WTF Is... A Tax-Free Savings Account?
Bag a SARS-free piggy bank, legally
You’ve probably seen ads for tax-free savings accounts (TFSAs). And, if you’re a healthy sceptic, chances are you’ve been thinking it’s a trap. Well, good news: it isn’t. What it is, is a financial tool that the government introduced three years ago to encourage South Africans to save. HOW IT WORKS
Usually, when you put your money in a savings or investment account, the growth on these investments may be taxed by the government. And that’s in addition to all the fees you pay to the financial institution for the privilege of having them invest your money. The main benefit of a TFSA is that you don’t pay tax on any interest or dividends earned on your money, regardless of how long you invest for – and you also don’t have to pay tax when you withdraw your money, explains Sylvia Walker, financial planner, speaker and author of Smartwoman. What’s more, you can invest as little as R50 a month (the price of two coffees), so you can start saving even if you don’t have lots of spare cash available, she adds. Another benefit is that you can access your money easily – there won’t be long notice periods or penalties for making a withdrawal. And you can choose whether you want a low-risk investment option or a high-risk, high-return investment. Pretty easy, right?
IS A TFSA FOR YOU?
Because they’re fairly simple, tax-free savings accounts can be a good option for first-time investors wanting to enter the savings market, says Daryll Welsh, head of product at Investec Investment Management Services. If you already have other investments, it’s worth considering that for any short-term investment the first R23 800 returns you earn are exempt from tax anyway, says Walker. And if you’re older than 65, that goes up to R34 500. But if the returns on your current investments exceed those thresholds, then a tax-free savings account could be a good option. “While there is little tax benefit to be had in the short to medium term for these accounts (given current capital gains tax and income tax exemptions), the longerterm tax benefit at the time of withdrawal – particularly from a capital gains tax benefit – can be significant,” agrees Welsh. As for long-term investments, it depends on what you’re saving for. If it’s for retirement, a TFSA is generally not the best tool for the job, says Walker, who recommends taking out a retirement annuity for that purpose. “But it’s a good way to save for longerterm goals that are not linked to retirement,” she says. A prime example – your kids. Welsh says it’s been encouraging to see that a number of accounts have been opened by parents for the benefit of their children. And that by starting to invest at such a young age, these accounts allow the process of compounding to work in their favour. “Imagine starting your working career with an accumulated lump-sum saving that takes away the pressure to put away more than you may be able to save when starting out in the ‘real world’”. The trick to getting the most out of your TFSA is to stay investing, says Walker. “Don’t be tempted to cash in when money is tight. Remember the end goal – why you took it out in the first place. It’s the discipline of saving and not the vehicle that is important.”
SIGN ME UP
You can get a TFSA from your bank, an asset management company or long-term insurance company – in many cases, you can simply sign up online. But depending on which company you go with, different fees will apply and you can expect to earn different amounts of interest on your money.
If you’re the type of person who’ll take a smaller, guaranteed return over the chance of a higher return, a bank may be a good option. “Banks give you a predetermined interest rate, so you know what your return will be,” explains Walker. But that guaranteed interest rate may be far lower than what an asset manager could get you with a little more risk. Another reason to go with a bank? If you only want to save the bare minimum monthly amount (say, R50). “Most long-term insurance companies and unit trust companies would start at
R200 per month or so for a TFSA,” says Walker. Still shop around though – different banks offer different rates, charge different fees and have different minimum investment amounts.
They’ll possibly get you the highest returns with the least fees because you’re dealing directly with the guys who actually invest your money. “Asset managers and longterm insurance companies offer growth based on the performance of the fund in which you invest,” says Walker. The key here is to have time on your side – so if the value of your investment does drop, you can leave it invested until the market swings back up in your favour. Different companies will invest your money in different funds, so ask about which funds they’re investing in, why those ones and how those funds are performing. If you don’t feel confident evaluating those numbers yourself, consult an independent broker or financial advisor – one who is not affiliated to any company that offers a TFSA. She’ll be able to advise you on which offering is best for you, based on your timeline, investment goals and appetite for risk, says Walker.
LO N G -T ER M INSURANCE COMPANIE S .
Like with an asset management company, your return will be based on the performance of the fund your money is invested in. Unlike an asset manager, a long-term insurer could also offer you investment advice through one of their financial advisors. And if you already have, say, a retirement annuity or pension plan with the company in question, it may be tempting just to add on a TFSA. But before you do, be sure to investigate all the fees, including those for depositing, withdrawing and switching investment funds and ask about any others that might apply.
TS AND CS APPLY
Okay, so what’s the catch? For starters, you can only invest R33 000 a year into your TFSA and there’s a lifetime cap of R500 000, says Walker. Your TFSA contributions form part of your annual tax return, so SARS will know how much you’ve been stashing in there. And if you had R33 000, withdrew R10 000 and then put R10 000 back in later in the year? You’ll be liable for tax on the R10k you put back in – because the limit is on money deposited, not how much money is sitting in the account. The other thing to remember is that TFSAs may be tax free, but fees will still apply. And, depending on which company you go with, there could be layers and layers of them – including admin fees, advice fees, investor fees and withdrawal fees. These will each be expressed as a minuscule percentage of your investment, but they add up. What’s more, these fees are often so well hidden in the fine print that you won’t even realise you’re paying them. Lastly, “the plan is not protected from creditors,” cautions Walker. “With a retirement annuity, even if your business goes under or you lose everything financially, your retirement savings are protected.” This isn’t the case with a TFSA – another reason why it’s not the best choice for retirement savings.
SO, SHOULD YOU GET A TFSA?
A tax-free savings account is a useful tool to have for long-term savings goals other than retirement. It’ll earn more interest than your cheque account, but unlike with, say, a fixed-term account, you’ll have easy access to your money if you need it. And as long as you stick below the threshold, you won’t pay any tax. If you’re not investment savvy, the best way to ensure that you’re getting a good deal is to consult an independent financial advisor.