Is a tax-free savings account the best option for you?

Many South Africans have started taking advantage of Tax Free Savings Accounts (TFSAs), which were established by the government as an easy and safe way for citizens to increase their savings. When investing in a TFSA, you won’t be taxed on any growth on your investment — you won’t pay tax on dividends, interest or capital gains tax. And when you consider that the interest offered in a traditional savings account is usually less than the inflation rate, it’s no wonder that TFSAs are widely considered to be beneficial savings vehicles.

[DISCLAIMER: This article is not an endorsement of TFSAs over other long term vehicles as every portfolio is unique and may require different investment products. Let’s chat first before making any final decisions.]

Since March 2015, South Africans have been entitled to invest up to R30,000 a year (or R2,500 a month) in a tax-free investment, and contributions are capped at a lifetime maximum of R500,000. While they do obviously have tax benefits, the main goal of a TFSA is to encourage people to save, and R2,500 a month is thought to represent a realistic target.

Many experts believe that any South African with taxable income should take advantage of this investment option (no matter how little or how much money they have to invest), as this ‘mini tax haven’ will dilute their overall tax rate over their lifetime. If investors invest the maximum amount allowed, they will reach the limit in just under 17 years, which means that they will have R500,000 — plus capital growth, dividends and interest — as a tax-free investment. And once they have reached the R500,000 cap, it’s simply a question of watching money grow with the power of compound interest.

However, there are times when a TFSA may not be an appropriate investment tool. Some experts believe that the term tax-free savings “account” has led many people to opt for cash deposits instead of other investments, which could offer better growth opportunities and even lower costs. A TFSA may help you to avoid tax on interest, but investors could see greater capital growth with other savings products.

Although you will save on tax on the growth of your investment, plus you won’t be charged performance fees, a TFSA still has fees and transaction costs that should be considered. It’s also not advisable to go above the annual R30,000 limit, which applies to the combined annual payments of all your approved tax-free savings accounts. If you do, there will be tax penalties — any contributions made in excess of these limits will be taxed at a rate of 40% of the total amount exceeding the limits. Furthermore, you need to be careful not to donate more than R100,000 a year to children or grandchildren, or you will be liable for donations tax.

Paul Leonard, regional head of Citadel, highlights in an article published on Fin24 that tax-free savings accounts “should not be viewed as a one-size-fits-all solution.” TFSAs are not intended for short-term savings. As with any investment vehicle, they are designed for a specific purpose and are best suited to the lower taxpayer who only needs access to an investment in the medium- or long-term. According to Leonard, “you would only benefit meaningfully from the tax-free treatment of money in the TFSA once the value of the investment is sufficient to exceed the annual interest exemption and capital gains exclusion.”

When it comes to saving for retirement, a TFSA could suit you if your income is below the income tax threshold; or if you are uncertain about your job security and may need to access the capital in the case of unemployment; or if you are considering emigrating and may wish to expatriate your capital. It is also appropriate for topping up retirement savings that are over the maximum annual amount on which South Africans can receive tax breaks. However, it is generally recommended that investors first make use of all the tax breaks available for retirement funding investments, then use a TFSA as a complementary tool.

Tax-free investments do have some restrictions that don’t apply to retirement annuities (RAs). For example, if you make a withdrawal, you can’t simply replace it another year in addition to the annual limit. However, compared to RAs, tax-free investments offer flexibility in that you have access to the funds without early withdrawal penalties, so you don’t have to wait until retirement before they are available. And a big bonus of a TFSA is that, not only are your contributions not tax deductible, but you also won’t have to pay tax on any of the proceeds when you access the funds (unlike with an RA).

In conclusion, a TFSA allows you to save without incurring any tax on the growth of your investment and, in order to grow your portfolio, it can be worth making the most of all tax-free benefits available. A TFSA can be a great way to supplement retirement savings or achieve other long-term savings objectives, and it can also provide flexibility if you need funds in an emergency.
However, everyone has their own unique set of circumstances that need to be considered when deciding how to save for retirement. It is, therefore, always worth seeking professional advice and carefully scrutinising any investment to see if it’s your best option. So don’t hesitate to arrange a meeting if you wish to discuss whether a TFSA could help you to achieve your personal financial goals.

Original source:

fin24 – when not to use a tax free savings account

fin24 – how to choose a tax free savings product

fin24 – does the taxman help you save for retirement

Posted in Blog, financial-planning.