With a tax-free investment account, you don’t pay tax on your investment returns – both while you’re invested and when your investment pays out. The taxes you save remain invested to grow, which can make a big difference in the long run.
Tax-free means:
- No tax on interest or other income
- No dividend tax
- No capital gains tax
This type of investing works especially well if you earn taxable income. You can get tax-free savings products including cash deposits and ETFs through nearly all banks, investment companies, and stockbrokers.
Read: How To Invest In Stocks: Step By Step Guide
South Africa has one of the lowest household savings rates in the world, To encourage the culture of savings, the government introduced tax-free investment and tax-free savings accounts in 2015 to incentivize good savings habits. Tax-free investment and tax-free savings are relatively the same things.
Pros and Cons of Tax-Free Investing
Pros
- It grows your savings without any taxation.
- You have unrestricted access to your money. (However, it is recommended to keep your money saved in the account over a long-term horizon so as to fully realize the benefit of compounding your tax-free return.)
- You do not pay any initial fees or exit penalties
- Choose from a range of funds to suit your investment needs.
- You have the option of opening a tax-free investment for minor children.
Cons
- Only South African resident individual investors (not trusts, companies, stokvels, etc.) are eligible.
You are only able to contribute a maximum of R33 000 per annum or R500 000 over your lifetime. - Any amount exceeding the annual or lifetime contribution limit will be subject to significant tax penalties (taxed at 40%)
The contribution limit applies to all the tax-free accounts held in the individual’s name.
Read: Types Of Stocks To Invest In
Tax-free investment Account: frequently asked questions
Am I allowed to withdraw from my TFSA?
You can make withdrawals from your TFSA at any time. However, it is best practice to keep your capital invested in your TFSA for as long as possible to maximize your tax benefits. Any withdrawn contributions will still count towards your lifetime contribution limit. If an investor has already reached their annual or lifetime contribution limit, that investor may not withdraw and contribute again.
Can I open more than one TFSA?
There is no limit to the number of Tax-Free Savings Accounts you can have, but you must ensure the sum of your annual contributions across all TFSAs doesn’t exceed the annual contribution limit, or you will have to pay the penalty tax.
What is the difference between TFSAs and retirement annuities?
Tax-Free Savings Accounts were created to encourage saving and not as a retirement product, although you may use them for retirement savings. The key distinction is that TFSA contributions are made with after-tax money and do not qualify for any deductions against taxable income. Retirement annuity contributions, on the other hand, are made with pre-tax money and are deductible from your taxable income.
TFSAs and RAs also differ with respect to access to funds, investment allocation limits, tax levied on withdrawals, and contribution allowances.
Read: How Much Should I Save For Retirement
Can I set up a TFSA for my child?
Yes, only parents and legal guardians can set up a Tax-Free Savings Account in their child’s name. To do so the minor must have his or her own ID number and zeros can be entered in place of a tax number for a minor. If the parent or guardian uses the parent’s tax number, then all contributions will be linked to the parent’s tax number and count towards the parent’s Tax-Free Savings Account contribution limit.
In order to set up a TFSA for a minor, the following is required:
The child’s parent or legal guardian has to complete the application
The parent has to supply a copy of the unabridged birth certificate of the minor
The parent has to supply a copy of their (the parent’s) ID
Can I transfer my TFSA from one provider to another?
Yes. If you wish to transfer your TFSA from one provider to another, keep in mind that such a transfer can only be made between service providers. You cannot withdraw your funds from one TFSA and deposit them into a new TFSA. Such action would be seen as a withdrawal, and any reinvestment would then count toward your annual and lifetime allowances.
What is the period for which the annual limit applies?
The South African tax year runs from 1 March to 28 February of the next year.
What happens if I contribute more than my annual allowable amount of R36,000?
If you contribute more than your annual allowable amount of R36,000 in a tax year the amount contributed above the annual allowance will be taxed at a rate of 40%, regardless of your personal income tax rate. This is a risk, especially if you are contributing towards multiple TFSAs.
For example: If in one tax year, you invest R16,000 in a TFSA with provider A and R30,000 in a TFSA with provider B, you will have contributed R10,000 more than the annual limit. You will have to pay 40% tax on the excess R10,000 you have invested ie a tax penalty of R4,000 on the R10,000 above the annual limit.
It’s important to monitor your TFSAs across all accounts regularly to avoid exceeding the limit.
Should I let SARS know that I have a TFSA?
Even though no tax is payable on earnings within a TFSA, South African tax residents are obliged to disclose information about their investments to Sars when submitting annual tax returns. This includes certificates issued for income within a TFSA.
How to invest in a Tax-free investment account
It can be used in a fixed-term bank account, money market, unit trust, a JSE-listed exchange-traded fund, and more.
Best way to maximize on your Tax-Free Savings Account: Exchange-traded fund and a Unit Trust
Exchange-traded funds (ETFs) are passively managed investment funds that track the performance of a basket of pre-determined assets and are a collection of individual assets. You can invest in stocks, commodities, bonds, currencies, or a mixture of different assets to give you basically anything your heart desires.
Read: HOW TO READ A FACT SHEETS/MDDs
Similar to a standard unit trust, tax-free unit trusts allow you to invest in top-performing companies and have the potential to generate greater returns than an ordinary bank account over the long run. Unlike a standard unit trust, you don’t pay tax on interest, dividends, and capital gains, which means your investment has the potential to grow faster.
Four TFSA providers offering ETFs:
Three TFSA providers offering unit trusts:
- Allan Gray
- Coronation
- NinetyOne
There are more platforms that offer TFSA unit trusts. Before opening a tax-free investment account do your own research and make sure the decision you take aligns with your goals.
Satrix, Sygnia, and Easy Equities offer both ETFs and unit trusts, but – if you’re investing for the long term – the total fees on ETF-powered TFSAs beat that of unit trusts tracking the same index.
A TFSA should be viewed as part of your overall investment portfolio to ensure that it is achieving its purpose.
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