Tax-incentivised investments and their tax benefits: How to get the most out of your contributions

I’m sure you have heard the Ben Franklin adage that only two things in life are certain – death and taxes. We have very little control over the former, but the latter presents us an opportunity to be calculated by using financial products and techniques, within the legal framework of South Africa, to reduce our tax bill and increase our investment value.

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In South Africa – there are many incentives in place from the government and legislative bodies to encourage South Africans to have long-term investments while reducing their tax payments. Therefore, if you are saving for retirement, wanting to minimize your current tax bill or reduce future tax implications on investments – there are numerous financial products, permitted by the government, to assist you with your financial goals.

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With all the financial products on offer, it is vital to understand the nuances and advantages of these products to make an informed decision. No two products are the same, thus you must make sure that you understand what they are for and what tax advantages they have. The products available to you through a registered financial services provider are: retirement annuities, unit trusts, endowments, and tax-free investments or employer-sponsored funds such as pension or provident funds.

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There are several factors to be taken into consideration when deciding on an investment product, these include: your age, risk tolerance, your financial needs now and in the future, access to your investment, the tax efficiency of those investments and most importantly your time horizon.

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First, let’s briefly look at the types of tax you may be liable for:

1. Income tax: This is the tax paid on your taxable income and included in this is investment income such as interest and foreign dividends. The tax you are liable for is calculated at your marginal tax rate. All income you receive needs to be declared in your tax return.
2. Capital gains tax (CGT): CGT is applicable when you sell off an investment asset that has experienced capital appreciation (when the investment has grown in value). Capital gains or losses also need to be declared in your tax return.
3. Lumpsum tax: This is the tax that is paid on cash lump sums calculated using special SARS lump sum tax tables on a cumulative basis. The first R25?000 of a withdrawal lump sum and the first R500?000 on a retirement lumpsum withdrawal are tax-free once-off per person per lifetime.
4. Dividend withholding tax (DWT): This is a tax on investors receiving dividends from a South African company or a foreign company listed on the JSE charged at 20%.

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Tax is a part of life and one can never entirely avoid paying tax. However, when you pay tax and how much you pay can greatly impact your long-term plans. The investment products you choose will affect how and when you pay your tax. The following is a brief rundown of the tax implications and flexibility of investment products and returns.

1) Retirement Funds

• Retirement funds offer the most tax incentives, however, they are not very flexible in terms of accessing your funds. With a retirement fund, no tax is paid on interest, dividends and capital gains while the money is invested in the product.
• Contributions to a retirement fund are tax-deductible for individuals and employers up to a maximum of 27,5% of your taxable income or R350?000 per tax year.
• Unless you resign, you cannot withdraw your retirement funds until you are of retirement age. When you do retire, you can take up to one-third as a lump sum and the rest must be used to purchase a product that will provide you with retirement income. This is different for a provident fund that one accumulated till 28 Feb 2021 (the vested portion they can take 100% as a cash lump sum at retirement and the non-vested portion the 1/3: 2/3 rule is applicable – Which is one-third lump sum withdrawal, two-thirds Invested for annuity income).
• Because you do not pay CGT, DWT or income tax on the growth in your retirement fund, the true beauty is in the compounding of the tax-free growth, with every little bit saved adding to the compound interest.

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2) Tax-free investments (TFI)

• With a TFI account, no tax is paid on interest, dividends or capital gains. TFI contributions are limited to R36?000 per year and a lifetime max of R500?000. If you contribute more than these limits, tax penalties will apply at 40%.
• Contributions to a TFI are made from after-tax money and all withdrawals from the account are tax exempt. You can withdraw from your TFI at any point – however, what you withdraw will be subtracted from your contribution limits and you will not be able to replace it.
• I.e., with a TFI having a lifetime contribution limit of R500?000, and let’s say we have R300?000 already invested in the account – without any previous withdrawals. If the investor were to withdraw R60?000 from this investment, they will still only be able to contribute a further R200?000 to the account, over its lifetime, rather than R260?000 which would be over the lifetime contribution limit.

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3) Endowments

• Endowments are generally for higher-income earners looking to enjoy favourable tax rates. On all interest and capital gains tax is paid at 30% (offered by the Life Insurance company), rather than at the highest marginal tax rate (which is 45%) and all dividends are taxed at 20%.
• Endowments do not have contribution limits – however, you do need to lock in your money for a period of at least 5 years.
• The main point of endowments is that high-income earners pay tax at the rate the life company applies, which is 30% rather than the 45% marginal tax rate.

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4) Unit trust investments

• Unit trust investments offer the least tax benefits compared with the other investment options; however, it is the most flexible option when it comes to accessing your money. With a unit trust investment, individuals only start paying tax once the thresholds are met.
• Contributions and withdrawals on a unit trust investment are not restricted and contributions are made with after-tax income.
• The tax an individual would pay on interest, capital gains or foreign dividends is levied at your marginal tax rate and if you received local dividends – you would be subject to DWT at 20%.
• The flexibility of a unit trust investment allows investors the ability to withdraw from the account at any point in time.

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The tax year comes to an end at the end of every February. This is a brilliant time to call your financial advisor to review your portfolio and make sure you are making the most of the Tax benefits available to you. You forfeit your tax benefits from retirement funds and tax-free savings account if you don’t act on them each year.

Consult with your financial advisor about the tax benefits you can receive before the end of the tax season.

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Authors:

Mirriam Papo (CA(SA)), Keneilwe Mnisi (Professional Accountant (SA)) & Dylan Cutter (BCom Insurance & Risk Management)

Disclaimer:

The information contained in this document does not constitute advice by IWCP. Any legal, technical or product information contained in this document is subject to change from time to time. If there are any discrepancies between this document and the contractual terms and conditions, the contractual terms and conditions will prevail. Any recommendations made by an adviser or broker must take into consideration your specific needs and unique circumstances.

IWCP is an Affiliate of Liberty Group Limited. Liberty Group Ltd is an Authorised Financial Services Provider in terms of the FAIS Act (no. 2409). Terms and Conditions apply.

For more details about any product benefits, definitions, guarantees, fees, tax, limitations, charges, premiums/contributions or other conditions and associated risks, please speak to an IWCP Financial Adviser or your Broker.