You recall the ‘mind blowing' emoji? That's how I feel every time I find someone without a tax-free savings account (TFSA).
After all, it's one of the best investment decisions you can make as a South African. It's a total no-brainer if you're serious about investing. And, just last week, Tito Mboweni, the SA finance minister, increased your tax-free annual limit from R33 000 to R36 000.
So, would you believe it, an already incredible government backed investment, just got better.
And yet still, so few people realise the enormous wealth they can create by starting immediately.
But let's back up a bit and recap exactly why this is a total no-brainer move for anyone who hasn't already maxed out their limit.
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What exactly is a TFSA?
A TFSA is exactly what it says: A savings account which doesn’t attract income tax, dividend tax or even capital gains tax on the returns it makes.
Let me say that another way: All this money which you would have given to the government, instead flows directly into your pocket. For this reason, it’s a superb way to invest especially if you’re in it for the long-term.
So, how does a TFSA work?
• You can only contribute a maximum of R36 000 per tax year (annual limit). Any portion of the unused annual limit is forfeited - it is not carried forward to the new tax year.
• There is a lifetime tax-free investment limit of R500 000 per person.
• If a person exceeds the limits, there is a penalty of 40% on the excess amount.
• A person can have more than one TFSA, however, you are still limited to R36,000 per tax year. This means you can invest for example R12 000 across three different TFSA providers.
• Returns on investment are added to the capital contributed, the balance may exceed both the annual and/or lifetime limit. The capitalisation of these returns within the account does not affect the annual or lifetime limit. This is important, but I’ll show you why in a bit.
• It’s also important to understand, if you withdraw the returns and reinvest the same amount, that amount is regarded as a new contribution and impacts both the annual and lifetime limits. So, any withdrawals made cannot be replaced. Sending funds into a TFSA is a one-time offer by government. If you withdraw you can't do it again. That’s why you should be looking at a TFSA for longer-term investments.
• Parents can invest on behalf of their minor child. The minor child will use his/her own annual or lifetime limits.
My recommendations on how to optimize on your TFSA
1. Don’t withdraw ANY funds from the account – not even in an emergency! You want to benefit from compounding growth. Early withdrawal hinders your ability to maximise your growth.
2. Only withdraw these funds as the LAST of your retirement money (remember it’s the compounding effect you want to preserve).
3. There are various underlying assets you can choose to invest in with your TFSA (depending on your TFSA supplier). I suggest investing in an offshore ETF. This security will give you more exposure and potentially better growth in the medium- to long-term.
Even though you can, don’t open more than one TFSA account. This will save you costs and administration headaches.
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So, how much can you reasonably expect from a good TFSA provider?
If you maximise your annual investment allowance and spend the next 14 years adding R36,000 per year (or R3,000 per month), your investment will be worth R30.5 million in 45 years’ time.
And, to put that in perspective, based on today’s CGT rate, if you achieved this same investment growth with almost any other investment product you would then owe the government R5.49 million in tax when you cash out.
That’s right, the South African government is essentially giving you R5.49 million, just for using a TFSA as a long-term savings vehicle.
How can you open an account?
Rand Swiss is ranked as one of the top three TFSA providers in SA. If you’d like me to personally help you set up a TFSA, you can email me on firstname.lastname@example.org
and I’ll show you exactly how to set up the account discussed.
On a final note, with the Coronavirus driving global markets lower, now is an excellent time to be deploying new money. You’ll be getting in at a discount when you buy the underlying ETF. And, since the tax year has just ended, you’ll likely be able to maximise your contribution at a time when markets are very low!
Rand Swiss, Wealth Manager