What is tax-free savings account?
Tax-Free Savings Account (TFSA)
I wish SARS named this the Tax-Free Investment Account because the name is confusing. There is a difference between saving and investing. Saving is putting money away for a specific purpose, maybe an emergency fund or a holiday. Investing is the art of having compounding work in your favor through buying assets like shares, ETFs, etc.
The banks will allow you to invest in a TFSA linked to a money market account, essentially cash. Cash does not beat inflation. Do not choose this option, please.
Open a TFSA linked to the stock market. This way you get exposure to the markets, and you can get dividend income and capital growth, all tax-free.
- No 20% dividend tax
- No Capital Gain Tax
- If there is some form of cash in your TFSA, you will also not pay any tax on the interest earned. This means that you get your full investment return without being taxed on any growth you ever earn.
Contribution limits
Contributions are limited to a maximum of R36 000 per year, and a total lifetime contribution of R500 000. It does not matter if the balance in your TFSA exceeds R500 000 because naturally, investment growth is expected; rather, it is the total lifetime contribution that is limited to R500 000 per individual. If you do not use your annual contribution of R36 000 in a tax year, you will not be permitted to roll it over to the following year, and your contribution will therefore be forfeited.
Summary:
- R36 000 per year into the account.
- If you earn any dividends in your TFSA and you reinvest them, that does not get deducted from your R36k.
- R500 000 lifetime limit in contributions from your pocket.
- If you take out any money, you cannot deduct it from your R500 000. If it is out, it is out. Only R500 000 in. This must be the last place you withdraw from. Do not goal-save in here for a vacation or wedding.
- You can put in the full R36 000 in one go, but you can never put in more.
- EasyEquities has an automatic system where if you try to put in more, they will allocate the over-contribution to your ZAR account.
- If the service provider does not have this automatic system, be very careful. Earnings on the amount above the annual limit will be taxed at a rate of 40% regardless of your personal income tax rate.
- This is a risk, especially if you are contributing towards multiple TFSAs. If you have multiple TFSAs, keep accurate records of deposits.
TFSA for minors
Opening a TFSA for a minor is the best gift you can give your child. The sooner you do this the better. There are no disadvantages to doing this. I have seen many misinformed individuals saying this will disadvantage the child. The only negative is your child will have a compounded portfolio before they turn 18. Why would you want your child to start from scratch when they start working? Sure, they will never be able to contribute on their own. That is the point of generational wealth. Open accounts for the kids.
Share TFSA
SARS needs this vehicle to be as low risk as possible. You cannot invest in single stocks in a TFSA. Only ETFs are allowed. The risk is lower. SARS does not want us to gamble with retirement savings.
I max out my TFSA first every year before I buy single stocks. Compounding must start as soon as possible. and they must be tax-free.