Imagine paying no taxes on an investment and your money can be accessed when you need it. If this is something you are interested in, then a tax-free savings account is for you. This ideal investment scenario is available to all South Africans, but there is one caveat: you can only invest a certain limit in this structure per year.

Rules of Tax-Free Savings Account (TFSA) 

No tax: It sounds too good to be true, but when we said no tax, we meant no tax. Tax-free savings accounts don't pay any income, dividend, or capital gains tax on the returns from this investment. This leaves your investment to grow to its full potential.

Annual limit: The current annual limit is R36,000. This amounts to a R3000 per month contribution. There is also an R500,000 lifetime limit set on contributions. You could have invested R303 000 to date if you add up all the annual limits since the inception of tax-free savings accounts in 2015.

No carryover: Unlike the game pool, where you get two shots and it carries over, a tax-free savings account does not carry over. Meaning if you did not invest the full R36 000 per year, you lose out on it going forward. So maximising it is important. Withdrawing from your fund does not allow you to contribute it back again. Example: You invest R36 000, then a month later withdraw R30 000. You can't invest for that year again, as you have used your limit for the year. 

Penalties: If you contribute more than R36 000 to your tax-free savings account, then a penalty of 40% of the amount over R36 000 will be added to your normal tax payable for that year.

Accessibility: Any person, even minor children, can have multiple tax-free savings accounts. The annual limit of R36000 aggregates across all accounts, meaning you can't contribute more than the annual limit to all your accounts combined. If you desperately need some of your funds, any withdrawals are tax-free on your account. 

Where can I invest in a Tax-Free Savings Account?

We provided an independent rating of all the top tax-free savings account providers in the market. Use this link to review our ratings on TFSA providers.  

What should I use it for?

The alternative investment solution to a tax-free savings account is a discretionary investment. Discretionary investments differ from tax-free savings accounts in that they attract taxes, and you can invest in them as much as you want. Both of them can be used for long-term and short-term goals. As you will see from the below example, tax-free savings accounts are better suited for long-term investment goals as you benefit from no taxes. You can use discretionary investments for short-term savings goals.

Below is an example of the two tax comparisons. Every person in South Africa has an annual interest tax exemption limit of R23 800 for people under the age of 65 and R34 500 for people over the age of 65, which means you need quite an investment amount which growth will be greater than these exemptions. You will notice that initially, the tax consequence is the same between the discretionary investment and tax-free savings account, but over time, as you will see below, your tax liability will start growing.

Here's an example: The below table shows the year of assessment and the annual limit that was applicable for that year, including the interest exemptions that applied each year. I assumed that the investor contributed the annual limit at the beginning of each year and then applied a growth rate of 9% on the investment. In the growth column, the amount within the brackets is the total investment amount for that year and before the brackets shows the growth earned for the year. The column furthest to the right, shows if invested in a discretionary investment, would you have been liable for any taxes on the investment amount. Notice that the tax liability has started to grow in the last two years.

From the example, you will note that using your tax-free savings account to save for a holiday, car, or home deposit might have little tax benefit for you, and you cannot replenish the investment amount if you make a withdrawal. You can use discretionary investments to save in the short term and leave your TFSA to grow uninterrupted. 

As we can see, in the short term, these accounts don't add many tax-free savings, but in the long run, they will be tax-saving machines. Using your tax-free savings account for long-term goals such as children's education and supplementing your retirement savings will have the biggest tax savings and benefits. You want to maximise your growth and leave the investment to grow for a long period to not only start getting tax-free benefits but continue to do so in the future. 

At Finsights, we want you, the everyday hero, to take control of your finances, become aware of financial independence, grow your knowledge, and let us be your financial independence partner. 

Onward to Financial Independence