When not to use a tax-free account

Financial planners can think of very few reasons why not to invest in tax-free savings accounts (TFSAs). The benefits are clear.

However, Lizl Budhram, head of advice at Old Mutual Personal Finance, says if you intend to save more than the R33 000 annual limit or R500 000 lifetime limit, then a tax-free savings account may not be suitable for your savings needs.

The South African Revenue Services (Sars) will levy a tax of 40% on all contributions that exceed R33 000 per tax year.

But “even in such cases, it would most likely still be beneficial to use the tax-free savings account for the first R33 000 of your annual saving amount”, she advises. 
This means that the TFSA is really only “unsuitable” when you have already reached your annual or lifetime limit for investing in a TFSA. 

She says investors who have more than one tax-free savings product (for example with two different service providers) must be aware that the maximum limits will apply across all the tax-free savings products, and not per product.

Ricardo Teixeira, chief operating officer at BDO Wealth Advisors, says the TFSA would not be suitable to taxpayers who have not utilised their interest tax exemption (of R23 800 when you are younger than 65 and R34 500 if you are over 65).

There is also little benefit to someone whose salary is below the annual income tax threshold of R75 750 (R117 300 for those aged between 65 and 75; and R131 150 for taxpayers over 75). 

The TFSA is not the only tax-exempt savings vehicle  South Africans can choose from. Retirement annuities (RAs) are also exempt from income and capital gains tax on the investment returns earned. 

“In deciding to open a TFSA, one should consider the benefit of contributing to a retirement annuity in the first instance. The reason being that your contributions to a retirement annuity are tax deductible whereas the contributions made to a TFSA are not,” Teixeira says.

In both instances the investment returns realised are exempt from tax, he explains. 

However, access to capital, estate planning, protection from creditors and the limit imposed on contributions to a TFSA all need to be taken into account in making the right decision.

“As a rule of thumb it is advisable to maximise your tax deductions, so contributing to a retirement annuity in the first instance is likely to be the right starting point for most South Africans,” explains Teixeira.

He adds that the incentive of tax- exempt investment returns has not enticed the local low-income taxpayer to save using a TFSA.

“It would appear that the policy intent has not been matched by the tax reality. It is the higher income earner and taxpayer who stands to benefit the most from a TFSA,” says Teixeira.

Nyasha Musviba, founder of SATaxGuide, says there must be a purpose for using a TFSA. There is little benefit in using the account as a normal transactional account.

“If you are investing an amount in a tax-free savings account, but you withdraw it the same year, there is no real benefit. You are using your allowance; however, you are not getting the tax-free benefit, since the tax benefit is on the growth of the savings,” he remarks.

Keith Engel, CEO of the South African Institute of Tax Professionals, says TFSAs are not aimed at creating long-term retirement savings, but can be used to augment existing retirement savings.

However, he is concerned that consumers are merely “shifting savings”. “The fact that people are investing into these accounts will only mean something if their overall savings are higher.”

His advice is for individuals to invest in traditional retirement saving vehicles such as employer-provided pension funds, provident funds and retirement annuities, which will grow tax-free. 

The next objective is to become debt-free as quickly as possible, and once this has been achieved, to invest in a TFSA.