I wrote about my son’s ordeal with SARS, where he started to receive final letters of demand – despite being a student, for my News24 column.

That situation taught us a lesson I want to share with you now, especially with the tax year-end deadline of 28 February approaching.

Here is what happened: my son sold some investments that had grown nicely over the years. The sale produced a capital gain of R43 000. After the annual R40 000 capital gains tax exemption, he had a taxable gain of R3 000. Not terrible, but it triggered a SARS filing requirement he had missed for three years, which is why he received the final demand letters for penalties totalling R1 000.

The thing is, if those investments had been in a tax-free savings account (TFSA), there would have been no capital gains tax. No filing requirement. No final demand letters. Just growth he could access tax free.

Use it or lose it

My son could have split his redemption and sold a portion just before 28 February (with a capital gain of less than R40 000) and then the remainder on 1 March. In fact, that is a strategy I am employing right now as I am re-balancing a portfolio – so I am selling 50% now and 50% in March to benefit from the R40 000 capital gains tax exemption in both tax years.

But you can also use this exemption to reset your base investment cost annually.

Investment platform Fynbos Money recently gave a presentation to illustrate how, if you have built up assets outside a tax-free savings account, there is a way to use the annual R40 000 capital gains tax exclusion to your advantage.

You do this every year by selling an investment with a gain, using your R40 000 exemption, and reinvesting the proceeds. This raises your base cost, which means lower tax when you eventually sell.

Let’s say you bought some shares years ago for R100 000 and they are now worth R150 000. If you sell them now, you have a R50 000 gain. The first R40 000 is tax free, and only R10 000 is subject to tax. The inclusion rule states that only 40% of the taxable portion of your capital gain gets included, so that means that only R4 000 (40% of R10 000) gets added to your taxable income.

So, out of a R50 000 capital gain, you only pay tax on R4 000 of it, at your marginal rate.

Furthermore, If you immediately reinvest that R150 000, your new base cost is R150 000. If the value of your shares now grows to R200 000, and you sell, your gain is now R50 000 instead of R100 000. You’ve effectively locked in R40 000 of tax-free growth.

If you continuously do this, you will save a significant amount in capital gains tax when you finally sell the investment – perhaps for retirement purposes.

Of course, the challenge is that it requires admin, and there will be a few days when you are out of the market as the reinvestment takes place. This means you could miss out on some good returns if the market ran during that period.

The TFSA alternative

There is a better way to avoid this whole exercise: use a TFSA from the start.

When you invest in a TFSA, all growth is tax free. Capital gains, dividends, interest – none of it triggers a tax liability. You can sell, switch funds, withdraw, and invest without worrying about SARS.

The current annual contribution limit to a TFSA is R36 000, and you have a lifetime limit of R500 000. That might not sound like much, but over decades, it compounds into something substantial. And every rand of that growth is yours to keep.

If my son had put his original investment into a TFSA years ago, he could have sold his ETF units without creating a taxable event. No final demand letters. No need to file returns for investments. No tax bill.

When a TFSA make sense

On the other hand, a TFSA works best for long-term goals – retirement top-ups, education savings for your kids, or building wealth you won’t need to touch for 10, 20, or 30 years.

You shouldn’t use a TFSA if you need regular access to that cash. You also shouldn’t use a TFSA as a place to store your emergency funds.

Every investment into your TFSA counts towards your lifetime limit of R500 000, and if you withdraw funds, you can’t put them back in if you’ve already used up that year’s allowance. You also can’t “catch up” on previous years’ allowances that you didn’t use.

Also, don’t over-contribute. SARS charges a 40% penalty on anything above your limits. It’s one of the few ways to mess up what’s otherwise a very taxpayer-friendly account.

Make a plan before 28 February

So here’s what I’d suggest before the tax year ends:

1. If you sold any investments during the tax year, check if you made any capital gains on those investments. If not, consider selling something that’s sitting on a gain and reinvesting it.
2. If you haven’t maxed out your TFSA contributions for this year, do it. The R36 000 annual limit resets on 1 March.
3. For any money you intend investing for the long term, put the first R36 000 of it into your TFSA.

The R40 000 capital gains tax exemption is useful, but it’s a year-by-year exercise. Using your TFSA, on the other hand, eliminates the problem entirely.

And if you have kids, open a TFSA for them now. You can contribute R36 000 a year on their behalf from birth, and by the time they’re adults, they’ll have tax-free growth that makes my son’s Satrix investment look small.

The deadline is 28 February. Don’t let that R40 000 exemption slip away, and don’t miss out on another year of TFSA contributions.