When it comes to investing, a tax-free investment is one of the most powerful tools you can add to your investment strategy—especially if you’re young. However, your tax-free investment needs to be handled the right way to unlock its full potential.

Talk of tax-free investing often leaves people’s eyes glazed over or squinting in confusion. So let’s demystify it for you.

 

 

What is a Tax-Free Investment?

A tax-free investment is a type of investment or savings vehicle where you won’t incur tax liabilities on interest earned, dividends received, or capital gains made. Don’t panic if these terms already sound intimidating—let’s break it down.

You know how SARS (South African Revenue Service) takes a cut of your taxable income? Well, the same thing happens with investments—they take a portion either as your investment grows or when you cash out. That’s why tax-free investments are like a VIP party for your money where SARS never gets an invite. They’re not allowed in—as long as you follow the rules.

This means you’ll never pay tax on the interest earned, dividends received, or capital gains within your tax-free investment—or when you eventually withdraw from it. That’s right. No tax. No. Tax. At. All. Can you say heck yeah!? Treasury did a fantastic thing for South Africans by introducing this savings vehicle in 2015.

So, why don’t we just invest everything in a tax-free investment? Well, wouldn’t that be nice! However, there are certain rules we need to abide by.

 

 

How Much Can I Invest in a Tax-Free Investment?

You can contribute up to R36 000 per year, and R500 000 over your lifetime. The sooner you start, the more you’ll benefit from compound interest over time.

 

 

Can I Withdraw Money from a Tax-Free Investment?

Yes, you can, but we would advise only if it’s for retirement. The true power of a tax-free investment lies in leaving it alone to grow and benefit from compound interest over time. We like to call this your “never touch money.” Using a tax-free investment for short-term goals defeats its purpose as a long-term savings vehicle.

That said, life happens, and sometimes you might need to dip into your tax-free savings. Just bear in mind that withdrawals are not deducted from your overall contribution limit. Once you withdraw money, it can’t be replaced. The value of your savings might grow, but your contribution cap remains fixed. So try to avoid touching your “never touch money.”

 

 

Can You Lose Money in a Tax-Free Investment?

Yes, you can. A tax-free investment allows you to invest in the same asset classes as any other investment vehicle, so the usual principles apply. Investing inherently comes with risk, and risk is essentially volatility—the degree to which an asset’s value can fluctuate. Different asset classes have different levels of volatility.

For instance, if you invest mainly in equities (stocks/shares), the value of your investments may decrease in the short term, but over the long term (plus 7 years), equities tend to outperform.

On the other hand, if you invest in cash and bonds, your investment will be less volatile (less risk in the short term), but it won’t grow as much in the long run.

Since tax-free investments are designed for long-term growth, short-term volatility shouldn’t worry you. In fact, when the market is down and your units have lost value, you should celebrate and buy more units (within your contribution limits) while they’re on sale!

What’s key here is diversification within your tax-free investment, and across your entire investment portfolio. The best approach is to consult with a financial planner to determine the right asset allocation for your investment time horizon.

 

 

Can I Have More Than One Tax-Free Investment Account?

Yes, you can have more than one tax-free investment account, but remember: the contribution limits still apply. You can contribute a maximum of R36 000 per year and R500 000 over your lifetime. You can move money between different tax-free investment accounts without it counting as a new contribution.

For example, if you started a tax-free investment with one company and later decided to move it to another, that won’t count as a new contribution. It’s your responsibility to track your overall contributions. If you exceed the limits, you’ll be taxed 40% on the excess amount.

 

 

What’s Better, a Tax-Free Investment or a Retirement Annuity?

The answer depends on several factors, such as your age, the type of income you earn, and your current tax situation. There is no one-size-fits-all answer.

If you’re not earning an income, a tax-free investment might be more beneficial than a retirement annuity because it allows you to invest in 100% equities for long-term growth. For example, a stay-at-home parent may find a tax-free investment a better option.

Generally speaking, a tax-free investment can be a powerful complementary tool in your investment planning. Let’s break it down with an analogy:

Imagine two baskets:

  • The basket on the left is your Retirement Annuity.

  • The basket on the right is your Tax-Free Investment.

In the Retirement Annuity basket, you’re only allowed to put certain things in it (think of them as specific ingredients, like cheese, bread, or fruit). You’ll get specific rewards for doing this. But in the Tax-Free Investment basket, you can choose whatever you want. You can invest only in fruits, or (even more excitingly) only in sweets! The rewards, however, come from a long-term perspective.

A tax-free investment gives you the flexibility to get creative with your investment strategy—without paying tax on the growth.

Growth within a retirement annuity is also tax free however when you want to have access to your retirement annuity (after age 55) only R 550 000 is tax free if taken as your ⅓ in cash the remaining funds will be used to buy an annuity which is taxed at your marginal rate of tax. 

There are benefits to a retirement annuity such as estate planning and creditor protection however that will be discussed in another article (coming soon). 

 

 

Can I Use a Tax-Free Investment to Save for My Children?

Yes, you can start a tax-free investment in your child’s name. But think carefully about the long-term implications. Any contributions you make to the account will count towards their lifetime contribution limit.

For example, if you max out their lifetime contribution and they decide to spend the entire amount at age 18, they won’t be able to contribute any more in the future. Similarly, if you use it for their education, you’ll be eating into their lifetime contribution.

 

 

What’s the Best Performing Fund with the Best Returns?

The answer depends on factors like active vs. passive management, fees, and diversification.

An actively managed fund means that a team of skilled professionals makes decisions about where to invest to achieve the best growth. These funds tend to be more expensive because of the expertise required.

On the other hand, an Exchange Traded Fund (ETF) tracks a specific index, like the S&P500 in the US. These funds have low fees because they are passively managed.

Warren Buffet famously bet $1 million that an index fund would outperform a collection of actively managed hedge funds over a 10-year period from 2007 to 2017. And he won! Why? Because the cost of investing in a fund can drastically impact long-term growth. Fees, whether called the EAC (Effective Annual Cost), TER (Total Expense Ratio), or TIC (Total Investment Cost), can be a huge barrier to growth.

The average EAC for investors in South Africa is around 3%. That may not seem like much, but over a 30-year period, a 3% fee could reduce your investment value by over 40%. Ideally, you want fees around 1%.

If your fund’s performance was 9% over the last 5 years, and inflation is at 6%, you’re only left with around 3% growth. But don’t forget the fees! If you’re paying 3%, your net growth could be 0%. Yuck.

Make sure to ask any financial institution for your fund’s EAC and take action to minimize these costs.

 

 

Can I Trade in a Tax-Free Investment?

Yes, but let’s clarify the difference between trading and investing. Trading involves short-term speculation where you try to time the market—buying low and selling high. This is a risky and active approach, and as mere mortals, we can’t predict the future, so it’s easy for things to go wrong.

Investing, on the other hand, is a long-term strategy. You buy and hold assets that are expected to grow in value over time.

 

 

Where’s the Best Tax-Free Savings Account in South Africa?

This depends on your goals, but in general, if you plan to invest for more than 10 years, look for a platform that offers access to global equity markets via low-cost ETFs. One of the most affordable DIY options in South Africa right now is Easy Equities, but it can be intimidating for beginners. If you need guidance, we partner with great companies that share our core values and can help you with tax-free investing. CLICK HERE to schedule a consultation.

Please note: This article does not constitute financial advice. If you need personalized advice, please contact a licensed financial planner (like us! CLICK HERE if you’d like to schedule a consultation)