Brendan Dale from Take Charge of Your Money asked Lizl Budhram, Head of Advice at Old Mutual Personal Finance, about the ins and outs of tax-free savings accounts.

Brendan: What’s the biggest benefit of a tax-free savings account?

Lizl: As you know, SARS likes taking a portion of all the income we earn, including growth on investments and the interest that we earn on savings at the bank. A tax-free savings account (TFSA) allows you to save without having to pay tax on the growth. Ever.

You’ll pay no tax while it’s growing and no tax when you withdraw it. That sounds fantastic and that’s just what you get with a TFSA. As the name suggests, it really lets you save tax-free.

For clarity, you pay no income tax, local dividends tax or capital gains tax on the investment.

Brendan: How much can you invest in a tax-free savings account?

Lizl: A TFSA works like any other savings account.

There is one thing to remember, though. There is a limit to how much you can invest in a tax-free savings account. The annual limit per tax year is R36 000 and the total amount you may invest is R500 000 (over the lifetime of the taxpayer). These limits apply to the sum of all your TFSAs, and over-contributing will lead to a very harsh tax penalty – for every R100 that you go over this limit you will have to pay R40 to SARS.

It’s important to understand how the limits are calculated and that they refer to the money you have added to the account and not to the balance. Any part of the annual R36 000 not contributed to your TFSA will be forfeited and won’t carry over to the following year.

Should you withdraw any money, your limits won’t change. Say you have invested the full amount allowed – R36 000 – at the start of the tax year and then decide to withdraw R10 000 a few months later due to an emergency. You won’t be able to top up your TFSA again until the following tax year. What’s more, the R10 000 won’t be deducted from your lifetime limit so you won’t be able to add another R10 000 to make up the shortfall.

Bearing this in mind, it makes sense to try and keep your money invested for as long as possible to gain the full benefit of a TFSA and the tax-free growth.

Brendan: What is the best way to make my money grow in a TFSA?

Lizl: The best way to use a TFSA is to invest the maximum amount per year and leave the money untouched for as long as possible. The long-term effect of tax-free compound growth can be significant.

If you chose to invest a monthly amount it would therefore be R3 000 per month. If that is too much, don’t worry – you can deposit whatever amount you have. The beauty of a TFSA is that you can simply keep investing, over many years, until you reach the lifetime limit. Even a small investment will make a big difference.

It’s important to know that there are different types of tax-free savings accounts. Using an interest-bearing bank account or a money-market account as your TFSA is a great start, but your only growth will be interest on the money you have invested. Your capital will therefore grow slowly and may not keep up with inflation over the long term. It’s also worth noting that the first R23 800 taxpayers earn in interest (if they are younger than 55) is tax free, so you may not be getting the full benefit of your TFSA when using an interest-bearing account since the interest would have been tax-free anyway.

A better option may be a tax-free savings account where you can invest in equity such as shares, exchange-traded funds, unit trusts, property or foreign markets. This will give you better growth prospects over time, along with greater tax benefits. A TFSA generally also has low fees, which helps your money grow faster.

You are allowed to open several TFSAs at different providers but this won’t necessarily be beneficial, and you will have to keep careful track of all your deposits to stay within the investment limits. If you do want to change to another TFSA, you can move your existing TFSA to a new provider. If you have several TFSAs you can even consider consolidating them all into one account.

However, the best way to maximise your TFSA investment is to invest as much as you can (within the limits) and to leave it invested for as long as possible. There are no limits regarding how much your investment can grow and how large the tax savings will be.

Brendan: Can I open a TFSA for my child?

Lizl: Yes, as long as you’ve registered them with SARS to get a tax number for them – this bit of admin is well worth it.

It’s important to understand that the money belongs to your child and is invested in their name. When they turn 18, they would have full access to it and could withdraw it if they wanted to. If they keep the money invested after their 18th birthday and continue to contribute towards the fund (provided they are still within their lifetime limit), they will benefit greatly from the years of compound tax-free growth.

It could give them a great head start in life.

As a result, tax-free savings accounts can be a very effective way to build wealth for yourself and your children.

If you have any questions, or need advice on the underlying investments, growth prospects and fees of a TFSA, speak to a financial adviser. If you are interested in an Old Mutual tax-free savings account, please speak to an Old Mutual accredited financial adviser.