The crux of the issue, says senior lecturer at the University of the Witwatersrand Lumkile Mondi, is how to hold the government accountable.
Why tax-free savings accounts?
Tax-Free Savings Accounts (TFSAs) were launched in 2015 by the government as a way to encourage South African households to save, and to increase the overall level of savings in the economy. South African households are sitting at a just over 15% savings rate; this is indicative of a low savings culture and lack of financial literacy among citizens.
How do they work?
An individual is allowed to invest a lump sum of up to R33 000 annually or R2 750 per month into the TFSA. While these amounts may not sound substantial, the compounding effect, together with the fact that the investment is tax-free, proves to be significant over the long term.
These contributions are capped at a R500 000 limit per person in their lifetime. Due to inflation, these limits are likely to be adjusted and increased every couple of years.
If you contribute more than the prescribed amounts as stated above, you will pay tax of 40% on the excess amount. It is therefore advisable not to exceed these limits, especially if you are below the 40% tax bracket.
Investors are allowed to invest in more than one tax-free savings account, as long as the R33 000 annual limit for total investments is not breached.
The benefits
With TFSAs you do not pay any capital gains tax (both when you withdraw or switch between funds), dividend withholding tax or tax on interest. The benefits can then only truly be experienced once the value of the investment exceeds the annual interest exemption and the capital gains exclusion. It is therefore advisable to invest in a tax-free savings account with a long-term view.
Estate planning benefits
Since you can choose beneficiaries on the investment, your investment can be paid to your beneficiaries immediately, and there are no executor fees. Although your beneficiaries will not have to wait for the estate to be wound up, the value of the investment will still be included in the estate for the calculation of estate duty.
What can TFSAs can be used for?
- You can use your tax-free savings investment as a top-up for retirement, after having exceeded the R350 000 mark per annum that one can receive a tax break on.
- Although the majority of South Africans hardly exceed the R350 000 contribution, TFSAs can provide you with the flexibility to access the capital before retirement, which you cannot do with your retirement annuity.
- You can open a TFSA for your minor child to fund their education or future, but since there is an individual lifetime limit of R500 000, the child may forfeit the benefits as an adult.
Investments that qualify as TFSAs
You can invest in tax-free savings accounts via unit trusts, exchange-traded funds, and some fixed deposits and endowment policies. This gives you the opportunity to access and invest in a diversified portfolio of different asset classes, i.e. equity, property, bonds and cash. A good opportunity also lies in investing in exchange-traded funds where you can possibly track a global index, giving you exposure to international markets.
Note that currently an investor cannot transfer their TFSA from one provider to another.
Costs involved in investing in TFSAs
The aim of government introducing TFSAs is to provide simple, cost-efficient products that can be easily understood by the average person. Although the aim is to keep costs as low as possible, costs that can still arise are:
- Service fee of the fund selected;
- Financial adviser service fees; and
- Platform service fees (in the case of a linked service provider account).
Providers are not allowed to charge performance fees.
On average, investing in a TFSA saves 1% a year in costs compared to other investments. While the number might sound insignificant, over time it does make a big difference on your investment returns.
You need to choose a suitable tax-free savings account based on your goals and time horizon.