OPTIMISING YOUR TAX-FREE INVESTMENT: IS A TFI WORTH IT?

Are tax-free investments worth the R500k limit? Here’s a breakdown of the rules and limits before deciding whether they’re worth using.

Some of the most common questions revolve around tax-free investments (TFIs). The questions range from the taxability of TFIs to whether they are worth the effort, given the R500 000 lifetime contribution limit.

Before I give my opinion, I want to take a minute and spell out the rules and limitations of TFI, namely:

1. Contributions are limited to a maximum of R46 000 per year. For the 2026 tax year, the limit was R36 000 per year. Minimum contributions are not regulated but are set by the different TFI providers. Some allow contributions to be made by debit order or as lump-sum investments, while other administrators accept only lump-sum debit orders.

2. Contribution maximums are aggregated. In other words, total contributions made to all TFI in the name of an investor are limited to R46 000 per year.

3. There is currently a lifetime aggregate contribution limit of R500 000. This may change over time (I hope it is increased substantially).

4. Exceeding the R46 000 annual or the R500 000 lifetime contribution limit will attract a penalty of 40% tax that will be payable on the amount that exceeds the limits. Don’t exceed the allowable limits.

5. There is no maturity date set within TFI.

6. One can access the proceeds at will; however, funds drawn from a TFI cannot be replaced.

7. Some administrators prefer to administer TFI as endowments, while others administer them as unconstrained investments. Be mindful that, where they are administered as endowments, withdrawals are restricted in the first five years to a single withdrawal, in accordance with endowment rules.

8. No tax is payable on TFI proceeds. This means no income tax, no dividend tax and no capital gains tax. Estate duty will still be payable should the owner of the TFI pass away. If an endowment structure is used and beneficiaries are nominated, the proceeds will be transferred quickly, and no executor fees will apply.

Regardless of whether you inherit TFI proceeds, the same contribution limits apply to each individual. Once you have reached your contribution limits, inherited TFI proceeds will become normal unconstrained funds.

9. Regulations determine that only funds without performance fees can be used to invest in TFI’s. Currently, hedge funds and direct shares are also excluded from TFI’s.

10. Although there is no limit on offshore exposure within a TFI, some administrators impose limits due to internal offshore capacity constraints. Offshore exposure is often capped at 45% by administrators. Offshore investing in a TFI is dynamic due to its tax-free nature. No tax on capital appreciation or rand depreciation is levied.

11. Only natural persons can invest in TFI (no companies or trusts). There are no age limits for TFI ownership, but owners must be South African residents.

Are TFIs worth the effort?

Absolutely! The younger the person is when they start investing in a TFI, the more it makes sense. Even newborns can have a TFI without any penalties for the parents. A TFI is the perfect birth gift for any newborn.

Consider the following example:

At the age of 22, Mr Young starts investing R3 800 per month into his TFI. This is funded by his salary, birthday money, and incentives from parents and grandparents, with the funds remaining invested. Under current legislation that sets a lifetime contribution limit of R500 000, this limit will be reached in just under 11 years.

Mr Young is a diligent investor who wants to grow his wealth. If he remains invested and achieves a return of 12% per year, the following will apply:

By the age of 33 when Mr Young reaches his contribution limit, he would have accumulated roughly R1 030 000

If the R1 030 000 is left to grow at 12% per year then:

At the age of 55, the funds would have grown to approximately R12 500 000

At the age of 65, the funds would have grown to approximately R38 000 000

Where parents start investing for young children and they have the discipline to remain invested, substantial growth can be achieved with relatively little contribution. For example:

At birth the baby is gifted a TFI  funded with R46 000 by parents, grandparents and family members. Every year, the TFI is topped up by investing R46 000 from gifts (birthday money, etc.) and savings. This can carry on for just short of 11 years (10 years and 10 months to be exact).

By the age of 11, the TFI will reach a maximum of R500 000 in contributions (under current legislation), which would have grown to R1 030 000, as previously mentioned, if a return of 12% is achieved. Now the magic of compound returns starts to come into play.

By the age of 21 the value will be R3.2 million.

By the age of 45 the value will be R48 million.

By the age of 65 the value will be R468.4 million.

Even if ad-hoc withdrawals are made during the journey to age 65, a substantial amount can be accumulated over the full period. Think about it, the investment is already in the child’s name, no estate duty applies if the parents pass away.

There is full liquidity to purchase assets when needed. Tax-free withdrawals can be made when retired.

When the child turns 65, and no withdrawals have been made, the value in today’s terms (real value) will be almost R20 million, assuming an inflation rate of 5% per year. This is a substantial sum that will be sufficient for many retirees who need R1 million or less per year in today’s terms.

If one considers the tax benefits of tax-free income when starting to draw against a TFI, one cannot ignore a TFI.

For a 30% taxpayer who needs R70 000 per month net of tax, R100 000 per month needs to be drawn from an annuity. This means using the 5% rule, R24 million is required to fund the income.

For the same person drawing R70 000 per month from a tax-free source, such as a TFI, a capital amount of R16.8 million is required. That is a 30% lower capital requirement.

Can anyone ignore that? Unfortunately, for all current and soon-to-be retirees, TFI started too late, and we did not have the full advantage of time and tax-free returns that today’s young people have. Don’t deprive them of this major benefit, and it is never too late to start benefiting from tax-free returns yourself either.

I don’t believe it should be an “either-or” decision. TFI is just another arrow in the financial planning quiver. An arrow that is effective and on target.

TFI can be used very effectively for educational provision. Traditional ‘study policies’ are outdated and redundant, although I believe there are still marketers out there promoting them. A TFI is a much better solution.

Take care and enjoy your tax-free returns.