Everyone should have a Tax Free Savings Account (TFSA)
During his 2015 budget speech Nhlanhla Nene introduced the tax free savings account to the public, with the purpose of increasing the dismal state of savings culture in South Africa.
Personally I have heard a lot of hesitancy to start such an account, and wondered whether or not people feel there is some sort of catch to them. There must be some serious restrictions to these types of accounts right? Just another account I cannot touch till I retire or just another account that I must pay a fortune for in fees right? Let’s delve into some facts about these accounts:
Your contributions are limited
Accordingly to legislation you can only contribute a maximum of R33 000 for each tax year, and a maximum of R500 000 for your lifetime (these contributions are sure to increase in future budget speeches). For most middle class individuals R33 000 per year is completely reasonable and it would take just over 16 years to max out these contributions.
There are no growth limits to your investment and dividends are not considered as contributions however there will be large penalties if you contribute over contribution limits (40% tax on all contributions over R33 000 per year). It is your responsibility to adhere to the monitoring of your account and your contributions. Having multiple TFSA’s also does not help with this as this contribution counts with regard to all tax free savings vehicles.
Can I withdraw?
You can withdraw freely at any time from a TFSA, however if you withdraw money from this account your contributions have still been made and you cannot contribute over your total R33 000 per year and R500 000 for your lifetime no matter how much of the investment you withdraw.
All withdrawals are completely tax free – no income tax, no capital gains tax and no dividend withholding tax while invested.
Transferring your funds from one account to another are currently not possible, but this is in the pipeline for the future.
Fees are determined by the account provider
These are some of the most competitively priced accounts on offer as everyone is competing for a stake in the general public’s savings. Regulations state that fees for tax free savings accounts need to be reasonable, and amid the intense investment fees must fall focus most providers seem to be very well priced. Providers are strictly not allowed to charge performance fees to these accounts.
What can you invest in?
Currently you may invest in unit trusts (only without performance fees), bonds and most ETF’s.
It is crucial to not to let your funds be exposed to only bank account interest, which is sadly how many people have been using their tax free savings account. Since this is a long-term investment vehicle it is important to invest in higher risk asset classes (such as ETF’s), which will give you the best return in the long run.
Click here for a list of ETF’s you are able to invest your tax free funds in to.
The benefits of this investment over time can be significant
The earlier you start your tax free account the more interest you can generate on this investment over time, and the more income you generate the greater your tax saving will be. It does not necessity mean that it is the most effective way to save (although it can be), retirement annuities if utilised properly and given reasonable fees can still provide greater tax benefits because these contributions are deductible to your taxable earnings (retirement annuities generally cost an arm and a leg in fees).
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 year to utilise and the benefits of a tax free savings account are only going to increase the longer you stay invested.
In summary tax free savings accounts haven’t always had the press that they entirely deserve. They are not ideal for every situation, but for individuals with many more years left until retirement I feel that they are a must have.