The first money you should invest and the last money you should ever use – TFSA's
The South African treasury introduced Tax-Free Savings Accounts (TFSA) in the 2015/2016 tax year.
According to treasury the purpose was twofold:
1. To encourage saving within the country
2. And to reduce financial vulnerability and reliance on debt
Treasuries full press release can be found here.
On the name
I have a real bug with the name of these products. It sounds like a savings account similar to what is offered at your usual bank. But tax has never been a concern in a transactional bank account.
They should be called Tax-Free Investment Accounts. Because using them as your primary account for investments is a very good idea. Let me tell you why.
Limited contributions into these accounts mean that every cent invested is important
The legislation states that you can contribute a maximum of R36 000 for each tax year (as at the 2020/2021 tax year), these yearly contribution limits have increased twice since inception of the accounts. A maximum of R500 000 in contributions is allowed in your lifetime. It is likely that lifetime contributions will increase eventually too.
For most individuals R36 000 per year is a lot of money and would take over 13 years to reach the lifetime limit as it stands. Investment growth is not considered as contributions and neither are dividends received from your investments.
Contributions over the allowed R36 000 are penalised by being subject to a 40% tax.
It is your responsibility to adhere to the monitoring of your account limits and your contributions. Having multiple TFSA’s with different providers does not help to increase contribution allowances as the limits apply across all accounts.
The biggest benefit of these accounts is that all withdrawals are completely tax free – no income tax, no capital gains tax and no dividend withholding tax are applicable.
You CAN withdraw buy you SHOULDN’T
You can withdraw freely at any time from a TFSA, however if you withdraw money from this account the contributions made still count towards your contribution limits and you cannot deduct withdraws against contributions already made.
It is very important to keep the lifetime limit of R500 000 on your mind as withdrawals will inhibit your ability to make the most out of this account in the long-term.
Transferring your funds from one provider to another is allowed. I did so after my first year of having the account in an effort to move away from a stockbroker whose fees was inhibiting my investment returns.
Fees are determined by the account provider
When a fancy new type of investment product comes along, it’s often a way for large companies to wrap something which looks shiny to you but hidden inside are ridiculously expensive fees which are certainly not in your interest.
There has been a fee transparency war happening in the investment world for the past few years and I am happy to report that these are some of the most competitively priced accounts on offer. I would caution you to not start an account with a provider that charges fixed monthly fees but rather charges low transaction fees based on the value of your transactions.
What can you invest in?
Currently you may invest in unit trusts (only without performance fees), bonds and most ETF’s. Individual company shares, commodities and cryptocurrencies are not allowed. This is likely due to their volatility.
It is crucial to not to let your funds be unutilised and only subject to bank account interest returns on your capital. This is sadly how too many of these accounts have been used. It is investments into ETF’s and unit trusts which will provide the greatest return over the long-term in these accounts and therefore result in the greatest tax savings upon withdrawals (by saving capital gains tax, and dividend withholding wax).
A list of ETF’s most of which can be invested in can be found here.
The benefits of this investment over time can be significant
The earlier you start investing within your TFSA the higher the returns you can generate in this account over time. Stick in it for the long-term and let compound interest work its magic. The higher the returns over your lifetime the greater your tax saving will be which means more money in your pocket when it comes to withdrawals one day.
Over 30 years, you can have an investment balance which is 41% greater than that of a taxable investment.
They are best used for retirement saving
I have seen some articles that promote TFSA’s for things like saving for your child’s education. This may not be a wise move, remember you have a R40 000 allowance on capital gains every and the benefits of a tax free savings account are only going to increase the longer you stay invested. Withdrawing yearly for school fees doesn’t align with that goal.
Quite simply put, your tax-free accounts should be the first place your money is invested and the last place that you withdraw from. It is the ideal long-term retirement savings vehicle, and should be one of the of your investment portfolio.