You may be aware from the recent coverage in the press, that National Treasury has passed legislation to permit investment in Tax Free Savings Accounts (TFSA) as of 1 March 2015.

For those of you familiar with the tax free “ISA” in the UK, the TFSA is based on the same approach and the UK system is one of the systems that National Treasury researched, when building the framework for South Africa’s TFSAs.

How do TFSAs Work?

Each tax payer is now permitted to open two TFSAs per year with one or two companies (“service providers”) of their choice. These accounts are tax free vehicles (“wrappers”) for products offered by the likes of banks, insurers, asset managers and stock brokers, to name a few. The type of products that will be made available, are those that you are already familiar with, and probably already invest in. We expect bank savings accounts, term deposits, unit trusts and ETFs to be the most commonly used products. However, many products are permitted as long as they meet the principles of being simple, transparent and suitable.

Products that are explicitly excluded, include products that charge performance fees, individual share dealing accounts and insurance products with contractual payments (like a retirement annuity).

Permitted Annual Contributions

The total permitted annual contributions to all of an individual’s TFSAs will be R 30 000 per annum, with a maximum lifetime contribution of R 500 000. To put this in perspective, this amounts to savings of R 2 500 per month for just under 17 years. Although the current legislation does not cater for annual inflationary increases in the amount of the permitted annual contribution, it is expected that this will increase from time to time so as to ensure that in real terms the amount of the increase remains consistent with the initial permitted savings threshold.

Tax Free

All investments bought within a TFSA will not attract any income tax, capital gains tax or dividend withholding tax while you hold the investments in the TFSA. This means that after you have reached the R500 000 lifetime limit, the investments in the accounts can continue to grow tax free as long as you retain the TFSA.

Withdrawals

One of the key considerations in managing the risk of any investment is to consider the ability of the investor to withdraw their funds if required (liquidity). A Retirement Annuity is one such investment that doesn’t offer access to your savings, however a significant benefit of the TFSA is that you can withdraw funds at any time. However, any funds that are withdrawn may not be reinvested in a TFSA. In other words once you withdraw funds, that portion of your maximum R500 000 of lifetime contributions is lost forever.

Monitoring and Compliance

Taxpayers will be responsible for managing their overall yearly contributions to remain within the R 30 000 limit, although it is expected that the product providers will assist this process through their own internal checks and balances. Individuals will need to declare the total amount of contributions made into tax free accounts in each tax year, in their tax returns.

Difference between the Annual Interest Income Exemption and a TFSA:

The current interest income exemption of R 23 800 (R34 500 for taxpayers over 65 years of age) only applies to interest earned and not capital gains, nor dividends, and this is the main difference between the two forms of tax savings.

It should be noted however that National Treasury will gradually reduce the annual interest exemption by not increasing the allowance into the future as it has done in the past. This means that over time the R23 800 interest will become less and less relevant to taxpayers in real terms.

It is the responsibility of the tax payer not to breach the permissible TFSA annual and lifetime savings thresholds. Should a taxpayer invest in excess of these thresholds, the excess funds will be subject to a penalty tax charged at the taxpayer’s marginal rate of tax.

What Should I Do?

Firstly, depending on your circumstances, it may make sense to use this tax free savings account to save for the long term, and at the same time, benefit from the liquidity that comes with the tax free savings account.

Another apparent opportunity is to use this TFSA to save for your children, or grandchildren. Many of us have started putting away money for our kids, or grandchildren, and it is a fantastic opportunity for them to benefit from the tax free compounding for a long time into the future. In terms of current legislation a taxpayer can donate R100 000 per annum, without donations tax implications.

In the meantime, please contact us if you would like to know more about these products, and how they fit into your financial plan.