Why a tax free savings account and how to manage it

When it comes to saving for a rainy day, South Africans are world wide known for not saving enough for unforeseen circumstances.

Even those who do save, must navigate the pitfalls and make sure they do not pay unnecessary fees and money to the SARS.

When it comes to saving for retirement, your investment return i tax free, but this article relates to voluntary savings.

You have basically have to option of an endowment, a unit trust investment and a tax free savings account. A tax free savings account is limited to R36 000 per year and R500 000 over your life time. Every time you make a deposit into the account, you use your yearly and lifetime allocation. The fault people make, is that they withdraw from the account, because you have access anytime to the funds. If you want to use a tax free savings account optimally, you should make deposits into the account and leave the money in the account for the long run. That way you used your lifetime and yearly allocation and you got maximum out of it with all the compound interest you earn over the years.

In the words of Albert Einstein - "compound interest is the eighth wonder of the world. He who understands it, earn it...he who does not...pays it"

If you deposit money into the account and withdraw it, you used your lifetime allocation and did not get the benefit, by that you are the one paying compound interest.

The other options you have with voluntary savings are subject to tax. Any growth attracts capital gains tax. Income (excluding local dividends) is taxed at 30% for individuals (different rates apply for companies and trusts) – this is deducted at the point of distribution. Capital gains tax is deducted when your withdrawal is paid.

You should thus use your tax free savings account first, you should see it as a long term investment which you do not have access to, that way you are one of those who earn compound interest.