Tax-free savings accounts are a 'gift', so why do South Africans shy away?

Tax-free savings accounts (TFSAs) were introduced by the government eight years ago in a bid to encourage South Africans to save more effectively.

Every citizen is allowed to invest up to R36,000 a year, 100% tax-free and up to a maximum of R500,000 over their lifetime. This means you pay no tax on the growth of that investment, and you get every cent your investment earns.

So why are South Africans not making use of this tax-free gift from the government? Based on conversations I’ve had with friends, family and clients, I suspect it has something to do with commonly held misconceptions about TFSAs. It’s time to debunk these myths.  

Myth 1: You need a certain level of income and/or regular income to open a TFSA

Anyone can open a TFSA in SA, no matter how much or little they earn, or whether their income is regular or not. You just have to ensure you meet the investment minimums stipulated by the financial institution of your choice. These can be as low as a lump sum of R250 to open the account. 

Myth 2: You must pay into a TFSA every month 

Most financial institutions allow you to make an initial lump sum payment into a TFSA, then you can contribute monthly, annually or not at all. 

Myth 3: You have to invest a minimum amount in a TFSA each year

It is advisable, but not compulsory, to make the most of your tax-free savings allowance by contributing the maximum tax-free allocation to your TFSA each year.

If you are below the R36,000 a year cap before February 28 2023, it’s a smart move to make whatever lump sum payment you can before the cut-off date to maximise your annual tax-free savings allowance. 

Myth 4: You can only get a TFSA if you’re 18 or older

Every SA citizen, from newborn to pensioner, may have a TFSA at any time of their life. While under-18s may not open a TFSA themselves, a parent or guardian may open a TFSA on behalf of a minor. 

It’s a great idea for parents to open a TFSA for their child as it’s possibly the best savings vehicle for their future education.

Due to zero tax on capital growth, whatever you invest for your child will benefit fully from compound interest during what is typically a long investment timeline. This means the returns should be fantastic if you choose the right underlying investment for your child’s TFSA. 

Myth 5: You can’t withdraw any money from a TFSA until retirement

You can withdraw money from your TFSA when you like, with no penalty.

Warning: just because you can withdraw from your TFSA doesn’t mean you should.  Dipping into your TFSA too often can derail your investment outcomes, because every withdrawal counts against the one-off R500,000 tax-free lifetime limit. 

Myth 6: You can only have one TFSA

You can open as many TFSAs as you like with as many different service providers as you like. The only restriction is that the total of your annual contributions across all your TFSAs must not exceed the yearly tax-free savings limit of R36,000. If you do go over the annual tax-free savings limit, the excess will be subject to 40% tax. 

Myth 7: TFSAs are for local investments only

There is no restriction on investing your annual tax-free allowance offshore. This flexibility is another reason the TFSA is a great investment choice; it is a savings vehicle that allows you to diversify your investment portfolio by easily gaining offshore exposure. 

Remember: the TFSA is only the savings vehicle — you get to choose the underlying investments that power it, which can be anything from rand-denominated offshore investments to low-cost index funds and exchange traded funds (ETFs). 

Myth 8: A TFSA is the same as a retirement annuity

Both TFSAs and retirement annuities (RAs) carry zero tax on the growth of your investment (capital gains, dividends and interest). That’s where the similarities between the two end. 

You can withdraw from a TFSA whenever you like, whereas you are not allowed to withdraw from an RA until you are 55. This is set to change when the government's new two-pot retirement system comes into effect on March 1 2024.

The new system will see contributions to RAs split into a retirement pot, which cannot be touched until retirement age, and a smaller savings pot, which you will be able to make a withdrawal from once every 12 months. 

But even under the new system there will be an integral difference between TFSAs and RAs: all withdrawals from the savings pot of an RA will be taxed at marginal rates, whereas withdrawals from a TFSA will remain as is — 100% tax-free. 

The other big difference is that any contributions made to an RA qualify for a tax deduction of up to 27.5% of your taxable income (up to a maximum of R350,000 a year), whereas there is no tax deduction for contributions to TFSAs. 

Importantly, RAs are limited to a maximum 45% offshore exposure, but you can make the underlying assets in your TFSA 100% offshore. 

Myth 9: Your money is guaranteed

It is possible to lose money in a TFSA, as they allow investments in a wide variety of asset classes (including equities, bonds, listed property and cash) with varying degrees of risk. When you have chosen your TFSA, you decide what you want to invest in and how much risk you want to assume. It is always wise to discuss your choices with a trusted financial adviser before making a final decision. 

Myth 10: If you have a retirement annuity, you don’t need a TFSA

On the contrary: a TFSA should be viewed as an important part of your long-term retirement plan, because it serves as a highly tax-efficient way of supplementing your retirement savings.

This article was sponsored by Sygnia.