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The deterioration of the government’s finances has made news headlines for months and continues to attract scrutiny ahead of the announcement of the national budget in February. After the mid-term budget announcement by Finance Minister Enoch Godongwana in early November much has been written about the possibility of now or higher taxes to be introduced next year. In view of this, it is now more important than ever to fully utilise the benefits of a Tax-Free Savings Account (TFSA).
When it was introduced, it quickly became a popular account to set up for children, but all investors should include this in an overall financial plan. It offers a tax benefit that dwarfs the relief provided by retirement annuities, for example.
A TFSA offers many benefits that will complement any balanced investment portfolio, especially over the long run.
The discretionary investment product is only available to individuals in South Africa and was introduced by the State to encourage a greater savings culture in the country.
What sweetens the deal, are the tax exemptions that come with it, from withholding tax on dividends or interest to income and capital gains tax on any switches or withdrawals from the account.
The only drawback of the product is the R36 000 limit in annual contribution and R500 000 over an investor’s lifetime. Some view a tax-friendly saving of R36 000 per annum as pocket change, yet over time it can deliver significant growth.
If an investor utilises the maximum benefit allocation every year, it will take just more than 13.5 years to reach the lifetime limit of R500 000. At the current interest rate of 8.5% p.a. with an additional capital value added every year, without any withdrawals, the investment should be worth approximately R972 000 in 13 years.
That shows great value for money and is a plausible portfolio filler for any family member in any age range. It is a fantastic starter solution and a tax haven where investors can hoard their cash, and just forget about it as it takes care of itself in years to come.
There is an abundance of TFSAs available in the market. The financial services industry was quick to introduce a range of options. TFSAs can take the form of money market or fixed-term bank accounts, a unit trust investment, or a JSE-listed exchange-traded fund. TFSAs can be issued by banks, long-term insurers, unit trust managers, mutual banks or cooperative banks.
TFSAs are very flexible in their structure and allow investors to cease or increase contributions at will, whether monthly, quarterly, annually, or on an ad hoc basis, however, some providers insist on a minimum contribution level for administrative purposes.
While the investor is free to withdraw funds from a TFSA at any time, early withdrawal penalties do apply and differ between providers.
It is essential to understand the longer-term implications of early withdrawals that compromise investment returns. Any withdrawal made from a TFSA is deducted from the lifetime contribution limit.
For example, if R200 000 has been saved in a TFSA and a full fund withdrawal is made, the total remaining lifetime contribution will reduce to R300 000.
TFSAs are offered by banks and linked investment services providers (LISPs). A LISP offers better variety as most banks only offer money market funds while most LISPs offer a wider selection of money market and growth unit trust funds both locally and offshore.
Even though the capital will never be invested for a fixed term and will always remain fully liquid, here are the other specifications of the TFSA:
Parents may make contributions to a TFSA on behalf of a minor, however, proceeds from withdrawals must be paid into a bank account in the minor’s name.
When accessing the investment, funds will be available within three business days, but this may also depend on the financial institution’s processes.
Any amounts exceeding the R36 000 annual limit will be taxed at a rate of 40%. This means, if the investor paid R1 000 over the limit, he or she will be liable for R400 tax. Should investors have more than one savings account, it will remain their responsibility to ensure that they do not over-contribute to the tax-free savings accounts they may have with various financial service providers.
When it comes to estate planning the full value of the investment is paid to an investor’s estate in the unfortunate event of death and unfortunately cannot be paid out directly to a beneficiary.
The TFSA will be frozen, and beneficiaries will not have immediate access to this investment until the estate is wound up. This means a beneficiary should be nominated in the will and full estate duty and executor’s fees will be applicable.
* With the end of the tax year on the horizon (29 February 2024) now is a good time to add to any TFSA you have if you have not yet reached the annual limit or set up a new account. It is the best time to review your contributions to retirement annuities. If you have not reached the allowed contribution, make use of this option.
More about tax efficiency here: Tax planning
* Gavin Butchart is the Financial Director and Head of the Mauritius office of Brent Wealth. [email protected]