to R253 392, which includes tax savings of R13 518. This is based on an annual increase of 8% and an investment strategy of the Old Mutual Balanced Fund with expected returns of 4 - 5% above inflation yearly (after asset management fees),” says Minnaar.

He points out the following advantages for taking out a TFSA:

• All growth on your account is tax free.
• Transparent fees and charges.
• You choose how you want to invest – with lump sums, regular investments, or a combination of both.
• You have full access to your savings from day one – with no penalties.
• You can increase, decrease, or stop your regular investments at any time.
• You have a choice of a range of selected underlying funds that can meet your unique investment needs.
• The option to switch your underlying investment funds as many times as you like, at no cost.
• There is no term attached to your plan so you choose how long and how often you want to invest.

According to Minnaar, there are no real disadvantages to a TFSA, other than an annual tax-free contribution limit of R33 000.

“The South African Revenue Services (SARS) will levy a tax of 40% on all contributions that exceed R33 000 per tax year. You should therefore monitor the contributions you make to all your tax-free investments to ensure you do not exceed the limits imposed by the government. This is especially key if you have multiple tax free savings accounts,” he advises. 

Have a look at the guidelines SARS currently has in place for TFSA’s. 

In it for the long-run

Nic Andrew, head of Nedgroup Investments, suggests investing for the long-term, rather than the short-term in order to reap the most benefits from the power of tax-free compounding.

That being said, he advises a one-on-one consultation with a financial planner to ensure your chosen path truly suits your financial needs.

“A good starting point to determine this is to understand what it is you want to achieve and by when. Communicate this with your financial planner along with your current budget needs and future expenses such as your children’s tertiary education costs,” he explains. 

He adds that, “In addition to adequate planning, it is important for South Africans to educate themselves on tax incentives which may help them in both the short- and long-term.”

If you're considering opening a TFSA, have a look at this article where we compare them across the top South African banks. You can also have a look at our Salary Tax Calculator to find out how much tax you'd pay for different income brackets. 

*The information in this article was correct at the time of publication.