Tax-free savings: The costs of early withdrawal

In a previous blog entitled “What does the ‘tax-free’ part of tax-free savings mean?’ we discussed how tax is applied on taxable versus tax-free savings. We used an example of a R1,000 investment that increased in value to R4,500 over 10 years.

In a situation where this is not invested in a tax-free account, you would have to pay tax on the difference between your initial investment and the value at withdrawal time. So if you withdrew the R4,500, you would have to pay tax on R3,500 (R4,500 - R1,000).

In tax-free investing, you would not have to pay tax on the R3,500.

But what if you withdraw earlier?

“In the above example, your R1,000 doesn’t increase neatly by the same amount each year,”says EasyEquities’ Almero Oosthuizen. “By the end of year one, your investment will have grown by approximately R160 to R1,160. In year two, it will have gone up by R350 to R1,350, then up to R1,570 in year three, and so on.”

In year five, half way through our 10-year example, your investment would probably be worth approximately R2,115, which would you’ve earned R1,115.

In year 10, your investment rockets to R4,500, which means you’ve earned R3,500 on your initial R1,000.

So the growth in your investment in years 6-10 (R2,385) is more than double the growth in years 1-5 (R1,115).

“This is the power of compound interest,” explains Almero. “Whether you’re invested in a tax-free account of not, it’s always best to leave your savings untouched for as long as you can.”