Tax Free Savings Accounts Made Simple: A Step-By-Step Guide

Written by Julie Brownlee on March 26th, 2016

The Complete Guide To Tax Free Savings Accounts

I have no doubt you’ve heard of tax free savings accounts (TFSA).

Most of us have, and we hear how brilliant they are to invest with and how every South African should have one.

But how exactly do tax free savings accounts work?

What are the benefits of using this type of account?

What can you use tax free savings accounts for?

How should you go about picking the right tax free savings accounts?

And is a TFSA actually worth considering?

Let’s delve a little deeper to find out the answers to these questions and much more…


BONUS: Get your hands on this TFSA Cheat Sheet and discover the best ETFs you can invest in using your Tax Free Savings Account!

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The Ins And Outs Of Tax Free Savings Accounts


The government introduced tax free savings accounts last year in a bid to encourage us to save more for the long-term.

They offer a number of benefits and even if you’re a high income earner, they’re worth making use of.

Most brokerages and investment firms encourage them, whilst some have even called them a “no brainer”.

But are TFSA’s really the best savings account?

To work out whether they’re right for you, you need to understand exactly how they work…


How Much You Can Invest In a TFSA


Each year, you can put R33,000 into a tax free saving account (TFSA).

There is a cap on the total amount you can save of R500,000.

So if you invested the maximum R33,000 each year, it would take you 15 years to hit this cap.

Of course, at some time in the future the annual contribution or the total amount could rise, increasing the tax-free benefit.

So whilst it’s capped at R33,000 per year, and R500,000 over your total investing period, this could change.


What Can You Invest In?


Tax free savings accounts aren’t just for saving money.

You can use them to invest in a number of different products, including unit trusts and exchange traded funds.

Yet there are some exclusions.

For example, unit trusts that charge performance fees and derivatives.

The major benefit to you is that any interest, dividends or capital gains you earn is tax-free.

Over the years, the savings can mount up, and your returns are exposed to the wondrous effect of compounding.

(I’ll touch on that again in a second).

Not to mention all those taxes you would’ve paid by investing through other accounts never leave your TFSA account, so you effectively boost your performance just by ‘reinvesting’ these taxes you normally would’ve had to pay.


What If You Invest Too Much?


You can have more than one TFSA.

For instance, you may decide to split your annual amount between unit trusts and a fixed deposit account by using two separate accounts.

The onus is on you to manage the amounts you pay in.

But nothing changes when it comes to your limits and how much you can put in.

If you exceed the annual cap or the total limit, you’ll pay a tax penalty of 40% on the excess amount.

Depending on what your goal is, there are workarounds.

For example, if you’d like to open a TFSA for your kids you can open one in their name and contribute towards it without ever denting your own TFSA limit.

So if you were planning on opening a ‘university fund’ through a TFSA you can still do so, without ever having to impede your own tax free investing!


Why You Need To Leave Your TFSA Alone!


One major benefit of a TFSA is by contributing regularly over the years, you can grow your money and benefit from compounding.

Compounding is a great way to get your savings to grow.

Whether it’s interest or dividends you receive, if you reinvest this money (in other words don’t withdraw it), it will go on to earn interest or dividends in the future.

This causes a snowball effect to take place.

But this isn’t the only reason why you shouldn’t touch money you’ve invested in your TFSA.

If you withdraw money from your TFSA, you can’t replace it.

For example, you invest R33,000 one year in your TFSA, but later decide to withdraw R15,000.

You can’t invest another R15,000 in the same year or you’ll have to pay a tax penalty.

Whilst this encourages you to save, it also means you need to ensure that you don’t need the money you’re putting to work in your TFSA.

TFSA investing really is for the long term, and it’s not just a ‘benefit’ you’ll miss out on if you withdraw early, but you’ll get penalized if you want to replace that amount.

So what about transferring funds between your accounts?

At the moment you can’t transfer balances between TFSAs.

Yet as reported last week, the Treasury plans to introduce this facility in November after consulting with various product providers.

So keep an eye out for that later this year…


How To Pick The Right TFSA For You


The first decision you need to make is what to invest in.

Are you looking to put away cash?

Or do you want to use your TFSA for investing on the stock market?

If you want to do both, you’ll need to open more than one account.

You just need to ensure that you don’t exceed your annual allowance (they do check, so don’t play with fire).

Then it’s a case for looking for the best account weighing up fees and costs.

All TFSAs must have reasonable costs, but they do actually vary from bank to broker, so it’s worth shopping around.

Compare what’s on offer and pick the most cost efficient one for you.

And remember, the more you pay in costs, the bigger the impact is on your long-term returns.

If you’re looking for a great way to compare costs between the various TFSA providers without having to spend hours on the phone or digging through emails, have a look here.


5 Ways To Make The Most of Your TFSA


To ensure you make the most of the benefits that come with TFSAs, stick to the following tips…

TFSA Tip # 1: Start Early

Yip, you’ve definitely heard this one before.

But as with all long term investing, you need to start contributing to a TFSA as soon as possible.

The quicker you start, the longer your money has to work for you and for compounding to work its magic.

TFSA Tip # 2: Contribute The Maximum Amount

If you can, invest the maximum annual amount of R33,000 into your TFSA.

This means you’re making the most of the current tax free threshold and means your money will work harder for longer.

Remember, using a TFSA is not like normal long term investing where your investment period is technically unlimited.

When it comes to TFSA’s, you only have 15 years in total to save and grow your money.

So if you don’t contribute the maximum at some point you could stand to lose out.

TFSA Tip # 3: Don’t Take Money Out

View your TFSA as a very long-term savings account.

The longer you leave money there, the more you benefit from all interest, dividends and capital gains being tax free.

Plan to only start dipping into your account once you reach retirement.

TFSA Tip # 4: Don’t Invest Too Much

I bet you haven’t heard this one before?

“Don’t invest too much”.

But the thing is, the tax penalty is hefty.

40% to be precise.

And you really don’t have to pay this, but it comes down to you, and not overinvesting.

That’s why you want to ensure that you don’t exceed the current annual amount of R33,000.

If you have more than one TFSA, keep accurate records of what you invest in each to ensure this doesn’t happen.

Don’t let an avoidable error cost you in the long run.

TFSA Tip # 5: Open TFSAs For Your Children

If you still have children at home, consider opening up TFSAs for them.

You could funnel a portion of birthday or Christmas money into their accounts each year.

Not only will this give them a head start, but it will help you instil the importance of saving.

And when it comes to saving for things like university funds why pay tax on these contributions when you simply don’t have to?


When Not To Use TFSAs


Believe it or not, TFSAs aren’t for everyone.

As Matthew Lester pointed out in, a large number of investors don’t pay tax on interest or capital gains anyway.

This could be because:

  • The interest they receive is less than the current annual allowance of R23,800 (or R34,500 if over 65) or;
  • Their capital gains don’t exceed the current annual allowance of R40,000.

For this type of investor, the only saving is on dividend tax.



TFSA's Are Hands Down The Best Savings Account At Your Disposal


There are many benefits to using TFSAs to kick-start your savings.

Whilst they’re not perfect for every investor, if you have a substantial portfolio or savings they will likely help you save money on tax.

If you’re looking for a way to apportion some of your investment capital into a product for the long-term, you really should consider TFSAs.

By investing the maximum amount each year, you could create a substantial nest egg over the years, which could help you to fund some of your retirement.

I’m sure at this stage you’re wondering what exact ETFs you should be putting your money into with your TFSA?

We’ve been asked this question so often we decided to put together a TFSA ETF Cheat Sheet just for you!

In it we reveal all the best ETFs you can include in your TFSA, so you don’t have to spend hours researching, or spending time asking advisors and unnecessarily trawling the net.

All you need to do is tell us where to send your copy!

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Here’s to tax free investing. 

Julie Brownlee | The Money Lab

Julie Brownlee
Editorial Contributor
The Money Lab