Janet Hugo. Supplied
February is tax month and time to review your investments and take advantage of some of the few breaks from the taxman. The two most important taxes to consider are capital gains tax (CGT) and income tax.

The cost of profitability

CGT is the tax on the gain (profit) you earn on an investment. Forty percent of your capital gain is added to your income tax and taxed at your marginal tax rate. This inclusion rate increases to 80% for trusts. So, the effective rate for individuals can amount to 18%, and 36% for trusts.

One of the CGT tax breaks is the annual R40000 exemption. You can use this to rebalance your investment portfolio to the extent of a R40000 gain without paying tax. It’s wise to do this from an estate planning point of view, as you keep increasing the base cost, which will reduce future gains.

Deferring the sale of an asset is also regarded as a way of minimising the long-term impact of CGT, because you can benefit from the compound growth during the extended time-frame. You can also use the asset as collateral to borrow money to make other investments. Borrowing does increase risk, but a deferred sale and CGT does mean that the SA Revenue Service bears some of it.

The three wonders of ras

The other main tax to review is income tax, which you can reduce effectively by investing in retirement annuities (RAs), because the contributions are tax deductible. You can continue to benefit in retirement, because you don’t have to convert an RA into a compulsory annuity.

Another advantage of investing in RAs is that there’s no tax within the fund, which speeds up the growth. And if you do transfer the funds into a compulsory annuity, you don’t pay CGT on the gain. (You may have to pay a lump-sum tax if you make a withdrawal to invest in a discretionary investment.)

The third benefit is that RAs can be used as an effective estate planning tool, because retirement funds do not form part of your estate and attract estate duty.

RAs have one disadvantage, however: they need to be compliant with regulation 28 under the Pension Funds Act, which limits the equity allocation to 70% and the offshore to 30%. This can reduce risk, which is appropriate for retirement investments, but also growth over the long term.

Remember to check your RA contribution amount in February and top it up to 27.5% of your income (to the maximum of R350000) to make full use of the tax deduction.

Why not go tax-free as well?

Tax-free savings accounts (TFSAs) are another great way to protect your after-tax savings. As with RAs, there’s no tax within the fund, but in this case the contributions are not tax-deductible.

One of the most significant advantages of using TFSAs is that the underlying investment strategy is not regulated, and you can assume more risk and allocate a greater proportion to equity and offshore investments. This makes them excellent investments to gift to your children and grandchildren who have long investment horizons.

And check your contributions in February to make sure you’ve invested up to the R33000 limit during the financial year. There is a lifetime limit of R500000, but this shouldn’t deter you from using them for yourself and your children.

A word of warning

There’s been much talk in the media lately about using section 12J investments to reduce income tax. The government introduced this tax break to encourage investments into new ventures that will assist economic growth.

The investments are fully tax-deductible, which can effectively reduce the cost by up to 45%. This is attractive from an income tax perspective, but if you sell your share, CGT is applied to the full value of the investment as opposed to the gain. (The base cost is set at 0.) There’s also much risk involved, because you need to hold the investment for five years, which affects the liquidity of your portfolio, and there may be much risk attached to the investment itself. There’s a chance that you may lose your money.

So, as a word of warning, I wouldn’t recommend investing in a section 12J venture just because of the tax break.

Where to from here?

There are other ways of minimising tax, so seek professional advice from a qualified financial planner with the Certified Financial Planner (CFP) accreditation. Tax planning forms a very important part of financial planning and can have a significant effect on long-term returns.

Janet Hugo CFP is the Financial Planner of the Year for 2018/19. She is an independent wealth manager at Sterling Private Clients in Hermanus.