Tax-Free Savings Accounts: The Pros And Cons

Most South Africans find it difficult to save, given that they’re struggling just to make ends meet. With the majority of the population living near or below the bread line, there’s not much money left over to save. This lack of savings, combined with high levels of consumer debt means we become financial burdens on the government in the long run. It's for this reason that tax-free savings accounts were introduced in March 2015 as an incentive for people to start saving money.

A new type of account was created and many financial institutions now offer these accounts. And since they offer a tax break, you will see them referenced on your yearly tax return (ITR12). Let's have a closer look at these accounts and what they mean to you, as a taxpayer.

What is a Tax-Free Savings Account?

Essentially, it's a savings account that invests your money in various financial products such as bonds, unit trusts and bank deposits.

The best thing about this account is that you won't be taxed on anything. No tax will be burdened for the growth of your investment, nor for a withdrawal from your account.

What are the annual limits for Tax-Free Savings Accounts?

There's an annual contribution limit of R36,000 per tax year and a lifetime limit of R500,000. Once you've reached your lifetime contribution limit of R500,000 no further investments in tax-free savings accounts will be allowed.

How many accounts can I have?

The annual R36,000 limit can be contributed to as many tax-free savings accounts as you'd like, but you can't invest more than that for the year. For example, if you have contributed R20,000 to one account so far then you can only invest a total of R16,000 in any other accounts.

Annual contribution limit does not carry over

If you don't allocate the full amount of your investment allowance for the tax year, then it's lost and you start from scratch the next tax season with a new annual limit. For example, let's say you save R16,000 for the tax year. It’s not possible to carry over any of that money when the next tax season begins since there is no more space.

Contributions to a tax-free saving account for children.

In some cases, parents will open a tax-free savings account for their kids. However, they must be aware that any contributions they make towards the account count towards the child's annual and lifetime contribution limit.

What are the Benefits of a Tax Free Savings Account?

You get tax free growth, even if you reinvest.

The main benefit of a tax-free savings account is that your growth or earnings on the initial investment are not taxed when you withdraw. This means you can continue to invest and reinvest, and it won't affect your lifetime contribution limits.

For example, if you invest R36,000 for the year and receive a return of investment of R5,000 that you wish to reinvest, the total amount in the account will be R41,000. This means you can invest your full R36,000 next year even though you've re-invested R5,000 this year - the initial reinvestment is not counted towards your annual or lifetime limit.

Withdrawals are unlimited, but there are limitations.

You're always welcome to withdraw your money from the account, but any amount that you re-invest will count as a new contribution. This means it will also count against your annual and lifetime limits.

Let's pretend you withdrew an amount of R36,000 from your tax-free savings account to cover a short-term cashflow issue. A few months later, in the same tax year, you come into some extra funds and so you deposited R36,000 back into your tax-free savings account. If you haven't made any other contributions this year, then this money would take you over your annual contribution limit (plus it will be added to your lifetime contribution). But if you have already made contributions in the current tax year, then this payment would have pushed you over your annual maximum contribution level.

If you contribute more than the limit, what else happens?

If you exceed the annual or lifetime limits imposed by the SARS, they will penalize you with a stiff 40% penalty tax on the year you exceeded the limit. You'll have to pay this at your next assessment.

For example, if you invest R10,000 in one account and R36,000 in another account, the excess contribution will be R10,000. That translates to a tax penalty of 40% of the excess contribution (R10,000 X 40%), or R4,000 that you'll need to pay.

What should I tell my accountant to report on my income tax return (ITR)?

Tax-free savings accounts are great and your financial institution will issue you with and IT3(s) which you will use to complete the relevant section on your tax return. There is a question on your return which opens the Tax-Free Investments section. This is where you'll capture the information on your account's tax certificate for your annual tax return. Alternatively, you could make use of our services to help you complete and file your taxes. Get in touch with us today to ensure you are maintaining your tax compliance status.