Five points to consider before opening a Tax-Free Savings Account

Everyone wants a savvy solution that will make the most of their money and in this regard, one of the most popular topics is a Tax-Free Savings Account (TFSA).

While a TFSA sounds great in principle, according to Oliver Balcomb (CFP®), a Director at the Consolidated Group, it is important to understand the mechanics of this investment vehicle before adding a TFSA to your financial portfolio.

“South African’s generally aren’t great at saving money so in 2015 TFSA’s were introduced to increase the overall level of savings in the economy,” says Oliver.

TFSA’s provide taxpayers with a vehicle to save and grow tax-free earnings. The maximum amount that you can invest for the tax year is R36 000 and contributions are capped at a lifetime limit of R500 000. “A TFSA is all about the tax savings as it is a vehicle where your compound growth, whether it’s from interest, capital gains or dividends, is tax free,” says Oliver.

The benefits of a TSFA depend on your personal circumstances and with this in mind, Oliver has five points that will help you decide if this is the right investment vehicle for you:

1. The Benefits

A TFSA is a great option when setting aside money for any goal. It can be used to save towards a car or your child’s education but usually it’s used to supplement your retirement plans. The benefit of a TFSA is that any growth in the money held in the account is tax free which allows for much faster growth of your savings relative to a traditional savings account. In addition, a TFSA allows you to withdraw money at any time with no penalties or tax, but just remember that if you do withdraw, it will slow down the growth of your investment.

2. Penalties

Keep track of your contributions to your TFSA to avoid depositing more than you are permitted. While it would be nice to put all your savings into your TFSA, once you reach your annual R36 000 cap, your additional contributions will be taxed at 40%.

3. A long-term vehicle

TFSA’s are not intended for short-term savings. It takes just short of 14 years to reach the lifetime contribution of R500 000 so this is a long term investment and ideally, it should form part of your retirement planning. On this longer term basis, you might also consider investing in high growth asset classes as opposed to shorter term, less aggressive funds. An advantage of TFSA vehicles is that the investment make-up is unrestrained and you are not restricted to limits within various asset classes.

4. Tax Relief Options

You also need to take a broader look at your personal tax situation. You should only consider a TFSA if you have already fully utilised the tax relief available through other retirement vehicles such as a Retirement Annuity, where your contributions are tax deductible, and your earnings are not taxable. A TFSA only gives you the benefit of not being taxed on the earnings.

5. Leaving a legacy

TFSA’s have become popular among grandparents who use the savings as a nest egg for their grandchildren’s university fees. The downside is that the minor’s income is likely to be below the tax threshold which means an investment in the child’s name is usually tax free anyway. And due to the lifetime cap, you deny them the opportunity to set up their own TFSA when they are older and more likely to benefit from a tax-free investment. But this aside, if the TFSA was put in place for your children’s or grandchildren’s retirement funding, it becomes a viable option.

Oliver concludes by advising that similar to most investment vehicles, TFSA’s are designed for a specific purpose and should not be viewed as a stand-alone solution. He says that if you are considering this option, it’s always best to consult with your financial planner first.

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