FAQ
What makes a TFSA different to other investments?
The main difference between a regular investment and a TFSA is that you will never pay tax on any of the gains you earn from a TFSA. That includes interest, dividends and capital gains.
Normally if your investment pays you interest then you will be taxed at your income tax rate on that interest. If your investment is in shares that pay a dividend then you will be taxed on the dividends (this works differently for local and foreign shares). Most importantly, if your investment grows in value over time (which is always the goal), and you sell the investment, you will be taxed on the gains you have made (capital gains tax). With a TFSA, you avoid all of these taxes.
In other words, the major benefit of a TFSA is strongly tied to how much you earn from your investment. The more you earn, the more you would normally have to pay in tax and therefore the more you benefit by having that investment in a TFSA.
In summary, the “Tax Free” element of a TFSA can be a huge benefit, if you give your investments a chance to deliver good returns over a long period of time.
Aren't pensions and retirement annuities also tax free?
No. By contributing to a pension or retirement annuity you can reduce the amount of tax you pay now, and instead, pay that tax when you withdraw from the retirement fund later.
If you are in a high tax bracket now then it’s likely you’ll pay less tax when you draw down on your retirement funds later, because you’ll be retired and not earning the same income you are today. This should put you in a lower tax bracket but you will still pay tax on the investment.
The other disadvantage of traditional retirement funds is that they are limited in terms of where they can invest. Regulation 28 of the Pension Funds Act is designed to protect investors by ensuring that retirement funds are invested in a well-diversified and prudent manner but this doesn’t always align with everyone’s investment strategy.
In contrast, a TFSA is a very flexible investment vehicle. As long as you invest through a properly registered financial service provider you can invest in almost anything that fits your investment strategy.
How do I invest in a TFSA?
You can open a TFSA through any authorised financial institution, including banks, brokerage firms, and investment managers.
A TFSA is NOT just a savings account, you can open a TFSA and invest in almost anything including stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Treat your TFSA as your primary long term investment vehicle (until you've reached your contribution limit) so you can maximise the tax free gains and the power of compounding.
There is an annual contribution limit, which is currently R 36,000. This may change in future as it has already increased since TFSAs were first introduced in 2015. This is the "tax year" as defined by the South African Revenue Service (SARS) so it runs from the beginning of March to the end of February. This limit doesn't roll over so if you miss the deadline to make your contributions then you can still only invest R 36,000 the following year.
There is also a lifetime limit of R 500,000 which may also be increased in the future.
R 500,000 seems like a lot but if you contribute the maximum of R 36,000 per year (R 3,000 per month) you'll hit that limit within 14 years. With inflation in the region of 5% per year that R 500,000 will be worth half as much in 14 years. (i.e. If you spend R 500,000 in 14 years you'll only be able to buy something that costs around R 250,000 today).
However, if you have been investing wisely with those TFSA funds you could have easily doubled your money within 14 years. That's the power of compounding!
No matter how you slice it, maxing out your TFSA as fast as possible is the best way to ensure you have significant savings in the long term.
What if I don't "max out" my TFSA?
Like any investment you should be contributing as much as you can based on your personal circumstances. However...
The annual limit on TFSA contributions makes it tricky to build up capital if you have very bursty income, for example if a big portion of your income comes through bonuses or commissions. You can't invest more than R 36,000 per year into your TFSA(s) and if you do you get heavily penalised.
But, if you don't invest the R 36,000 maximum in one year, it doesn't roll over to the next year and it will simply take you longer to get to the lifetime limit.
Given the effect of compounding we know that time is essential so getting your total contributions to that lifetime as fast as possible is key to maximising the long term gains. That's why prioritising that R 36,000 contribution to your TFSA should be a priority in your financial plan.
But there is a caveat. Remember that SARS only measures money in. So if you take any money out of your TFSA that has no effect on your limits. You can't contribute those funds back later without impacting your limit.
If you stretch yourself too far financially just to get money into your TFSA each year and you're forced to take it out later then you'll undo a lot of the good that you get from using the TFSA.