With the end of the tax-year being imminent, tax-paying South Africans are taking all steps to reduce their tax liabilities and other tax efficiencies, and that includes making use of the annual tax-free savings account (TFSA) contribution limit of R36 000. While the tax benefits of tax-free savings accounts are indisputable, a TFSA should be viewed as part of your overall investment portfolio to ensure that it is achieving its purpose. Here are 10 ways to ensure your TFSA works for you:
1. Use your available tax-free savings
TFSAs, which were introduced in South Africa in 2015, provide tax benefits in that all the growth and income received on the investment are tax-free. This means that you are not liable for any capital gains tax, dividends withholding tax or tax on the interest received. However, keep in mind that your contributions towards your TFSA are made with post-tax money meaning that no tax deduction is available on your contributions as is the case of retirement fund contributions. With this in mind, it makes sense for investors to first ensure that they are contributing adequately to a retirement fund to minimise their taxable income before taking out a TFSA.
2. Think of your TFSA as a long-term investment
The tax benefits achieved by investing in a TFSA are not realised early on which means that TFSAs do not make good emergency funds accounts. According to Jaco van Tonder of Ninety One, the value of the tax benefit in the first five years is incredibly small, and the investment return and tax-saving only become meaningful after about ten years. As such, it is advisable for investors to take a long-term view when setting up a TFSA. Although TFSAs are not necessarily intended as retirement funding vehicles, you can use yours to supplement your retirement savings. However, should you be earning below the tax threshold, i.e., you do not pay tax on your income, they do make very effective investment vehicle to build over the long-term as a retirement nest egg.
3. Set up a payment system that works for you
Legislation allows you to invest up to R36 000 per year towards a TFSA, or R3 000 per month, with the maximum lifetime contribution being R500 000. Most product providers make allowance for a minimum monthly contribution of R500, with the option of making monthly or annual contributions, or even ad hoc contributions as and when the opportunity arises. Depending on the nature of your earnings, set up a debit order or payment system into your TFSA that works for you. For instance, if you are a commission earner, you may want to contribute a smaller monthly amount via debit order with the option of making ad hoc contributions as and when your cash flow allows.
4. Don’t withdraw prematurely from your TFSA
Legislation permits you to withdraw from your TFSA at any time, but it is important to first understand the implications of doing so. Any withdrawal made from your TFSA is deducted from your lifetime contribution. For instance, if you have contributed a total of R300 000 towards your TFSA and you withdraw R50 000, you will still only have R200 000 lifetime contribution available to you. In other words, you can’t top up your TFSA again after a withdrawal and any withdrawal will result in you forfeiting your tax benefits, while at the same time wasting part of your lifetime contribution and losing out on potential investment returns.
5. Align your investment portfolio with your investment horizon
When setting up your TFSA, give careful thought as to how you intend to use the proceeds in the future and then choose an investment portfolio that is aligned with your timeline. For instance, you may wish to use it as a savings vehicle for your newborn child’s tertiary education, in which case your investment horizon is approximately 18 years. On the other hand, if you want to use it to supplement your retirement funding, you may be looking at a longer time period. Either way, if you’ve taken a long-term view on your TFSA, consider having a higher allocation to growth assets and less allocation to cash and fixed income which are poor long-term investments.
On this note, remember that if you are under the age of 65 you receive an annual tax exemption of R23 800 per year on all interest income. Over the age of 65, this exemption increases to R34 500. Assuming you receive an annual interest rate on your savings of 5%, you would need to have at least R476 000 under the age of 65, and R690 000 over the age of 65, in your TFSA before you receive a single rand of tax benefit by using a TFSA for interest-bearing investments. Therefore, your TFSA will only really start working in your favour if you target the growth asset classes which underlying assets pay dividends or trigger capital gains tax which you are now exempted from in your TFSA.
6. Choose a reputable investment platform
When choosing a TFSA provider, South Africans are spoilt for choice. Most reputable investment platforms offer a wide array of local and offshore funds to choose from, meaning that you can construct a portfolio that meets your specific investment goals. While you also have the option of investing in a money market or fixed-term bank account, it is likely that your TFSA will achieve more favourable returns over the long term if housed in a more aggressive unit trust portfolio. Importantly, consider choosing an investment platform that can provide a holistic overview of all your investments, including your retirement annuities and discretionary investments.
7. Be careful of setting up a TFSA in your child’s name
Think twice before setting up a TFSA in your child’s name as, in doing so, you will effectively be using part or all of their lifetime allowance and this could prevent them from being able to save tax-free later on in life. For example, if you set up a TFSA in your child’s name on birth and invest R500 000 towards this investment over the first eighteen years, you will have exhausted their lifetime contribution threshold and they will not be able to save in a TFSA during their lifetime, bearing in mind that you need to keep careful control of how much you contribute towards your TFSA each year.
8. Don’t make over-contributions
If you contribute more than your annual allowable amount of R36 000, keep in mind that earnings on the amount above the annual allowance will be taxed at a rate of 40% regardless of your personal income tax rate. This is a risk, especially if you are contributing towards multiple TFSAs.
9. Be careful when transferring between providers
If you wish to transfer your TFSA from one provider to another, keep in mind that such a transfer can only be made between service providers. You cannot withdraw your funds from one TFSA and then deposit them into a new TFSA. Such action would be review as a withdrawal and any reinvestment would then count toward your lifetime allowance.
10. Keep up-to-date with SARS
Even though no tax is payable on the earnings within a TFSA, as a South African tax resident you are required to disclose all investment information to Sars when submitting your annual tax return, including certificates issued for income within your TFSA.