Making the most of your Tax-Free Savings Account

"Some taxpayers close their eyes, some block their ears, some shut their mouths, but all pay through the nose." – Evan Esar , American humourist and writer.

Short of earning less money there are very few ways to (legally) avoid tax, which makes it crucial that you make the most of the avenues that are available to you, such as a investing in to a Tax-Free Savings Account (TFSA).

Tax-Free Savings Accounts, which were introduced in South Africa in 2015, provide tax benefits that can turbocharge your savings and grow your investments. Savers are not liable for any capital gains tax, dividends withholding tax, or tax on interest received on investments held in these accounts.

The tax benefits are indisputable, but it's still important to look at your TFSA in the context of your entire investment portfolio. This will help you to understand how to utilise the tool efficiently and to make sure it's working to help you reach your overall investment goals.

Below are a few tips to help you make the most of your TFSA:

1. Start early and max out your contributions each year

Saving and investing without the burden of tax is always fantastic. However, the really big tax benefits come to those who remain invested for the long term. This is because tax savings increase over time as compound growth is earned on the tax saved. 

The graph below illustrates the impact of compounding tax savings. In Year 1 there is a tax saving of R533 (1% of the investment value) and by Year 20 the annual tax saving is R527,309 (23% of the total investment value):

This means that the longer you are invested the more your money will grow, and the more tax you’ll save. Try to max out your annual contribution limit of R36,000. Remember that if you do not invest the full R36,000 in a year you won’t be able to roll it over to the following year.

2. Avoid the temptation to withdraw money

Even though you are able to withdraw from your TFSA at any time, it is important to understand the long-term implications of doing so. 

Once you have deposited money that amount is deducted from your lifetime contribution for good. There is no replacing withdrawn funds. For example, if you have R300,000 saved in your TFSA and make a full withdrawal, your total remaining lifetime contribution balance will reduce to R200,000. 

Investors should view their TFSA as a long-term investment vehicle rather than an account from which to access cash for an emergency or other short-term needs. 

3. Invest in high-growth assets

When you invest in a TFSA, your time horizon should drive the composition of your portfolio. 

While a more conservative portfolio mix might seem attractive because of its lower-risk profile, historically equities have provided the highest returns over longer time horizons. 

Funds such as the 10X High Equity Index Fund are ideal for maximising growth over the long-term and will give you the best chance of earning a considerable return and maximising the tax benefits of your TFSA. 

You can choose from a range of low-cost 10X TFSA funds suitable for a variety of investment goals.

It is also important to keep in mind that there are already generous tax exemptions for interest income in place. South African taxpayers under the age of 65 are allowed to earn interest income of R23,800 per year tax-free (that increases to R34,500 for those over 65).

So, if you invest your TFSA in a fixed deposit or an interest-bearing account, such as a money market fund, you will get an additional tax benefit only if you earn more than R23,800 in interest (or R34,500 for those over 65).

4. Don’t exceed your contribution limits 

Don’t undo all your good tax-saving work by accidentally contributing too much. If you contribute more than your annual or lifetime limit, the amount contributed above the allowance will be taxed at a rate of 40%, regardless of your personal income tax rate. 

This is a risk, especially if you are contributing to multiple TFSAs so it’s important to keep track of your contributions across all your TFSAs to avoid this. 

For example: If, in one tax year, you invested R16,000 in a TFSA with provider A and R30,000 in a TFSA with provider B, you would have contributed R10,000 more than the annual limit. You would have to pay 40% tax on the excess R10,000 you had invested ie a tax penalty of R4,000 on the R10,000 you invested above the annual limit. 

Ready to get start making the most of a gift from the government? Sign up for a 10X Tax-Free Savings Account before the end of February and, not only will you pay no tax, you’ll also pay no fees until July. That’s right, everyone who signs up for a 10X Tax-Free Savings Account before 28 February 2022 won’t pay fees until 1 July 2022. Ts&Cs apply.

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