Most life insurers, banks, unit trust companies and LISP platforms offer tax-free savings accounts (TFSAs) which are easily accessible and attractive to those wanting to save for the longer term. However, the number of TFSA options in the marketplace has left many investors confused as to which TFSA product to choose and how to maximise the benefits of such a vehicle. As with any investment vehicle, TFSAs need to be fully understood before introducing them into your overall portfolio. In general, however, a tax-free savings account should be viewed as a long-term savings vehicle in order to achieve maximum benefit from it.
The most obvious benefit of a tax-free savings account is that all proceeds earned from it – including interest income, capital gains and dividends – are exempt from tax. This means that you get your full investment return without being taxed on the growth you earn. Unlike retirement fund contributions, it is important to bear in mind that contributions towards a TFSA are not tax deductible which means that you will be investing with after-tax money.
If you’re planning to save through a tax-free savings account, your contributions will be limited to a maximum of R36 000 per year with a total lifetime contribution of R500 000. It does not matter if the balance in your TFSA exceeds R500 000 because naturally, investment growth is expected; rather, it is the total lifetime contribution that is limited to R500 000 per individual. Keep in mind that if you do not use your annual contribution of R36 000 in a tax year, you will not be permitted to roll it over to the following year, and your contribution for that tax year will be forfeited.
Most tax-free savings accounts provide complete contribution flexibility, allowing investors to stop and start their contributions at will. Investors can choose to contribute monthly, quarterly, annually or on an ad hoc basis, although some providers insist on a minimum contribution level for administrative purposes. Tax-free savings accounts can take the form of money market or fixed-term bank accounts, a unit trust investment or a JSE-listed exchange-traded fund, and can be issued by banks, long-term insurers, unit trust managers, mutual banks, or cooperative banks.
While you are free to withdraw funds from your tax-free savings account at any time, early withdrawal penalties can differ from provider to provider, although they cannot exceed R500. More importantly, it is essential to understand the longer-term implications of early withdrawals from your TFSA so as to avoid compromising your investment – this is because any withdrawal made from your tax-free savings account will be deducted from your lifetime contribution limit. For example, if you have R200 000 saved in your TFSA and make a full withdrawal, your total remaining lifetime contribution will reduce to R300 000 – yet another reason to take a long-term view of your tax-free investment.
From a tax planning perspective, it is important to keep in mind that the annual contribution limit of R36 000 per individual is strictly enforced, and any contributions in excess of this annual limit can be subject to penalty tax of 40% of the excess. Investors should therefore manage their tax-free savings account contributions carefully to ensure they remain within the limits, particularly where they operate multiple TFSAs across different platforms. Remember, the annual contribution limit of R36 000 applies to the sum of all the contributions to a person’s tax-free savings accounts. Remember, while there is no limit to the number of tax-free savings accounts you can have, it is important to manage them closely to ensure that you don’t exceed your annual contribution limit.
Opening up a tax-free savings account in your child’s name is a great way to save for their education, although there are long-term consequences for doing so which should be factored in. If you open a TFSA in the name of your child, you will effectively be using part of their tax-free allowance which may prevent them from saving in a tax-free investment later in life.
Recent legislative changes make provision for investors to transfer a TFSA from one service provider to another without being penalised. Investors are not permitted to withdraw funds from one TFSA and deposit them into another. In other words, the transfer must take place between two service providers.
Before investing in a TFSA, investors should ensure that they are maximising their tax-deductible contributions towards a registered retirement fund, such as their occupational retirement fund or a retirement annuity. With investors permitted to channel up to 27.5% of their taxable income towards a retirement fund on a tax-deductible basis, the tax benefits of a retirement fund outweigh those of tax-free investments.
If employed appropriately in one’s portfolio, maximum benefit from tax-free savings accounts can be achieved over the longer term. That said, your investment horizon, goals, returns, debt levels, income and the extent to which you are making use of the other tax-efficient savings options are all factors to be considered before setting up a TFSA.
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