Understanding Tax-Free Savings Accounts

Since it was first introduced on March 1 2015, Tax-Free Savings Account (TFSAs) have received a lot of media attention. When they were first introduced with an annual contribution limit of only R 30 000, most people were less than enthused about it, but three years later, it’s worth taking another look at.

According to treasury, the TFSA was designed to encourage a savings culture, without having to pay tax on the earned interest. The secondary objective was to increase the overall level of savings in the economy, which would bring wider macroeconomic benefits.

According to a survey by Intellidex, a total of 207 172 accounts were opened in the 12 months to February 28 2017 (averaging 567 accounts a day), bringing the total number of TFSAs opened since inception in March 2015 to 459 848. Total assets in these accounts amount to R5.174-billion, implying an average account value of R11 251. With the new accounts opened, TFSAs continue to dominate the market. The major asset class held in TFSAs is in the form of cash at just over 47% (from 51% the previous year), followed closely by equities, which rose from 36% to 40%.

What are the benefits of TFSAs?

The TFSA is a great saving and investment vehicle because it allows any South African over the age of 18, regardless of income level, to earn interest on a number of investments without having to pay income tax on the money earned.

You can open your TFSA at a bank, through a broker or an advisor at an insurance company. You can also open multiple accounts with different financial institutions. Just like every other account, interest rates vary on tax free savings accounts. The rate of return will depend on the investment you purchase.

Tax-Free Savings Accounts typically offer lower interest rates than other high interest savings accounts. Holders of this account who don’t max it out have more opportunities to invest in just about anything. In terms of investments options, TFSAs are flexible. You can choose from a wide range of investment options — stocks, bonds, mutual funds, exchange-traded funds that are classified as collective investment schemes, fixed deposits, unit trusts, retail savings bonds, linked investment products and certain endowment policies issued by long-term insurers. Products that expose an investor to an excessive level of market risk are excluded.

TFSAs are flexible and can be used for shorter-term savings, or as a strategic part of your long-term financial plan. Their contribution limit that qualifies for tax exemption is R 33 000 per annum, up to a maximum of R 500 000 per lifetime. You can make periodic monthly contributions or partial contributions to your TFSA. Any unused contribution room can be carried into future years indefinitely.

You are allowed to transfer any portion of the value in any of your TFSA to another service provider, and service providers can facilitate such a transfer. Note that financial institutions might charge a transfer fee to move your account. Your service provider will then issue a certificate specifying the details of the transfer. Additionally you have two weeks to transfer the amount to the new service provider, and the transferred amount will not count towards the annual contribution limit. This was not allowed during the first year of the incentive, until March 1 2016, to allow all product providers to prepare.You should keep this certificate of transfer for a minimum of five years.

How to choose the best TFSA

If you want to take a DIY approach to investing, you can open a self-directed TFSA account and choose for yourself which stocks you want to invest in. When choosing a tax-free savings account, there are a few features you should pay attention to, starting with the interest rate. Some accounts offer “teaser” rates that are higher to start with, but your money will likely earn more interest in a TFSA that offers an everyday high interest rate. Other features to consider include whether the account charges a monthly fee or transaction fees. You should also be informed of whether the account allows you to easily transfer money back and forth with your regular chequing account.

Withdrawal flexibility

You can withdraw money from your TFSA at any time, for any reason, without paying tax. Funds can be accessed within seven business days. This simplifies the accounts and increases liquidity, both of which encourage added savings.

When you withdraw money from your TFSA and then try to deposit the money back within the same year, it could cause your total contributions for the year to exceed the annual contribution room limit. In that case, there is a penalty of 40% of the excess amount. For example: if you invest R 35 000 — exceeded the annual limit by R2 000 — 40% of R 2000 = R800 must be paid to SARS. This penalty is added to the normal tax payable on assessment.

If you’re contributing to or withdrawing from multiple TFSAs make sure you’ve got a system to keep track of everything so you don’t over-contribute.

You can also have more than one tax-free investment, but you are limited to the annual limits per tax year.

Disadvantages of TFSAs

Like any other investment vehicle there are rules to be followed. You cannot use the account as transactional account. Debit or stop orders and ATM transactions will not be possible from these accounts. Only new accounts will qualify as the idea is to encourage new savings, in other words existing accounts may not be converted. In the case of fixed deposits (or policies with a guaranteed return) early withdrawal penalties are allowed.

Think long term

Look at a TFSA as part of your short- and long-term savings plan! If after doing your own research you’re still not sure what’s right for you, your best bet might be consulting a financial advisor. She can give you tailored advice. Your financial advisor can provide the objective advice and portfolio strategy you need to reach your investment goals.

Should you open a TFSA?

If you open a TFSA, you could use it to save for your retirement, to supplement other income you may have, or you could use it for short-term goals like buying a home, a car, or to start a business. If you have money to save, it’s a good idea to put it in a TFSA.

For more on TFSAs visit the South African Revenue Services website.

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