What do I need to know about investing in a tax-free savings account?

Tax-free savings accounts do exactly what the label says: they allow you to save without paying tax.

If you save in one of these accounts, you won’t pay any income tax on the interest you earn, dividends tax on the dividends you earn or capital gains tax (CGT) on the capital gains you make.

These accounts are created under provisions in the Income Tax Act that came into effect in 2015 in order to encourage South Africans to save.

These provisions make it possible for different financial institutions to offer you tax-free savings accounts housing anything from bank savings accounts to unit trusts or exchange traded funds.

The tax benefits are, however, limited by way of the amount you can contribute, so as not to give up all the tax revenue from investments, especially on returns and growth earned by those with more to invest.

In addition to this, the regulations on tax-free savings accounts attempt to ensure your savings are protected by restricting the accounts to financial products that are simple, have reasonable costs or do not result in you incurring a penalty should you suddenly be unable to save.  

Here are the key things you should know about tax free savings accounts:

The investment limits

The amount you can invest in a tax-free account each year is limited – for the 2021 year you can invest only R36 000 and a maximum of R500 000 over your life time.

The limits apply to the amount you invest in these accounts, and not the growth in them. The growth on the amounts you save is not limited.

So your tax-free savings account can grow to more than R500 000 over your lifetime, as long as the amount you put into the account does not exceed R500 000.

If you withdraw any amounts that you have contributed, they still count towards your annual and lifetime limits. In other words, you cannot replace the amounts you withdraw. If you contribute R350 000 and then withdraw R100 000, you can only contribute another R150 000 (R500 000 – R350 000).

If you contribute R36 000 each a year, it will take you just less than 14 years to contribute the maximum amount.

Each financial services company is prevented by regulations under the Income Tax Act from accepting contributions of more than R36 000 a year and R500 000 over your lifetime.

However, you should be careful not to exceed the contribution limits if you contribute to accounts held with more than one company.  

If you do contribute more than the limits, the amount that exceeds these limits will be subject to a once-off tax penalty of 40%.

Financial services companies who offer tax free savings accounts must report how much you have invested in them to the South African Revenue Services (SARS) and SARS can apply the penalty in the tax year in which you overcontribute.

Rules on the underlying investments

The underlying investments for tax-free savings accounts include bank savings accounts, fixed deposits, unit trust funds, life insurance portfolios and exchange traded funds.

Some of the investments you will not be able to invest in through a tax free savings account include:

Any investments that charge performance fees. A number of unit trust funds that typically charge a performance fee have launched a fund fee class in which there are no performance fees, so that these funds can be included in tax-free savings accounts.

Any exchange traded note (ETN) or other exchange traded fund (ETF) that is not registered as a collective investment scheme.

Structured products and smoothed bonus accounts. These products are excluded as the regulations prohibit any investment products in which part of the return is withheld from you.

Structured products typically guarantee a portion of your return linked to a market index or your capital, or both, but you pay for the guarantee by giving up a portion of the promised performance of the market index.

Smoothed-bonus portfolios withhold some returns after good performance in order to smooth performance in years when returns are not as good.

Products that pay loyalty bonuses if you stay invested for the full term.

Any investment with more than 10 percent in a single share or commodity.

Any investment in shares where less than 80 percent of the shares are listed on a recognised stock exchange.

Any investment that includes derivatives, except in cases where these are held only to reduce potential losses.

Investments with high penalties for early withdrawals.

Individual stockbroking accounts through which you can select your own shares.

Any investment products that include life assurance or disability cover.

If the account has a fixed term and a guaranteed rate of return, the return must be calculated in line with a formula in the regulations.

Access to your savings

Investments can have a maturity date, but it may not be more than five years and you must be able to withdraw, despite the term, after giving 32 days' notice.

If you do give notice before the term is up, you may be charged a penalty for an early withdrawal, but it cannot exceed the higher of R300 or an amount that is determined in a formula set out in the regulations.

The formula takes into account how long you have been invested for, how much you are withdrawing, how long you have until maturity and the interest you could have earned if you had stayed invested.

If the returns you earn on an investment are not linked to interest rates, the maximum penalty you can be charged for early withdrawal is R500, but this penalty should reduce each year until there is no penalty after five years.

If there is no maturity date on a tax-free savings or investment account, you must be able to access your money within seven days of requesting it.

If there is a maturity date, you must be paid out within seven days of the maturity date.

Transferable

Your savings in a tax-free savings account can generally be transferred to another provider, but there are a few T&Cs. Read more: Can I transfer savings in a tax free savings account to an account with another provider?

No escaping death tax

The one tax that may be payable on a tax-free savings account is estate duty. If you die with money in a tax-free savings account, it will be deemed to have been sold (disposed of). No CGT will be payable, but the tax-free account itself cannot be transferred - the amount in your account will be included in your estate for estate duty.

If your tax-free savings account is a policy on which you have named beneficiaries, the amount can be paid directly to the beneficiary and your estate can avoid executor’s fees, but the policy benefit will still be included in your estate for estate duty.

If the assets remaining in your estate, after all expenses are paid, exceeds the estate duty exemption, and you are not leaving the money to your spouse, your estate will pay estate duty.