To Tax-Free Save or Not?

Should you have a tax-free savings account or not? It seems as if it is the ideal vehicle to save in, regardless of the goal or time horizon, because the returns are tax free. However, there are a few considerations when it comes to having a tax-free account.

Ester Ochse, Product Head, FNB Integrated Advice says “So, the question is: to TFSA or not? Tax-free savings account was created due to South Africa’s low savings culture, with a household savings rate of 0.2%. Stats SA notes that less than 36% of South Africans are spending more than 10% of their income on saving, investing and insuring. To address this, an internationally recognised savings and investment vehicle was created to foster a culture of savings in South Africa, this was the Tax-Free Savings Account or TFSA.”

Ochse highlights some considerations when taking out a TFSA

Stay within the contribution limits
As mentioned above, if you contribute within the limits, the growth is tax-free. If, you go above the limit in a year, it will attract a tax rate of 40% for that year. The contribution limits are at the customer’s level and not at the account level. So be especially cautious when contributing to multiple TFSAs. It may be better to have only one TFSA, for ease of management as well as truly being able to leverage the compound interest effect.

Try not to withdraw from your TFSA
A TFSA is not a transaction account and should not be used as such; the idea is to add funds and let them grow over the long term. The reason for this is that when one has contributed to a TFSA and then withdraws from it, you cannot “top up” again as the original contribution is counted towards your lifetime contribution. For example, if you have contributed R72,000 to a TFSA over a period of 2 years and you withdraw R20,000 for an emergency, it is still deemed that you have contributed an amount of R72,000. Later on, if you decide to put back the R20, 000 it would be considered an over contribution and could be taxed at the 40% rate. Rather leave contributions untouched to take full advantage of your TFSA.

TFSA is a great long term investment vehicle
With the benefits of growth being tax-free in a TFSA, it makes the ideal vehicle to consider as an add-on for retirement savings. However, remember that it is not a retirement vehicle; it can be used to add to your retirement nest egg, which may include your company pension fund, preservation funds or retirement annuity.

Make sure that your actual investment is also long term
A TFSA can have multiple product types within it to allow you to invest across multiple asset classes such as cash, unit trusts and shares. Therefore, when looking at a TFSA, consider what your goal is with the investment and when you are going to be using the funds. If it is a longer-term goal, such as supplementing retirement provisioning in 15 years plus, consider exposure to more growth-type assets, such as unit trusts or ETF’s that have a higher exposure to growth type assets (property and shares).

Cash investments should rather be used for shorter and low risk investments as they will most likely underperform inflation over the long term. However, the cash investment option can be suitable for retired clients seeking low risk guaranteed returns and would help minimise the taxable interest income by investing in a TFSA cash offering.

Should I open a TFSA for my child?
This is an interesting debate and again comes down to what the intention is. If you open one in their name, then you are using their lifetime contribution limit. It can be very powerful if the idea is to supplement the child’s retirement, but if it is to pay for high school fees, it may not be the best option for the child. With a sizable tax-free investment portfolio available to them once they turn 18 years old, you can offer your children a head-start in life.

TFSA is a powerful investment vehicle when used correctly. Himal Parbhoo, CEO of FNB Cash Investments explains that “A TFSA is a great solution to add to your long-term investment strategy. One can contribute an amount of R36,000 per year to a lifetime limit of R500,000 in a TFSA vehicle and the growth on that is tax-free, regardless of whether that growth is from compound interest, dividends or capital.”
As mentioned above, a TFSA is a great long-term saving vehicle and should be use as such. For example, let’s assume you are a 30-year-old that contributes R3,000 per month to a TFSA. Specifically, into a high growth portfolio that targets CPI +5% and leave it to grow until the age of 70. You would have contributed an amount of R500,000 by the age of 45. But instead of drawing it and using it, you leave it to supplement your retirement, by the age of 70 the investment is worth about R12,300,790, which you can then use tax-free.

“Many young people have been using TFSAs over the past few years to take advantage of all the benefits because they know they won’t have to pay income tax, dividend tax, or capital gains tax on the returns. This is fantastic for South Africa because it instils the culture of saving and investing at a young age, which leads to wealth creation and financial independence,” concludes Ochse.

Opening a TFSA is also rather easy, and you do not need to start with the huge amount of R3,000 per month. Even starting with R300 per month is possible. Opening a TFSA is very easy via the FNB App via Savings Goal under nav» Money>savings goals. Remember that once you are done, you add the savings contribution to your budget under Smart Budget on nav» Money.