Tax-free savings accounts (TFSAs) were introduced in 2015 to encourage individual resident in SA to save more. Through a TFSA, the growth and income received on the investment is tax-free, which means you are not liable for any capital gains tax or income tax on the dividends and interest received on your investment. 

There are limits to how much you can contribute. Currently, the maximum amount you can contribute to a TFSA is R33 000 per year (or R2 750 per month via debit order) and the maximum lifetime contribution is R500 000. Don’t be daunted by this amount, however. You can start your TFSA investment with Investec Asset Management from as little as R500 a month.

You can withdraw money from your TFSA at any time without penalties, but once you’ve reached your lifetime maximum allowance, you can’t top up again after a withdrawal. By dipping into your TFSA over the short term, you are not only not getting the tax benefit that accumulates with time, but you’re also losing out on the potential long-term returns.   

TFSAs should be used as long-term investment vehicles – either as a welcome boost to your own retirement pot or for example to provide your kids with a wonderful start in adult life – such as a university education or a deposit on their flat. Why long term? Because that is the way to maximise the value of the tax incentive. Since the growth and income received on the investment is tax-free, you only realise a tax benefit once there has been substantial investment growth on the portfolio. You would normally see the returns of a TFSA matching or even exceeding your contributions only after about ten years. After 20 years the value of the tax-saving becomes substantial relative to the size of the original contribution.

Furthermore, remember that the maximum lifetime contribution to a TFSA is R500 000. Once you’ve reached your lifetime maximum allowance, you can’t top up again after a withdrawal. By dipping into your TFSA over the short term, you are forfeiting the tax benefit that accumulates with time, you are wasting part of your lifetime contribution and you’re also losing out on the potential long-term returns.   

Given our view that investors should invest in a TFSA for at least ten years to realise the tax benefit, we believe the portfolio's asset allocation should reflect a long-term view and have a higher allocation to growth assets (like equities both locally and offshore) rather than a large allocation to cash, which provides a much lower return over the long term.  

It’s simpler to illustrate with an example: If you’re diligent, and set up a TFSA once your child is born, you’d be able to contribute R2 750 per month for just over 15 years before you reach the current maximum allowed contribution. If you invest in a growth portfolio that generates investment returns 10% per year after all costs, the value of your investment at the end of that 16 years would be around R1,2 million. Taking inflation into account, the equivalent value in today’s money terms would be around R500,000. 

If you had instead invested these TFSA assets in a money market fund (or cash deposit), the portfolio would likely be worth only R330,000 or less in today’s money terms.

It seems that a good starting point for most TFSA investors is to have a look at South African unit trust funds from the “ASISA Domestic Multi-Asset: High Equity” or similar category. These funds have historically produced very attractive long-term risk-return trade-offs, and work even better when tax does not affect the structure of the investment decision.

One can comfortably move even higher up the risk curve, especially for longer investment horizons. The most commonly selected investment option on the Investec Asset Management platform has been the Investec Global Franchise Fund.

TFSAs are a fantastic additional incentive to encourage investors to save more, specifically for those with a long-term horizon, but the first savings priority for any investor should still be their contribution to a registered retirement fund (either through their employer or via a retirement annuity). 

Secondly, investors sometimes forget that they have an annual tax-free interest exemption. At current money-market rates, you can keep close to R300 000 in a money market fund before paying any tax on the interest. Ideally, this allowance should be used to set up your emergency cash pool rather than a TFSA.