By Kelin Pottier
Taxes reduce the returns on investments the same way costs and fees do, yet few people understand the taxes they pay, or use the allowances and incentives that can materially change their bottom line.
South Africans get generous tax allowances, including an annual contribution of R36 000 (up to a lifetime maximum of R500 000) into a tax-free savings account, where their investment can grow and compound without attracting tax on interest or dividends earned or capital gains.
The tax year runs from March 1 to end-February so there is still time to open a tax-free savings account and make use of this year’s allowance of up to R36 000. It is not ideal to scramble in late February to max out on your tax allowances, but better late than never, as they say. Consider using the opportunity to set up a standing order for the rest of the year, which will allow you to feel quite pleased with yourself come February next year.
There are a few basic taxes you should know about to structure your investment decisions in a tax-friendly way:
Most people are familiar with income tax, calculated on a sliding scale where the more you earn, the higher your tax bracket and the more tax you pay.
The tax bracket you fall into is important because it determines your marginal tax rate, which is the rate of tax you pay for every additional rand of income earned.
Any interest income you earn – whether it be from a savings account, a stokvel or a government bond – is included in your overall taxable income and taxed at your marginal tax rate, with the exception of the first R23 800 every year, which is exempt from tax (the exemption increases to R34 500 for people aged 65 and older).
Rental income and REIT distributions received are also taxable as income at your marginal tax rate.
Dividends Withholding Tax
Dividends, the portion of profits a company pays to its investors, are taxed at a flat rate of 20%. When paying a dividend to investors, Dividends Withholding Tax (DWT) is withheld and paid over to the South African Revenue Service (Sars) on behalf of investors.
If a company declares a dividend of R10 per share, tax of R2 per share is paid over to Sars, and investors will receive the remaining R8 per share into their brokerage account.
Capital Gains Tax
When you sell an investment in a collective investment scheme (ETF or unit trust) for more than you paid for it, the profit is known as a capital gain. The first R40 000 is exempt, but the rest is liable for Capital Gains Tax (CGT).
Capital gains are included in your total taxable income at a 40% inclusion rate and taxed at your marginal tax rate. A 40% inclusion rate means that 40% of the profit is taxed rather than the entire 100%.
Capital Gains Tax is realised only when you sell an investment, and you pay only on the portion of the investment sold.
Example: Sindi earns R33 000 a month (R396 000 a year). Her marginal tax rate is 31%. She buys five shares in a JSE Top 40 ETF for R100 each (total R500). The market has a great run and the shares in the ETF are now worth R200 each. Sindi decides to sell three of the ETF shares (for R600) and makes a profit (capital gain) on those three shares.
If Sindi sells her ETF shares today she earns a profit of R300 (R600 from the sale minus R300 cost). The R300 profit is included in her taxable income at the 40% inclusion rate (R300 x 40% = R120). The R120 is taxed at Sindi’s 31% tax rate, which amounts to R37.20.
How to minimise tax
Whilst many South Africans are aware of the tax benefits of retirement funds, fewer understand the value of tax-free savings accounts (TFSAs).
Investors can maximise their returns by investing in tax-free savings accounts, where the growth is free from tax on interest income, dividends or capital gains. Tax benefits compound over time as the tax saving is effectively reinvested and earns compound growth.
Tax-free savings accounts are not restricted by Regulation 28 and allow investors to maximise their offshore exposure or equity exposure to suit their needs. Also, investors can withdraw their funds at any time, bearing in mind that contribution limits can’t be replaced.
Investors are encouraged not to overlook this product in building their financial plan. Whether rebuilding their wealth, investing for a child or grandchild, or complementing their retirement savings, doing it tax-free will turbocharge the investment growth.
Kelin Pottier is Product Development Specialist at 10X Investments