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Making sense of tax-free savings accounts

A TFSA should be viewed as a long-term savings vehicle.

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 reduce their tax liability.

However, the number of TFSA options in the marketplace, together with the hype surrounding the concept of tax-free savings, have 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 it into your overall portfolio. In general, however, a TFSA should be viewed as a long-term savings vehicle in order to achieve maximum benefit from it.

Tax benefits

The most obvious benefit of a TFSA 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.

Contribution limits

Those who choose to save towards a TFSA should bear in mind that their contributions are limited to a maximum of R33 000 per year, and 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. If you do not use your annual contribution of R33 000 in a tax year, you will not be permitted to roll it over to the following year, and your contribution will therefore be forfeited.

Contribution flexibility

Most TFSAs 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.

Types of tax-free savings accounts

TFSAs can take the form of money market or fixed-term bank accounts, a unit trust investment or a JSE-listed exchange traded fund. TFSAs can be issued by banks, long-term insurers, unit trust managers, mutual banks or cooperative banks.

Withdrawals

While you are free to withdraw funds from your TFSA at any time, early withdrawals penalties can differ from provider to provider, but 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. Any withdrawal made from your TFSA is 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. With this in mind, it makes sense to view your TFSA as a long-term investment vehicle.

Over-contributions

The annual contribution limit of R33 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 TFSA contributions carefully to ensure they remain within the limits, particularly where they operate multiple TFSAs across different platforms. The annual contribution limit of R33 000 applies to the sum of all the contributions to a person’s TFSAs.

Saving in the name of a minor

Opening up a TFSA in your child’s name is a wonderful 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 TFSA later in life. For instance, if you set up a TFSA in your child’s name when she is born and invest R500 000 during her first eighteen years, you will have exhausted her lifetime contribution threshold and she will not be able to save in a TFSA during her lifetime.

Multiple TFSAs

There is no limit to the number of TFSAs you can have, but it is important to manage them closely to ensure that you don’t exceed your annual contribution limit.

Transfers

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 the funds from one TFSA and deposit them into another. The transfer must take place between two service providers.

Other tax-efficient savings options

Before investing in a TFSA, investors should ensure that they are maximising their tax-deductible contributions towards a registered retirement fund, such as an employer pension fund or 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 a TFSA. In addition, individuals under the age of 65 can use their annual tax-free interest exemption of R23 800 per year to reduce their tax liability.

If employed appropriately in one’s portfolio, maximum benefit from TFSAs can be achieved over the longer-term. 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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Craig Torr

Crue Invest (Pty) Ltd

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