What is a TFSA
A Tax Free Savings Account (TFSA) is a very specific type of investment account where you pay no tax on any of the income generated from the investment.
It's been possible to open a TFSA since 2015 and yet, despite it being one of the most powerful investment vehicles available it is chronically underused.
You can open a TFSA at a bank or a variety of other financial service providers, however we don’t recommend you open one at a bank as this limits your options.
It is not a savings account
A TFSA is not a savings account (despite the unfortunate name). At least, not in the way you would normally think of a savings account at a bank. It is much more powerful than that.
The ability for financial service providers to offer TFSAs was made possible through new laws that came into effect in 2015.
A TFSA is really a legal wrapper around the investments that you make into it. That legal wrapper protects any income or gains you get out of those investments from any tax obligations. That includes capital gains, dividend income or interest income. You can think of the TFSA as a special badge attached to your investments that gives them a Get out of tax free card.
Your contributions are limited
The incredible power of investing for tax free gains is not unlimited. The TFSA legislation limits how much money you can put into your TFSAs (yes, you can have more than one).
Maximum Contributions
- R 36,000 per year.
- R 500,000 in your lifetime.
The annual limit is applied each tax year (at the end of February) when SARS will check all of the TFSA tax certificates (IT3s) you have been issued by your TFSA providers. Any contributions you have made above R36k (across all accounts) during the tax year (since the previous March) are taxed at 40% (ouch!).
There is also a lifetime limit of R 500,000, but it's going to take you at least 13 years to hit that limit assuming you max out your contributions each year so that's not something to panic about, yet.
Its for the long term
Calling the TFSA a "savings" account gives the wrong idea about how you should use this facility. The benefits of not paying tax on your gains is very small initially (over 5 - 10 years) but get's very big in the long term. The TFSA should be used as a long term investment vehicle.
TFSAs vs RAs, Pensions and Provident Funds
If you are able to max out the contributions to your TFSA when you are young, and then leave it alone until you decide to retire, it will likely be even more valuable than a retirement annuity or pension. Firstly, you won't have to pay any tax on the withdrawals you make from your TFSA to fund your future income, and secondly, it will probably have grown more than a comparable retirement fund since TFSA investments are not restricted in the same way as retirement funds in terms of where they can be invested.
Never withdraw from your TFSA
The biggest mistake you can make with your TFSA is to treat it like a short-term savings account for goals like buying a car or going on a holiday. If you withdraw money from your TFSA that money can never be put back into the TFSA to benefit from tax free growth.
SARS only measures your TFSA contributions, they don't care how much you take out (because they can't tax you on that money anyway). It's a one way street.
If you have maxed out your contributions you can't contribute any more or you'll pay the 40% penalty tax and that applies across the sum of all of your TFSAs (if you happen to have more than one).