How to maximise your tax-free savings account for long-term wealth

Many South Africans are looking to reduce their tax burden and improve overall tax efficiency, and one of the most effective tools available is the Tax-Free Savings Account (TFSA). With an annual contribution limit of R36,000 and no tax on interest, dividends, or capital gains, the TFSA offers significant long-term benefits – although it’s important to ensure that you align your TFSA with your broader investment strategy. Here’s how to get the most from your tax-free savings.

Use your tax-free allowance wisely: The TFSA has become a key component of long-term financial planning because all income and growth earned within the structure, including interest, dividends, and capital gains, are tax-free. Note, however, that contributions are made with after-tax income, and no tax deduction is available on contributions such as in the case of retirement fund contributions. While it, therefore, makes sense to first maximise your retirement fund contributions, the TFSA remains an exceptional long-term investment vehicle.

Think long-term from the start: The tax benefit in the early years of a TFSA is fairly small, with the compounding tax savings only becoming meaningful after about a decade. With this in mind, a TFSA is best suited to long-term investing and is not ideal for an emergency fund. It can, however, be used to supplement retirement savings or to meet other long-term goals, such as funding a child’s tertiary education.

Structure your contributions to suit your cash flow: Legislation permits annual TFSA contributions of up to R36,000 with a lifetime limit of R500,000, with most providers allowing flexible contribution options for investors depending on their personal circumstances. For instance, if your income is variable, you can set up a modest debit order and top it up when additional income becomes available, thereby allowing you to consistently build wealth without placing strain on your budget.

Understand the implications of withdrawals: While it is possible to withdraw from your TFSA at any time, it’s important to understand the consequences because withdrawals can reduce your lifetime contribution capacity. For example, if you’ve contributed R300,000 towards your TFSA and withdraw R50,000, you may only contribute another R200,000 in the future, regardless of whether you replace the R50,000 later. Importantly, withdrawals not only reduce your tax-free limit but can also interrupt the compounding growth within the investment.

Match your investment to your time horizon: When selecting the underlying investment for your TFSA, consider how long you intend to stay invested. If you’re investing for your child’s education 15 to 20 years from now, or to supplement retirement income, your investment horizon may be long enough to justify growth assets. Having said that, it’s important to balance return expectations with your risk tolerance. Also, remember that individuals under 65 already enjoy a tax exemption of R23,800 per year on interest earned (R34,500 if over 65), so using your TFSA to invest in low-yielding interest-bearing assets might not be the most efficient use of your tax-free allowance.

Choose an efficient investment platform: There are numerous TFSA providers in South Africa, ranging from banks to investment platforms. While fixed-term accounts and money market funds are available, those with a long investment horizon should consider a more aggressive unit trust portfolio to harness better growth over time. Ideally, select a platform that provides consolidated reporting across your retirement and discretionary investments, so that your TFSA integrates seamlessly into your overall strategy.

Avoid over-contributions and penalties: It’s important to ensure that you stay within your R36,000 annual limit, as any contributions above this will attract a penalty tax of 40% from Sars, regardless of your personal income tax bracket. If you have more than one TFSA, be sure to track contributions carefully to avoid exceeding the threshold and incurring avoidable penalties.

Stay compliant with Sars: Even though no tax is payable within a TFSA, you are still required to disclose the investment on your tax return. Your provider will issue a tax certificate, and it’s important to include all TFSA-related information when filing with Sars. Maintaining transparency ensures compliance and helps avoid any administrative issues.

A TFSA can be a powerful tool for building long-term wealth, provided it is used strategically, managed consistently, and integrated into your broader financial plan.

* Odendaal is an associate financial planner at Crue Invest.

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