Making the most of your TFSA

TFSAs are a great initiative from government to encourage savings in South Africa. However, it is important to set them up correctly as long-term investments in order to maximise an investor’s lifetime tax benefit from the product.

25 Jan 2023

8 minutes

Jaco van Tonder

The fast view

  • A TFSA is not the only tax-efficient savings option. In general, investors should first provide for an adequate contribution to their retirement fund before taking out a TFSA.
  • The tax benefits of TFSAs compound exponentially over time.
  • Lifetime TFSA contribution limits are precious - don’t waste them.
  • The investment portfolio should be consistent with the investment horizon.
  • It is important to set a TFSA up correctly as long-term investments in order to maximise a client’s lifetime tax benefit from the product.

Tax-free savings accounts (TFSAs) were introduced in South Africa in 2015 to encourage individuals who are resident in South Africa to save more. The growth and income received on a TFSA investment are tax free. This means that you are not liable for any capital gains tax (CGT) or income tax on the dividends and interest received on your investment. But there are limits on how much you can contribute to a TFSA per annum, and over your entire lifetime.

The TFSA product is coming up for its eighth anniversary in February 2023, and over the past seven years many product providers, including life companies, banks, unit trust companies and LISP investment platforms, have jumped on the bandwagon and launched TFSAs. This proliferation of options and the accompanying wave of good news marketing material have confused many advisors and investors, leaving them wondering how best to utilise a TFSA as one of several different tax-efficient savings tools.

In this article we share some of the questions and feedback we have received when discussing this matter with financial advisors and highlight the implications of some of the product options.

01. A TFSA is not the only tax-efficient savings option

A lot of the media coverage on TFSAs appears to take people’s eyes off the fact that the first savings priority for any investor remains their contribution to some type of registered retirement fund (via their employer or a retirement annuity). In general, investors should first provide for an adequate contribution to their retirement fund before taking out a TFSA.

Over the course of 2020 and 2021, amid the impact of COVID-19 on the SA economy and markets, South African retirement funds were on the receiving end of some bad publicity. Specifically, the investment restrictions imposed on South African retirement funds via Regulation 28 attracted significant media coverage. The restriction on offshore investment exposure was significantly relaxed in March 2022, allowing retirement funds the freedom to invest up to 45% of their portfolio outside of South Africa. The tax benefits available to South African retirement fund investors really are significant. Especially when compounded over a period of twenty years or more, these benefits dwarf those of a TFSA. We remain convinced that retirement funds present good value to investors given the tax benefits

Secondly, investors should remember to use their annual tax-free interest exemption (currently R23 800 per year for individuals under age 65). At current money market rates of between 6% and 7%, an investor in South Africa can keep up to R350 000 in a fixed income fund before paying any tax on the interest. Ideally, this allowance should be used to set up an investor’s emergency cash pool.

02. The tax benefits of TFSAs compound exponentially over time

When TFSAs were originally launched, many investors and advisors underestimated the extent to which the tax benefits on TFSAs would compound over time. This happened because, unlike a retirement fund, the TFSA contribution is not tax-deductible upfront. This makes it difficult to calculate the rand value of the tax benefits.

These points are best illustrated by an example. In Figure 1 we project a TFSA’s fund values over a twenty-year period based on the following assumptions:

  • An investor contributes the maximum annual amount of R36 000, and this limit is never increased by National Treasury.
  • The R500 000 lifetime limit is never increased, and contributions cease when this limit is reached.
  • Assume a 10% per annum (p.a.) investment return and inflation of 6% p.a.
  • Further assume a roughly 50/50 split in investment return between interest and capital gain, resulting in an effective combined tax rate of 30% on total investment returns.

Figure 1: TFSA value projection split between contributions and investment return

Figure 1: TFSA value projection split between contributions and investment return

From Figure 1 there are three takeaways:

  • The investment return (the pink bars) takes a long time to accumulate, and only really becomes significant after ten years.
  • In the first five years the impact of the tax benefit is negligible.
  • After twenty years the tax saving represents more than 20% of the total fund value.

From a tax benefit perspective, it appears to not make sense for an investor to utilise a TFSA for an investment horizon of shorter than five years. This position, however, changes drastically after ten years due to the well known compounding effect of long-term investment returns.

03. Lifetime TFSA contribution limits are precious – don’t waste them

Current TFSA product rules, as set out by National Treasury, do not allow an investor to recover any part of their lifetime TFSA contribution limit should they need to dip into the TFSA assets to fund an emergency expense. Every time an investor uses part of their TFSA contribution allowance, that allowance is gone forever.

Withdrawals from a TFSA therefore waste part of an investor’s lifetime contribution allowance – ideally something to be avoided.

04. The investment portfolio should be consistent with the investment horizon

Another point that frequently comes up in advisor discussions deals with the ideal investment portfolio for a TFSA. There are two key considerations when constructing an investment portfolio for a TFSA investment:

  • As highlighted above, TFSA investments should be ten-year or longer investments, and investment portfolios should reflect this long-term investment focus.
  • Since TFSAs do not attract income tax or CGT, the risk-return characteristics of TFSA portfolios are neutral to whether returns come from capital gain, interest or dividends.

The simplest way to look at this problem is to evaluate different investment strategies with reference to a long-term return and volatility measure, and see how they stack up. In Figure 2 we give an example of such a comparison, looking at the fifteen-year annualised return and volatility statistics for several potential TFSA investment options.

Figure 2: Fifteen-year annualised return/volatility

Figure 2: Fifteen-year annualised return/volatility

Source: Morningstar Direct, as at 31.12.22. Performance figures are based on a lump sum investment, NAV to NAV, net of fees. Highest and lowest annualised returns since inception of the Ninety One Global Franchise Feeder, Opportunity, Equity and Money Market funds (12-month rolling performance figures) are: 45% and -40%; 43.8% and -15.7%; 65.8% and -34.8%; 18.8% and 3.8%, respectively. The total expense ratio of the Ninety One Global Franchise Feeder, Opportunity, Equity and Money Market funds (A class) are: 2.10%; 1.94%, 1.96% and 0.18%, respectively. Funds shown are for illustrative purposes only and are not necessarily the classes available on the Ninety One platform for TFSAs.

Figure 2 illustrates what we know intuitively – more conservative, fixed income-orientated portfolios merely reduce the likely long-term investment returns without really adding anything to the portfolio (since long-term investors should not be concerned about volatility).

Secondly, even though fixed income investments seem attractive because they appear to maximise the tax benefit for the investor in the short term, they disappoint in the long term because of their significantly lower total returns.

It seems that a good starting point for most TFSA investors is to have a look at unit trust funds from the “ASISA South African Multi-Asset: High Equity” category, or something similar. These funds have historically produced attractive long-term risk-return trade-offs.

Given that TFSA investment portfolios are not restricted by regulation and are long term in nature, investors with time horizons exceeding ten years should even consider more aggressive investment portfolios. The most popular investment portfolio for the Ninety One TFSA has been the Ninety One Global Franchise Feeder Fund, an offshore equity fund, which makes up twenty percent of total assets in the Ninety One TFSA product.

05. Keep it simple

Most large South African financial services companies have launched their own TFSA products, offering a range of options. Setting up a TFSA might sound like a daunting task. But it should not be – the best strategy really is to keep it simple.

There are several benefits to picking an investment platform, such as the Ninety One Investment Platform, for TFSAs:

  • Investors have access to a wide choice of local and international funds covering all risk profiles.
  • Investors can simply switch between funds on the platform if needed, avoiding the need for messy TFSA transfers.
  • Investors and advisors can monitor contributions to TFSAs centrally to ensure they do not exceed their annual TFSA contribution limits.
  • Investors can easily see a consolidated view of their entire investment portfolio, which might include a retirement annuity and discretionary investments in addition to a TFSA.

TFSAs are a great initiative from government to encourage savings in South Africa and are important financial planning tools for financial advisors. However, it is important to set them up correctly as long-term investments in order to maximise a client’s lifetime tax benefit from the product.

TFSA fast facts - Ninety One Investment Platform (IP)

The benefits of a TFSA are increasingly being recognised, as illustrated by the following summary data of Ninety One IP’s TFSA accounts as at 31 December 2022 (31 December 2021 details in brackets):
TFSA fast facts - Ninety One Investment Platform (IP)

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Authored by

Jaco van Tonder
Advisor Services Director

Important information

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