Before doing so, however, you need to understand the rules of a TFSA, which are as follows:
- A TFSA doesn't attract any income, dividend, or capital gains tax on the returns. The tax benefits become larger as your TFSA account grows and compounding interest goes to work.
- Unfortunately, you can only invest up to R36 000 a year and there’s a R500 000 lifetime limit on how much you can invest in TFSAs. If you don’t use your full contribution for a year, you cannot carry the excess over to the next year. If you make a withdrawal, you cannot top it up again in that year, so don’t miss out on these opportunities to invest up to the maximum and keep it in there for the long term.
- If you contribute more than the maximum in a year, you will be penalised 40% of the amount over the annual contribution.
- The best part of a TFSA account is that they are not subject to any investment limitations, such as Regulation 28. This means you can invest more offshore if you are using your TFSA to supplement your retirement savings by first ensuring you contribute the maximum to your TFSA first and then making your retirement contributions.
- Any person, even your children can have as many tax-free savings accounts as you like. The annual limit of R36000 aggregates across all accounts, meaning you can't contribute more than the annual limit to all your accounts combined.
- If you desperately need some of your funds, withdrawals are possible but not recommended, as it reduces your compounding interest.
How TFSA fits into your investment portfolio:
Let’s look at an example to understand the tax benefits within a TFSA. The current annual interest tax exemption limits are R23 800 for people under 65, and R34 500 for people over 65.
In the below table I have assumed that the investor contributed the annual contribution limit at the beginning of each year and then applied a growth rate of 9%, which is interest income. The column named ‘investment amount’ shows the year-end value for each year of assessment, that includes the contribution for the year, the growth and the previous year's end value.
The column furthest to the right illustrates that this investor would have paid no tax on interest even if he invested outside of a TFSA. This table illustrates that saving in TFSA for a short term goal is not tax efficient.
As we can see in the short term, these accounts don't add up to substantial tax-free savings. In the long run, you will experience the benefits of a TFSAs tax-saving superpower as the capital amount grows. Using your TFSA for long-term goals such as your children's education and supplementing your retirement savings will have the biggest tax savings and benefits compared to short-term uses. DM/BM
Author: Gabriel Botha, Business Development Manager at Prescient Investment Management
Disclaimer:
- Prescient Investment Management (Pty) Ltd is an authorised financial services provider (FSP 612).
- The value of investments may go up as well as down, and past performance is not necessarily a guide to future performance.
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