A look at three investment products that offer you tax benefits.
The December holidays have come and gone, and I was fortunate to be able to spend some time with my family at the coast. So, with the holidays long forgotten, it’s important to set aside some time to budget for the year ahead and, hopefully, have enough money for another relaxing December holiday at the end of 2019.
In these politically and economically volatile times, with opposition parties in Parliament baying for former President Jacob Zuma – among others – to ‘pay back the money’, you can save a bit of money by taking advantage of some tax dispensations offered by the South African Revenue Service (Sars). In getting Sars to ‘pay back my money’, the win is twofold: you and I get to bolster our savings and pay a little less tax.
Like you, I pay my taxes diligently, although, sometimes uttering a few profanities under my breath. However, when I can legitimately save some tax either by reducing my tax bill, or negating some taxable income altogether, I see this as a win. Any amount that you can invest adds up in the long term, so, if you can manage to put aside only an extra R200 a month, please do it. You will then have more money than you would have by doing nothing.
There are investment products that offer you tax benefits, so Sars really can pay back your money.
Caveat Emptor: I’ve been involved in wealth management for 16 years and have found that investing only for a tax benefit is likely to lead to disappointment. So, before I get into the detail of the investment offerings, let me say that you should first always consider the merit of an investment product itself and only thereafter assess the tax advantages, if any.
Tax-free savings accounts (TFSAs)
The reason for the introduction of the TFSA was to incentivise household savings. This practice can reduce the vulnerability that some households face from unexpected expenses, which in turn lead to an increase in debt.
Increasing household savings contributes to increasing the overall level of savings in the economy, to finance higher levels of fixed investments and promote growth prospects.
The TFSA provides tax benefits so that all growth in savings, no matter the source – income, capital or dividends – is tax free, and subsequent withdrawals are free of tax.
The product offers a broad range of investment options ranging from local cash to offshore equity. The annual contribution limit is R33 000, with a lifetime limit of R500 000. It is, however, subject to estate duty on death.
"Getting in earlier is better when it comes to starting a TFSA, as a long-term investment will benefit from the compound effect of tax-free growth."
Retirement annuities (RAs)
The second tax-saving investment product is a RA. RAs have received more than their fair share of bad press. But this is unwarranted for linked RAs, which can add great value to your investment portfolio.
An RA is, simply put, an individual pension fund – which can be held in addition to an employer fund – that allows people who are not part of a group scheme, or who want additional savings, to enjoy the benefits of investing in a retirement fund.
From the point of view of tax benefits, these contributions are tax deductible up to the lesser of R350 000 per annum, or 27.5% of the greater of remuneration or taxable income including any taxable capital gain but prior to the deduction for donations.
If you can afford to contribute, say, R50 000 per annum and have an average tax rate of 30% you will save R15 000 a year in tax. You can contribute R50 000 but physically invest R65 000 if you re-invest your tax refund from your RA contribution.
All growth, no matter the source – income, capital or dividends – is tax-free. There are also no estate duties or executor fees on death. However, in terms of Prudential Investment Guidelines no more than 75% can be invested in equity and no more than 30% offshore.
Many financial commentators say that limited offshore exposure negates all the tax benefits of this product. But in my view these offshore investments, and indeed any other investments, must do extremely well to offset the tax deduction on your contributions and tax-free growth.
A second cautionary note from such commentators is that you get taxed on the income you take from an RA once you’ve retired from the product and therefore would be better off in say shares, where you only pay capital gains tax (CGT) and dividend withholding tax, which are both lower than the marginal income tax rate. Again, I beg to differ. If you look at the difference in value, for example, of a share portfolio and an RA over 25 years – taking account of the contribution deductibility, and the reinvestment thereof, as well as the tax-free growth – it (compound the savings) more than makes up for the post-retirement income being subject to income tax.
I’m hoping that after reading this you’re committed to taking out an RA if you don’t already have one. It is, however, important to have a balance of discretionary and non-discretionary savings in your portfolio so that you create different tax and liquidity profiles.
Section 12J investments
Section 12J investments have been around since 2009, when the South African government introduced amendments to the Income Tax Act to stimulate the private sector and the economy.
These amendments introduced tax incentives for investors – individuals, trusts or small business corporations – through tax-deductible investments into Section 12J venture capital companies. Section 12J companies must be licensed with the Financial Sector Conduct Authority (formerly the Financial Services Board) and registered with Sars.
While contributions to a Section 12J investment are useful for high-income earners, the bulk of support for the sector has come from investors looking to reduce the effect of CGT.
"Unequivocally, this is an investment category where you must look closely at the underlying investments, the investment strategy and issuer compliance, before getting too excited about the potential tax saving."
From a tax benefit point of view, you can make unlimited contributions, which are deductible against taxable income. Don’t contribute too much, as the contribution is deducted before that of an RA in your tax calculation and you may not get the full tax benefit of your RA contribution. You must stay invested for at least five years, otherwise your tax saving will be recouped by Sars. On exit, your base cost in determining CGT will be taken as zero.
Whether I pay less tax (while earning the same income) or get some tax back, I have more money than I would have by doing nothing. You have until end-February to make your investments, so get onto it immediately – there is no time to waste in earning back your money!
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