Setting the record straight on tax-free savings accounts

With the thundercloud of high inflation, low growth rates and the prospect of a recession grumbling overhead as we enter 2023, a tax-free investment remains a ray of sunshine poking through the gloom. If ever you were going to open a tax-free savings account (TFSA), this is the year to do it.

TFSAs were introduced by the government eight years ago to encourage South Africans to stop slacking on saving. Each citizen is allowed to invest up to R36,000 a year 100% tax-free and up to a maximum of R500,000 in their lifetime.

There is zero tax on your capital investment or any growth on that investment, and zero tax on any withdrawals —  which means you get every cent your investment makes. The other major bonus is that TFSAs must, by law, be low-fee, so there’s less chance of high fees eroding your investment over time.  

So why, with this major incentive, are more South Africans not making use of this tax-free gift from government? Based on conversations I’ve had with friends, family and clients, I suspect it has something to do with poor communication, which has led to many falsehoods about TFSAs. It’s time to debunk these myths. 

Myth 1: A TFSA is one type of account

A TFSA is not a single, standardised investment vehicle (or account). A TFSA is the name given to any investment product designed for tax-free saving in SA. Provided it adheres to government regulations for tax-free savings vehicles, such as carrying low fees, a TFSA can be any of a number of investment products. These range from the stock-standard fixed deposit savings accounts offered by most banks to index-tracking funds and specialised electronically traded funds (ETFs).

Myth 2: You can only have one TFSA

You can open as many TFSAs as you like with as many different service providers as you like. The only restriction is the total of your annual contributions across your TFSAs must not exceed the yearly tax-free savings limit of R36,000. If you do go over the tax-free savings annual limit, the excess will be subject to 40% tax. 

Myth 3: TFSAs are for local investments only

There is no restriction on investing your annual tax free allowance offshore. Provided the offshore TFSA adheres to the rules for tax-free savings vehicles in SA, you can invest some or all of your annual allowance in, for example, an index-tracking fund with high offshore exposure or one or more 100% offshore exchange traded funds (ETFs).

This flexibility is another reason why a TFSA is a great investment choice: it allows you to diversify your investment portfolio by easily gaining offshore exposure, all while paying zero tax.

Myth 4: You can’t withdraw any money from a TFSA until retirement

You can withdraw money from your TFSA when you like with no penalty. The exception is TFSA products such as fixed deposits that may have a maturity term, but even in this case, the money must be made accessible to you within 32 days.

Warning: just because you can withdraw from your TFSA does not mean you should. Withdrawing from your TFSA may prevent you from reaching your savings goals, and it will definitely have an impact on your retirement outcome. This is because every withdrawal from your TFSA will count against the one-off R500,000 tax-free withdrawal limit every person is eligible for at retirement. For example, if you withdraw R200,000 from your TFSA when you’re 35, you will only be able withdraw R300,000 tax-free when you retire, and the balance will be taxed. 

And no, you cannot withdraw from your TFSA and then put it back without affecting your lifetime tax-free withdrawal limit. Every deduction counts as part of your lifetime tax-free withdrawal limit and every deposit counts towards your lifetime maximum contribution limit. 

While it’s good that you can access money from your TFSA whenever you like, it’s unwise to use it as a piggy bank. 

Myth 5: You need a certain level of income and/or regular income to open a TFSA

Anyone can open a TFSA in SA, no matter how much or little they earn or whether they’re income is regular or not. The only requirement is that you make the minimum contributions set by the service provider, which can be as low as R250 a month or even a lump-sum payment once a year. 

If you open a TFSA and cannot make the set payments, you may stop contributing at any time and resume at any time, all without any penalty. Nothing will happen to your savings if you stop paying; your capital investment will continue to grow according to the TFSA’s performance. For example, if you have R20,000 invested in a fund with an annual growth rate of 5% and then stop paying, that capital investment will grow by 5% tax-free.  

Myth 6: You must pay into a TFSA every month 

Not all service providers require monthly payments. Some allow you to make an initial lump sum payment into a TFSA, and then leave it up to you whether to contribute monthly, annually or not at all. 

Myth 7: You have to invest a minimum amount in a TFSA each year

It is advisable, but not compulsory, to make the most out of your tax-free savings allowance by contributing as much as you can to your TFSA each year. If you are below the R36,000 a year cap before February 28 2023, it’s a smart move to make whatever lump sum payment you can before the cut-off date to maximise your annual tax-free savings allowance.

Myth 8: You can only get a TFSA if you’re 18 or older

Every SA citizen, from newborns to pensioners, may have a TFSA at any time of their life. While under-18s may not open a TFSA themselves, a parent or guardian may open a TFSA on behalf of a minor child. 

It’s a great idea for parents to open a TFSA for their child, as it’s possibly the best savings vehicle for their future education. Due to zero tax and low fees, whatever you invest will benefit fully from compound interest during what is typically a long investment timeline. This means the returns should be fantastic if you choose the right TFSA. 

Myth 9: A TFSA is the same as a retirement annuity

Both TFSAs and retirement annuities (RAs) carry zero tax on the growth of your investment (capital gains, dividends and interest). That’s where the similarities between the two end, though.

You can withdraw from a TFSA whenever you like, whereas you are not allowed to withdraw from an RA until the age of 55. This is set to change when the government's new two-pot retirement system comes into effect on March 1 2024. The new system will see contributions to RAs split into a retirement pot that cannot be touched until retirement age and a smaller savings pot, which you will be able to make withdrawals from once every 12 months. 

Even under the new system there is an integral difference between TFSAs and RAs: all withdrawals from the savings pot of an RA will be taxed at marginal rates, whereas withdrawals from a TFSA will remain as is — 100% tax-free. 

The other big difference is that any contributions made to an RA qualify for a tax deduction of up to 27.5% of your taxable income (up to a maximum of R350,000 a year), whereas there is no tax deduction allowed for contributions to TFSAs. 

Importantly, RAs are limited to a maximum 45% offshore exposure whereas a TFSA allows you to invest 100% offshore. 

Myth 10: If you have a retirement annuity you don’t need a TFSA

A TFSA should be viewed as an important part of your long-term retirement plan because it serves as a highly tax-efficient way of supplementing your retirement savings.

An RA or provident fund is usually used as the main investment vehicle because most people won’t be able to retire comfortably on a TFSA’s R500,000 lifetime limit. However, a TFSA can, and should, be used for all extra savings as it carries zero tax and can therefore significantly boost your retirement outcome. 

It must be noted that when the new two-pot system comes into effect you will have the option to put extra savings into the savings pot of your RA. It will still be advisable to first put extra savings into a TFSA because these withdrawals are not taxed, whereas withdrawals from the savings pot will be taxed at marginal rates.

In addition, you can invest 100% offshore with a TFSA and diversify your investment portfolio. Putting extra savings into the savings pot of your RA is a good idea only if/when you reach a TFSA’s R36,000 per year or R500,000 lifetime limit.

This article was paid for by Sygnia.