The tax-free savings account came to life in 2015 and was introduced by the South African government to encourage citizens to save.

What is a Tax-Free Savings Account?

A tax-free savings account (TFSA) allows money invested in the account to grow over a longer period while remaining exempt from tax.

Therefore, the amount invested as well as the interest earned on the investment are not taxable.

Tax-free Savings Account Rules South Africa

Although the idea of not being taxed on the money you have saved so diligently, we always encourage anyone who is interested in a TFSA to first understand the ins and outs of such an account.

Restrictions

Both annual and lifetime restrictions are applicable to the amount of money you can save.

Per annum, you are limited to a total savings of R33 000 and in your lifetime, you cannot exceed a total of R500 000.

Initially, the limit of was R30 000 per annum but was raised in March 2017. This goes to say that a potential increase in limits may be possible in the years to come, especially based on inflation and other market related changes.

Any contributions which exceed these limits are taxed at a rate of 40% and will be payable by you on assessment for the relevant tax year.

Furthermore, it is solely your responsibility to monitor your contributions to make sure that you don’t exceed the limits.

Although your total contributions cannot exceed the limit of R500 000, the interest you earn on this amount is allowed to exceed this amount. You will not be taxed on any interest earned which results in the amount of R500 000 being exceeded.

Roll-over is Not Allowed

Should you not make use of your annual allowance, this allowance will not be rolled over into the following year. Therefore, any amount up to the limit of R33 000 that you do not saved, you will forfeit.

For example: if you save a total of R20 000 in one year, the remaining R13 000 will not be carried over and added to the following years’ limit of R33 000.

This may seem disadvantageous, as your financial situation may improve as you progress, allowing you to contribute more in one year than you were able to in previous years.

However, this is a mechanism put into place which serves to encourage South Africans to save as much as they possibly.

You Cannot Reinvest Withdrawals

Should you invest the full allowance of R33 000 in one tax year, but choose to withdraw an amount, you are not permitted to reinvest the withdrawn amount without penalty.

For example: If you withdraw and then reinvest the amount of R10 000 within the same year, your total contribution will total R43 000 and you will be taxed accordingly.

Be Careful When Switching

If you have an amount of money invested in on tax-free savings account and would like to move this amount to a different TFSA with a higher interest rate, it will be considered a new contribution.

This switching process is considered a disinvestment and reinvestment. Therefore, even though the amount was previously invested in a TFSA, the annual contribution for the current tax year will be reduced by the amount in question.

However, you are allowed to have more than one TFSA as long as the combined total of your contributions do not exceed the stipulated limits.

Therefore, instead of switching your existing investment, it may be wiser to open an additional TFSA with the product offering a higher interest rate.

In this case, you can contribute more towards the higher interest earning account and slightly less into the account which offers a lower interest rate.

Are Tax-Free Savings Accounts Worth it?

TFSAs were initially aimed to encourage low to middle income earning South Africans to start a long-term investment without the burden of paying tax on the interest rate earned.

These accounts are certainly beneficial to anyone who can make the most of the perks that come with such accounts.

The tax-free perks apply to every person who has a TFSA, but the degree to which they will benefit depends largely on factors such as age, level of current debt and level of income.

Age

The younger you are when you start saving with a TFSA, the more you can benefit by saving diligently from a young age, you may be more likely to reach the lifetime limit of R500 000 much sooner.

Therefore, there are more years until retirement over which your investment can earn interest and grow.

Furthermore, a TFSA may offer more flexibility at the age of retirement than what a retirement annuity (RA) will.

RAs generally come with annuity income, withdrawal restrictions and taxation.

Level of Debt

Because banks charge more interest on debt than what they pay on savings, trying to save while in a place of debt is counterproductive.

The sad truth is that an average South African household spends up to 70% of their earnings on debt repayments.

Therefore, the long-term benefits of a tax-free savings account do not exceed that of paying off debt as quickly as possible.

We encourage our clients to make every possible effort to settle their bad debt as quickly as possible so that they can begin to save that money instead.

Level of Income

According to Cosatu’s estimates, around 60% of South Africa’s population earns less than R60 000 per annum which is below the tax threshold of R75 750 per year.

For a person who earns R60 000 per year to be liable for income tax, they will need to have a current investment of just more than R185 000, yielding 8.5% per year. Unfortunately, this is an unlikely scenario.

Therefore, without a use of a TFSA, they can make use of the current tax exemption accounts which allow R23 000 per annum and still avoid paying tax on the interest earned.

However, for those who are in a higher income bracket and who are paying income tax, a TFSA is a good option.

Olemera Financial Planners in Johannesburg

For further information about tax-free savings accounts in South Africa or to find out more about our comprehensive financial planning services, contact us.