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Is a Tax-Free Savings Account (TFSA) really a no-brainer investment?

by , 04 February 2022
Is a Tax-Free Savings Account (TFSA) really a no-brainer investment?
Tax Free Savings Accounts (TFSAs) are one of the most underappreciated investment vehicles in the country. So, it's rather difficult to understand why most people still don't use them. They're one of the only tax efficient vehicles that come with almost no negatives.

What is a TFSA?

It’s an investment vehicle in which all income or growth on investments held inside are tax-free. This includes interest, dividends and capital gains. You can contribute up to R36,000 a year, with a lifetime limit of R500,000. As with a Retirement Annuity both these limits apply to the taxpayer, rather than the account itself. You will only be penalised if your contributions go above these limits. If the account itself continues to grow above the R500,000 level you continue to benefit from tax-free dividends, zero capital gains tax and no income penalties on interest.

You can invest in Fixed deposits, Unit Trusts, ETFs, Retail Savings Bond, certain endowment policies and linked investment instruments.
There are also no limits on withdrawals. But please note, when you withdraw funds from your TFSA, it doesn’t change our limits. So, if you take R50,000 out, you can’t replace it without eating further into that R500,000 lifetime allowance.

How to use a TFSA

TFSAs give you the greatest benefit, if you hold your investments in either high growth or high-income products. It must be noted that SA taxpayers currently get a R23,800 yearly interest exemption. With the current low interest environment, the vast majority of investors don’t fully use up this allowance. For these people having a fixed deposit or other interest generating investment inside a TFSA makes little sense.
Likewise conservative unit trusts or ETFs don’t take full advantage of the TFSAs potential

Rather put high growth Unit Trust and ETFs into your TFSA. I personally choose to go with offshore ETFS such as the MSCI World ETF. Unlike RA’s there is no limit to your offshore exposure. You can invest 100% of your TFSA in the S&P500 for example.  

Also, the longer you hold your funds inside the TFSA, the more growth and income you are likely to receive and therefore the greater the tax benefit.

TFSAs for kids

Minors are allowed to have TFSAs. They also have the longest potential investment time horizon. This makes them the ideal TFSA investors.

As an example, imagine investing in an ETF that generated a return of 15%. If a baby received a R10,000 TFSA investment in the year of its birth, by the time the child is just 25, that investment would be worth over R320,000. If the child was to hold the TFSA until retirement at 65 it would be worth an amazing R80+ million. And this is for a single R10,000 initial investment and no. other contributions.

Do you see why I call a TFSA a no-brainer investment?

You have less than a month to sort out your TFSA for this tax year. Remember you can only add up to R36,000 per tax year. If you don’t max out the contribution in the next month, you will lose the opportunity as the allowance resets and any contributions from 1 March 2022 onwards will go against the year-end Feb 2023 allowance.

Do not delay. If it’s for you, a gift to your kids, your family, this is one of the best (if not the best) way to maximise returns on a deposit of R36,000.

Is a Tax-Free Savings Account (TFSA) really a no-brainer investment?
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