As the tax year draws to a close, many South Africans are focused on minimising their tax liabilities and maximising tax efficiencies, including utilising the annual R36 000 tax-free savings account (TFSA) contribution limit.
While the tax advantages of TFSAs are undeniable, it’s essential to view a TFSA as an integral part of your broader investment strategy to ensure it aligns with your financial goals.
ADVERTISEMENT
CONTINUE READING BELOW
Here are some key strategies to help you get the most from your TFSA:
Use your available tax-free savings
Introduced in South Africa in 2015, TFSAs offer significant tax benefits, as all investment growth and income are completely tax-free. This includes exemption from capital gains tax, dividends withholding tax, and tax on interest earned.
However, contributions to a TFSA are made with post-tax income, meaning no tax deduction is available on contributions. As such, it makes sense for investors to prioritise contributing sufficiently to a retirement fund to reduce taxable income before allocating funds to a TFSA. This ensures a more tax-efficient investment strategy while maximising long-term financial benefits.
Think long-term
The tax benefits achieved by investing in a TFSA are not realised early on, which means that TFSAs do not make good emergency funds. The value of the tax benefit in the first five years is incredibly small, and the investment return and tax savings only become meaningful after about 10 years. As such, it is advisable for investors to take a long-term view when setting up a TFSA.
Although TFSAs are not necessarily intended as retirement funding vehicles, you can use yours to supplement your retirement savings. However, should you be earning below the tax threshold, i.e., you do not pay tax on your income, they do make a very effective investment vehicle to build over the long term as a retirement nest egg.
Structure your contributions
Legislation permits annual TFSA contributions of up to R36 000, or R3 000 per month, with a lifetime cap of R500 000. Most providers accommodate minimum monthly contributions starting at R500, offering flexibility to contribute monthly, annually, or through ad hoc payments as finances permit.
For example, if you earn a commission, consider setting up a smaller monthly debit order while retaining the option to make additional contributions whenever cash flow allows. This adaptable approach ensures you maximise your TFSA contributions without straining your financial resources, helping you build long-term wealth efficiently.
Think twice before withdrawing
Legislation permits you to withdraw from your TFSA at any time, but it is important to first understand the implications of doing so. Any withdrawal made from your TFSA is deducted from your lifetime contribution. For instance, if you have contributed a total of R300 000 towards your TFSA and you withdraw R50 000, you will still only have R200 000 lifetime contribution available to you. In other words, you can’t top up your TFSA again after a withdrawal, and any withdrawal will result in you forfeiting your tax benefits while at the same time wasting part of your lifetime contribution and losing out on potential investment returns.
Understand your investment horizon
When establishing your TFSA, carefully consider your intended future use of the proceeds and select an investment portfolio aligned with your timeline. For example, if you’re saving for your newborn child’s tertiary education, your investment horizon spans approximately 18 years. Alternatively, using it to supplement retirement funding may involve a much longer timeframe.
In both cases, a long-term outlook suggests prioritising growth assets over cash and fixed income, which typically underperform over extended periods. Additionally, keep in mind that individuals under 65 enjoy an annual tax exemption of R23 800 on interest income, increasing to R34 500 for those over 65. Structuring your TFSA wisely ensures it meets your financial goals while maximising its growth potential.
ADVERTISEMENT:
CONTINUE READING BELOW
Select an efficient investment platform
South Africans enjoy a wide range of options when selecting a TFSA provider. Most reputable investment platforms offer access to a variety of local and offshore funds, enabling you to build a portfolio tailored to your investment objectives. While money market or fixed-term bank accounts are an option, a more aggressive unit trust portfolio is likely to deliver better long-term returns.
Choose a platform that offers a holistic view of your overall financial portfolio, including retirement annuities and discretionary investments, ensuring your TFSA integrates seamlessly with your broader financial strategy for optimal growth and management.
Understand the lifetime contribution limit
Before opening a TFSA in your child’s name, carefully consider the long-term implications. Doing so will use part or all of their lifetime contribution limit, potentially preventing them from saving tax-free later in life. For example, if you invest the full R500 000 lifetime allowance over their first 18 years, their TFSA capacity will be exhausted, leaving them unable to contribute further in adulthood.
It’s important to weigh this decision against their future financial needs and opportunities. Additionally, ensure you strictly adhere to annual contribution limits to avoid penalties and maximise the tax benefits of your own TFSA contributions.
Avoid over-contributing
Exceeding the annual R36 000 TFSA contribution limit triggers a 40% tax on earnings above this threshold, regardless of your income tax rate. This risk is heightened if you contribute to multiple TFSAs, so it’s crucial to track your contributions carefully to avoid unnecessary tax penalties and maximise your benefits.
Be careful when transferring between providers
If you wish to transfer your TFSA to another provider, note that it must be done directly between service providers. You cannot withdraw funds from one TFSA and redeposit them into a new one, as this would be treated as a withdrawal. Any reinvestment would then count toward your lifetime contribution limit, potentially incurring penalties.
Keep up-to-date with Sars
Even though no tax is payable on the earnings within a TFSA, as a South African tax resident you are required to disclose all investment information to Sars when submitting your annual tax return, including certificates issued for income within your TFSA.