Much has been written about tax-free savings accounts (TFSAs) since they were launched, but, in light of the tax year coming to an end, it is prudent to remind ourselves of the benefits of investing in one.
I have always frowned on it being called a tax-free “savings account”, as I feel that it can be misleading for many people.
One might think of a TFSA as just another bank account where you save and not associate it with an investment where you should be thinking long-term.
WHAT IS A TFSA?
TFSAs were launched by government in 2015 to encourage more people to save. When you invest in a TFSA, any interest, capital gains or dividends from your investment are tax free, essentially making it a tax haven, albeit a small one.
HOW DOES IT WORK?
You can contribute a maximum of R33 000 in one tax year – a total of R2 750 per month. You will be taxed 40% for any investment above this limit, so it is not worth your while to contribute more in this investment.
While the above figures may not seem significant, the fact that your investment is free of tax and benefits from compound growth, investing in a TFSA may prove to be worthwhile over the long term.
A TFSA has a lifetime limit of R500 000, meaning that you can only contribute up to R500 000 in your lifetime into the investment.
This amount can be reached in just more than 15 years if you contribute the prescribed maximum limit every year.
WHAT IS THE VALUE OF A TFSA?
You will only realise and enjoy the real value of a tax-free savings investment once the value of the investment is sufficient to exceed the annual interest exemption – R23 800 for individuals younger than 65 and R34 500 for anyone older than 65 – and the capital gains exclusion of R40 000.
It is therefore best to only invest in a TFSA with a long-term view.
WHAT CAN YOU USE A TFSA FOR?
- To save for a long-term goal;
- To fund your children’s tertiary education;
- To save for a deposit for an investment property that will supplement your retirement income;
- To add some fun into financial planning and save for a trip of a lifetime around the world;
- To top up your retirement if you have maxed out the R350 000 limit in retirement funding, although you will not get the tax break on your income tax as you would in a retirement fund vehicle;
- . If you are a freelancer or are uncertain about your employment and cannot commit to a fixed amount into a retirement annuity, a TFSA allows you the flexibility to withdraw should you really need to;
- To save for retirement if there is a possibility that you might emigrate.
While you can access your retirement funds on emigration, it can be a lengthy exercise; and
- For estate planning purposes – if your TFSA is in an endowment vehicle, you can choose a beneficiary.
Should you die, the funds are paid directly to your beneficiary, avoiding executor fees, but not estate duty.
WHERE TO INVEST IN A TFSA
For those who cannot afford the maximum contribution of R2 750, many banks, asset managers and insurers offer TFSAs at a minimum recurring amount from only R250, making it an accessible investment.
You can invest in a TFSA via exchange-traded funds, unit trusts, endowment policies and some fixed deposits, giving you, the investor, access to different asset classes such as equity, bonds, cash and property.
Almost all investment houses offer a range of TFSA funds, so you do not have to stick to the banks’ offering of a savings account.
In fact, considering that a TFSA should be a long-term investment, a cash-based savings account is not necessarily the best vehicle.
- Financial adviser service fee;
- Platform service fee – in the case of a linked service provider; and
- Service fee of the fund selected
Providers are not allowed to charge performance fees on TFSAs.
If one of your New Year’s resolutions is to start investing for the long term, I hope you do consider a TFSA as part of your portfolio.
Makhu is a certified financial planner and personal finance coach