Jan 21, 2022
The South African government introduced tax-free savings accounts (TFSAs) to encourage individuals to save. As TFSAs are not subject to income or capital gains tax, more money is available to help your investment grow over time. While TFSAs offer attractive tax benefits, here are four money moves you should avoid to ensure your TFSA works for you.
The current annual TFSA contribution limit is R36 000 and the lifetime limit is R500 000. Any amount you contribute in excess of these limits will be subject to 40% tax payable by you. Financial institutions that offer TFSAs are required to inform the South African Revenue Service (SARS) of an individual’s contributions to their TFSA. SARS will monitor the individual’s annual and lifetime limits to determine if any penalties should apply. It remains the responsibility of the investor that they do not breach the annual or lifetime limits.
Some investors may hold TFSAs with different financial institutions, so it’s important to carefully check that the total contribution amount across providers does not exceed the limits.
A TFSA is a very liquid investment – there is no investment term. You can withdraw a portion or all of your savings whenever you want to – and you won’t pay any tax. When you make a withdrawal, you may face a tax penalty if you top up what you took out within the same tax year. It will depend on whether your reinvestment results in you exceeding your contribution limits. Any reinvestments will be regarded as new contributions and will be added to the existing contributions to calculate the total contribution limits. For example, if you invest R36 000 at the start of the tax year, subsequently withdraw R10 000 and later reinvest this amount in the same tax year, you will be subject to 40% tax on the R10 000 you have ‘added back’. Some financial institutions, including Ninety One Investment Platform, have systems in place to help prevent breaches to contribution limits, but ultimately it is the responsibility of the investor to comply with the limits. It takes time to build up a decent nest egg, so the money you commit to your TFSA should be allowed to grow. Sticking to a budget and setting up a separate emergency cash fund will help you stay invested in your TFSA.
Remember, investors also have an annual tax-free interest exemption, which comes in handy when setting up an emergency cash pool.
There are a wide variety of unit trusts funds in which to invest your TFSA, ranging from money market funds to equity funds. Investors typically only realise the tax benefits of a TFSA after ten years, so it’s important to take a long-term view. Consider a fund that has a significant allocation to assets that offers capital growth over the long term such as equities (both local and offshore). A cash investment, which only pays you interest on your capital, tends to provide much lower returns over the long term and will not keep pace with inflation. Investing in funds that offer attractive income and capital growth over the long term means that you should reap more tax benefits from your TFSA – besides paying no tax on interest earned or dividends, your capital gains will also be free from tax. More of your money will be available to benefit from the power of compounding growth.
The longer you remain invested, the bigger your potential growth and tax saving.
TFSA investors may be tempted to switch out of a fund when performance dips. For example, the performance of equity funds can fluctuate markedly. As these funds are long-term investments, it’s important to avoid focusing on short-term performance. In March 2020, equity funds were hard hit as the health and economic impact of COVID led to a crash in financial markets. Investors who sold out of equities at the market lows locked in their portfolio losses. The recovery in markets benefited those long-term investors who chose to ride out the difficult market conditions.
Sometimes, the best move is making no move at all. Of course, selecting a suitable fund is crucial to the success of your TFSA.