To have a tax-free savings account or not?
Should you have a tax-free savings account or not?
Should you have a tax-free savings account or not? It seems as if it is the ideal vehicle to save, regardless of the goal or time horizon, because the returns are tax-free. However, there are a few considerations in having a tax-free savings account.
Ester Ochse, product head of FNB Integrated Advice, says, “A tax-free savings account was made available because of South Africa’s low savings culture, with a household savings rate of 0.2%.
“Stats SA notes that less than 36% of South Africans spend over 10% of their income on saving, investing and insuring.
“To address this, an internationally recognised savings and investment vehicle, the Tax-Free Savings Account (TFSA), encouraged a culture of savings in South Africa.”
Ochse highlights considerations when taking out a TFSA.
1. Stay within the contribution limits
If you contribute within the limits, the growth is tax-free, but 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 the account level.
Be especially cautious when contributing to multiple TFSAs. It may be better to have only one TFSA, for ease of management and to leverage the compound interest effect.
2. Try not to withdraw from your TFSA
A TFSA is not a transaction account. The idea is to add funds and let them grow over the long term. The reason is that when one has contributed to a TFSA and then withdraws from it, you cannot top it up again, as the original contribution counts towards your lifetime contribution.
For example, if you have contributed R72 000 to a TFSA over two years and 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 return the R20 000, it would be considered an over-contribution and could be taxed at the 40% rate. Leave contributions untouched to take full advantage of your TFSA.
3. TFSA is a great long-term investment vehicle
With the benefits of tax-free growth in a TFSA, it makes the ideal vehicle to consider as an add-on for retirement savings.
However, remember, it is not a retirement vehicle. It can add to your retirement nest egg, which may include your company pension fund, preservation funds or retirement annuity.
4. 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. When investigating a TFSA, consider your goal with the investment and when you will use 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 ETFs with higher exposure to growth-type assets (property and shares).
Cash investments should be used for shorter and low-risk investments, as they will most likely underperform inflation over the long term.
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 offer.
5. Should I open a TFSA for my child?
This comes down to what the intention is. If you open one in their name, you are using their lifetime contribution limit. It can be 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, 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, explained, “A TFSA is a 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 and the growth on that is tax-free, regardless of whether that growth is from compound interest, dividends or capital.”
A TFSA is a great long-term saving vehicle and should be used as such. For example, a 30-year-old contributes R3 000 per month to a TFSA, specifically, into a high-growth portfolio that targets CPI +5% and leaves 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 withdrawing and using it, you leave it to supplement your retirement. At 70 years, the investment is worth about R12 300 790, which they can 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 would not 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,” concluded Ochse.
