A Critical Look at Tax-Free Savings Accounts

What could be better than a tax-free savings account (TFSA)? You get to grow your money in a safe place without having to pay any tax. Sounds pretty good to us!

As with all financial services, there are laws around TFSAs that strictly govern how and where you can save your money. Hippo.co.za takes a look at the ins and outs of these kinds of savings accounts to see if they really are as great as they seem.

Contribution Limitations

Unfortunately, you can't just put as much money as you like into a TFSA; there are annual and lifetime limitations.

Annually, you can contribute up to R33,000 per tax year. You can have an unlimited number of savings accounts but in total, your contributions can't be more than R33,000 per annum across these.

The lifetime limit is R500,000.

These limits are important to remember because, if you over-contribute in a year or in your lifetime, you will incur a hefty penalty from SARS – 40% of the exceeded amount.

Example

If you contribute R40,000 in one tax year, you'll have overpaid by R7,000. Therefore, the penalty will be 40% of R7,000, which amounts to R2,800.

Withdrawal Limitations

It's true that, if you withdraw money from your TFSA, you won't be taxed on it. You can also take money out at any time and as many times as you like. However, be aware that, if you withdraw money, this won't change how much you can contribute in total.

Example

Say you have contributed R250,000 in your lifetime to a TFSA and you decide to withdraw R50,000 from it. SARS only looks at how much you have put in already, not how much you withdraw. You will still only be able to contribute another R250,000 in your lifetime.

Reinvesting the Growth

There are two major benefits to TFSAs, one of which we've mentioned already – you don't pay tax on the growth of your investment. The other is that you can reinvest this growth and it won't count towards your annual or lifetime limits.

Example

Let's say you've put in your annual R33,000 maximum and your return on investment is R3,000 for the year. You can reinvest this R3,000 (put it straight into the TFSA) without being penalised by SARS. Even though you have now technically contributed more than the annual limit – R36,000 – the excess amount is the growth on your investment and doesn't affect your contribution limit.

TFSAs for Minors

When you have a child, you might want to open a TFSA in their name, perhaps to save for their education. Be aware that, because the account is in the child's name, even though they are a minor, it does count towards their personal lifetime contributions.

Example

Every year, you contribute the maximum amount to a TFSA in your child's name. In just over 15 years, your child will have reached their lifetime contribution limit and they will not be able to contribute any more money to any TFSA again, even if they wanted to, unless the government increases the contribution limits at some point in the future.

Our Verdict

As with all money matters, TFSAs are more complex than they initially seem. Despite this, they are an excellent way to save money, because even those who struggle month-to-month can put a little money away without worrying about paying hefty taxes. Should you want further details on TFSA or are you still unsure how it works, please contact an independent financial advisor to assist you with more details. As long as you're aware of the limitations, TFSAs make great savings accounts for South Africans.

Sources: Tax Tim

Prices quoted are correct at the time of publishing this article. The information in this article is provided for informational purposes only and should not be construed as financial, legal, or medical advice.