Personal finance: Maximise your savings with a tax free savings account

First published in the Daily Maverick 168 weekly newspaper.

One positive side-effect of the Covid-19 pandemic has been an increased awareness of the importance of saving. This is reflected by the fact that South Africans in a position to do so, are now saving more than before.

According to Statistics SA, the household saving rate increased to 0.7% in the first quarter of this year, up from 0.5% in the fourth quarter of 2020. Although this is not a huge increase, the upward move is encouraging, particularly since the national rate previously showed a downward trend.

In a bid to encourage savings, the government introduced tax-free savings accounts (TFSAs) in March 2015. You are allowed to contribute a maximum of R36,000 a year and R500,000 over your lifetime to tax-free savings accounts. The capped amounts only refer to your capital contributions and do not include the growth on your investments.

These savings vehicles do not carry any tax charges and consumers are starting to shift their savings into TFSAs in recognition of their benefits.

“With a TFSA, the entire growth is tax free, which means you typically will get a higher return in a tax-free savings account than a taxed savings account assuming the same underlying assets,” explains Marius Pretorius, head of marketing: retail savings and income for Old Mutual. “On the other hand, taxed savings accounts are exposed to a variety of taxes such as dividend withholding tax and tax on interest. This means that before you benefit from the return, tax will have to be deducted.”

The main advantage of TFSAs lies in their flexibility. You can contribute a once-off sum or make recurring contributions and you pay no tax on the growth of your investment.

Although they are called TFSAs, these accounts can include fixed deposits, unit trusts, retail savings bonds, linked investment products, exchange-traded funds (ETFs) and even endowment policies issued by long-term insurers.

Although you can withdraw from a TFSA at any time, Pretorius warns that they should not be viewed as short-term investments.

The frequency or timing of any withdrawals will depend on the type of TFSA you invest in. For example, if it is a 32-day fixed deposit account, you will have to give the financial services provider 32 days’ notice.

Products can also be a bit more complicated. For example, Allan Gray offers a unit trust-based TFSA that is structured as a life policy. When you die, the benefit can be paid immediately to your appointed beneficiaries and there are no executor fees. The value of the investment, however, will be included in your estate for the calculation of estate duty.

You can choose from an underlying unit trust or trusts from the Allan Gray Tax-Free Investment Fund list, which includes the Allan Gray Money Market Fund and the Allan Gray Tax-Free Balanced Fund, and a selection of unit trusts from other investment managers. Returns depend on the underlying unit trust selection.

“It is important to distinguish between the TFSA, which can be seen as the product wrapper, and the underlying unit trusts, which will generate the returns,” says Shaun Duddy, senior manager in product development at Allan Gray.

Glenn Grimley, head of Stash at Liberty, points out that if you withdraw from a TFSA, it does not “free up” the annual or lifetime limit for additional contributions.

“For example, if you have contributed R36,000 for the year by October, you will have reached your annual contribution limit. If you withdraw R10,000 in November, it doesn’t adjust your limit. You are still deemed to have made your annual contribution and you will be taxed at a rate of 40% if you make any additional contributions in that year,” he says.

Although financial service providers have alerts to let you know when you are nearing your contribution limits, it is important to remember that they do not have oversight of any other TFSAs you may have.

For example, if you have saved R18,000 in your Allan Gray TFSA, your statement will show that you are still able to contribute another R18,000. But you might also have saved R10,000 in an FNB TFSA, in which case you can only contribute another R8,000 for the year.

If you have multiple TFSA accounts, you need to keep a very careful eye on contributions to avoid paying 40% tax on any excess contributions.

Can you pass on TFSA benefits?

To answer this, DM168 posed a question to financial service providers: Mary has saved R300,000 in a TFSA. On her death, it goes into a testamentary trust for her son Michael, now aged 24. Mary also opened a TFSA for Michael in his name when he was 14 and so his contributions are now at R330,000. Does Mary’s R300,000 go to Michael tax free?

Johan Strydom, growth head at FNB Fiduciary, says Mary’s TFSA will form part of her estate and estate duty of 20% will be levied on it.

“After the estate has been wound up and all tax paid on the estate, Michael will receive the remaining benefit in Mary’s TFSA as a monetary amount via her will. So, other than the estate duty, no tax is payable on Mary’s TFSA benefit when it is paid over to Michael.

“Michael will still have a balance of R330,000 in his own personal TFSA. He can now contribute the money from Mary’s estate to his TFSA should he wish to but would have to abide by the R36,000 maximum annual contribution and the R500,000 total capital threshold,” he says.

Pretorius agrees, noting that Michael cannot add the full R300,000 to his TFSA as this would exceed the TFSA contribution limits and he would have to pay 40% tax on the amount exceeding the limits. “Note that the penalty for over-contribution is calculated each tax year and not at the end of the ‘lifetime’ limit,” he adds. DM168

Next week: Performance returns on different TFSAs and where you can invest.

This story first appeared in our weekly Daily Maverick 168 newspaper which is available for R25 at Pick n Pay, Exclusive Books and airport bookstores. For your nearest stockist, please click here.