You may be interested in investing your savings in a tax-free savings account (TFSA). However, the amount you’re allowed to save in this kind of account is capped. So, what does this means for any interest you earn above the limit?
We have a look at how tax-free savings accounts work, and we distinguish between contribution- and growth limits to illustrate what happens to the interest you earn.
Tip: Click here to switch your TFSA to a tax-free investment at no cost.
What is a tax-free savings account?
According to Ruvan Grobler, business development and wealth manager at Bovest, tax-free savings accounts are made up of contributions from post-tax income. As their name suggests, TFSAs are tax-exempt, within certain limitations.
A TFSA, Grobler explains, gives you the liquidity of a flexible investment. The total annual contribution in a tax year may not exceed R36,000, and your total lifetime contributions may not exceed R500,000.
“A tax-free savings account is an effective way to save for your goals, as any interest, dividends, or capital gains from your account will be free of tax,” says Grobler.
He points out that tax-free savings accounts can be used for the following purposes:
- Tax utilisation
- Long-term investing
- Supplementary retirement savings
These accounts are available through the majority of South African banks, and you can expect an interest rate of between 3% and 7%, depending on the institution you work through.
Contribution limit versus growth limit
The stringent constraints placed on TFSA contributions beg the question as to what happens when your interest exceeds this amount. This depends on the type of limit exceeded, whether contribution or growth.
The contribution limit prevents you from adding funds after you’ve reached the balance limit. The growth limit would prevent your funds from growing after that same limit, should such a limit apply.
Once you hit the R500,000 mark, you will no longer be allowed to make any new contributions. However, if you receive interest – or growth – on your balance of R500,000 (for example R2,000) then the fund will increase by that amount (totalling R502,000) without any penalties.
“While the lifetime limit of contributions is capped at R500,000, all earnings and growth can continue past the contribution limit as long as the capital stays invested. Therefore, there is no growth limit,” says Grobler.