Every time we hear that something is tax-free, we get excited because it means more saving of cash on our end. At one point or another, you may have heard about tax-free investments products, which build up to the end of the year. One such example is a tax free savings account (TFSA). So, what is TFSA? How do you invest in this tax-free investment vehicle? Read on to find out.
What is a tax-free savings account? How does it work? TFSAs are financial instruments that were launched by the national treasury on March 1st, 2015 to encourage the middle class and bottom class South Africans to save money. This type of saving accounts is an investment product whereby the capital growth, interest, withdrawals, and the returns on investment are not taxable. A TSFA can either be in the form a cash investment, equities, unit trusts, or a blend of all these. There are several ways to use your TFSA account. These include reducing your taxes, saving for retirement, saving for a specific goal (buying a house, a car, going for vacation, emergency fund etc.), splitting your income between your partner and spouse, or maintaining eligibility for government programs.
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How tax free savings account work
Now you know what TFSA is, but to further understand how this investment product works, we will look based on different aspects surrounding it.
Limit on tax-free savings accounts
What is my TFSA limit? Or, how much money can you put in a tax free savings account? Even though a TFSA is not taxable, its deposits are restricted. According to the existing governing laws, in any one TFSA, the monthly deposits cannot excess R 33,000 (R2,750 monthly), while the total tax free savings account limit 2019 life time contributions remains capped at R500,000.
Withdrawals from a tax-free savings account
What are tax free savings account withdrawal rules? Individuals can have access to the funds in their TFSA at any time they wish without being subjected to penalties as long as the account does not have a maturity date. If the account they hold does not have a maturity date, then one can request the funds and access them within 7 days. Meanwhile, if it has a one year fixed deposit, one will access their cash in 32 days after submitting their request to withdraw. The penalties for withdrawing early vary from one bank to the other but will not exceed R500.
One has to be keen on making withdrawals as they cannot be re-invested again. Once you withdraw, it affects your net contributions. For example, if you withdraw R100,000 saved in your TFSA, your lifetime contribution remains restricted at R500 000; hence, you can now only deposit R400 000.
Exceeding the annual TFSA limit
If you deposit more than the amount required, there is a stiff penalty tax of 40% of your contributions. As such, carefully monitor all your TFSAs from time to time to avoid going above the set limit.
Can I open more than one tax-free savings account?
Yes. One can choose to have various TFSAs but you have to ensure that the total sum of your annual deposits in all these different accounts does not go above the yearly set limit or you will be subjected to the 40% penalty tax. There is no limit to the number of Tax-Free Savings accounts you can have, but you must ensure that the sum of your annual payments across all TFSAs does not exceed the annual contribution limit, or you will have to pay a penalty tax.
How much interest do you get on a tax free savings account?
What is the tax free savings account interest rate? The amount of interest earned on a tax free savings account varies from one bank to the next. African Bank had the best interest rate set at 8.67% for a one year fixed deposit with a minimum contribution of R500. Capitec offers 5.12% for deposits from as low as R1. This bank is followed by Standard Bank which has an interest of 6.65% for minimum deposits of R250. The least competitive interest rate is for Nedbank which is set at 5.75% for maximum deposits.
What is the best way to use a tax free savings account?
To acquire maximum benefits and returns from your TFSA, individuals are urged to leave their money invested for longer periods of time. This is because they will benefit from the compound interest over the investment period. As Albert Einstein puts it, “Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn’t ... pays it.”
Tax-free savings vs regular bank accounts
What is the difference between a tax free savings account and a regular savings account? The main difference between these two types of investments is that a TFSA does not attract tax on its capital gains, interest withdrawals, and dividends, while the regular bank account is taxable. As such, if you want a rapid growth to your investment, then TFSA is the superior option for you.
Tax-free savings vs retirement annuities
Which one is more attractive to invest in between a tax free savings account and a retirement annuities? Here are the differences:
- The main element setting these two investment accounts apart is their preferential tax benefits. For instance, retirement annuities permit you to invest your pre-tax money for retirement saving. Just like other contributions, you will not pay any tax in the growth of the investment but will pay tax when receiving the benefits. This means that you not only delay your tax bill but also pay less tax as your income will be lower at retirement. On the other end, with a TFSA, one invests their post-tax money that is subject to a limit we previously touched on. With a TFSA, you do not pay taxes on the growth of the funds and when withdrawing the cash later on. Nevertheless, because you do not defer your tax payment with a TFSA, one ends up paying more taxes than would otherwise do for a retirement annuity.
- TFSAs are more flexible in terms of access to cash, but with a retirement annuity, one can only access their funds when they turn 55 years or earlier if they become perpetually disabled due to a sickness or injury.
- Another difference between the two accounts is the usage of its benefits upon maturity. With a Retirement Annuity, one can only withdraw a limited amount; a third of the total funds and the rest one has to use to buy a pension that will be giving you some retirement salary. TFSA on the other end has no such restrictions on the manner you choose to spend your cash when you receive it.
So, to answer which is better, note that both are good as tax free savings investments were introduced to supplement retirement annuities rather than compete with it.
At this point, you might be wondering, is a tax free savings account a good idea? The South African National Treasury developed TFSAs to help the lower earning citizens save for the future. As such, its worth is dependent on who uses them and whether they are using the investment instruments to their full capability. Now that you know what a TFSA is and how it operates, we hope that you are now well equipped to open one today! We wish you a fruitful saving journey.