South Africans are now able to invest up to R30 000 a year in tax-free savings accounts (TFSAs).

The aim of these savings accounts is to encourage South Africans to save for medium-term goals and emergency funding, reducing our reliance on debt and the temptation to access our retirement funds in the case of emergencies.

Any amounts invested in these TFSAs will not attract any form of tax including interest income tax, capital gains tax and dividend tax. Understandably, investors are asking whether TFSAs offer an alternative to less flexible retirement products.

TFSA: Invest with post-tax money but withdraw tax free

Contributions made to these accounts are from post-tax earnings but withdrawals from tax-free savings accounts are non-taxable. There is also no tax or other limitations when you withdraw the funds. However, you only really benefit from this tax saving if you keep the investment for a significant period of time and allow the funds to grow.

For example, if you save R2 000 a month over 20 years into a low-cost unit trust fund, earning inflation plus 5% (i.e. 11%) a year, your total contributions over the 20-year period will amount to R480 000.The fact that income on investments are tax free means that you earn an estimated additional R166 000.

Retirement fund: Tax benefit upfront, tax on withdrawal

Contributions to retirement funds are tax-deductible, but withdrawals are taxable and rules apply as to how you can invest your post-retirement funds. However, depending on your tax rate, products like retirement annuities and employer retirement funds may still offer more tax-efficient retirement savings unless you have a low tax rate and are not required to submit a tax return. In this case you may not benefit from the tax deductibility of contributions to a retirement annuity.

It is also important to note that TFSAs are limited to R30 000 per year, whereas currently you can contribute up to 15% of your salary into a retirement fund. Someone earning R300 000 a year would be able to contribute R45 000 a year to their retirement fund tax-free. This amount is set to rise to 27% next year.

 What you need to know

• Tax-free savings accounts are extremely liquid, allowing investors to access funds with seven days’ notice. However, the government penalises unnecessary withdrawals by prohibiting investors from reinvesting these amounts into the savings account.
• Any contributions in excess of the R30 000 per annum limit will be taxed at 40%.
• In order to promote savings, National Treasury is not allowing the conversion of existing saving accounts into TFSAs. However, where a low-income individual is invested in a product that is not suitable for their needs, such as endowment policies with a tax rate of 30%, National Treasury is investigating the possibility of allowing individuals to convert their savings or investment in current products into tax -free investments, as long as the value does not exceed the annual limit of R30 000. This however will only be finalised later this year.