RA, TFS, S12J….WTF?

Make SARS work for YOU 

The only certainty in life is DEATH and TAXES. And once a year we have the opportunity to make tax a certainty, and to get our own back from the taxman (SARS)!

With the tax year-end fast approaching, I am sure you are getting bombarded with messages and offers on RA’s (retirement annuities), TFS’s (tax free savings) and S12J (tax incentivised venture capital investment) investment offerings. This can be daunting and confusing.

Taxation and tax wrappers can have a significant impact on investment returns, and therefore become an important consideration in the investment decision making process, deciding between a normal (discretionary) investment, a tax free saving and an investment in a retirement annuity.

To better understand the impact of taxation on investment returns, the below illustrates the returns clients can generate by investing in a moderate risk balanced portfolio            (inflation + 5 %) through different investment vehicles. It is evident that a Tax Free investment is a lot more efficient than investing into a normal discretionary unit trust investment, with the tax free investment delivering an 10.6 % rate of return and the taxed investment only 8.7%.

Example : R 10 000 invested in a balanced fund over 10 years :

• Discreationary investment  - R 22 945 (IRR 8.7%)
• Tax Free Savings - R 27 461 ( IRR 10.6%)
• Retirement annuity - R 27 461 ( IRR 16.4%)                                                                 
• S 12 J -  R 23 067 ( IRR 14.4 %)

* RA and S 12 J,  IRR calculated on "Capital at risk" after taking into account SARS tax decustion or refund.

The discretionary investments lower return can be attributed to the taxation of: dividends, interest and capital gains. Dividends attract dividend withholding tax at 20%, income tax and capital gains will be dependent on the investor’s tax rates. For the purpose of the analysis below we have assumed a 40% tax rate and also assumed that the investor has already used their interest and CGT exemptions.

The example further illustrates that a retirement annuity remains the most compelling long term investment vehicle. This is as a result off the tax deductibility of contributions to retirement annuities, through this “subsidy” by the taxman i.e. for an investment of R 10 000 an investor with a 40% tax rate can get 40% of their investment or R 4 000 back from SARS, thus they will get investment exposure of R 10 000 for only R 6 000! The internal rate of return thus increases significantly; from 8.7% for a discretionary investment to 16.4% for a retirement annuity. The internal rate of return is calculated on the clients invested capital after deducting the tax refund from SARS.

It is important to note that the tax deductibility for retirement annuities and pension funds are limited to 27.5 % of taxable income or a maximum of R 350 000 per annum.  A S12J investment provides a similar return profile (assuming a similar return), however the investors return will be less than a retirement annuity as a result of S12J investments attracting CGT on any growth i.e. above the first rand invested.

From the analysis it is clearly evident that retirement annuities remains one of the most effective investment vehicles for long term investors, and in addition to the income tax deductibility of premiums, if structured correctly they also do not attract estate duty (20%) or executors fee’s (3.5%).

Investors often get lost in “chasing” returns and speculating or debating about last year’s winner and this year’s front runner. Even though there are very scientific processes to identify the most likely “winner” there is no certainty. Investors can however, significantly increase their returns by investing in the appropriate tax vehicles or wrappers. This does require careful planning, and the support of a qualified financial advisor.