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Know how your investments will be taxed

Because the amount of tax you pay reduces your investment returns, it is essential to understand in advance how you will be taxed.

In order to maximise your investment returns and achieve your long-term investment objectives, it is vital to understand how your investments will be taxed. Every investment type is subject to a different set of tax rules, and the different types of tax that you may be liable for will depend on your personal circumstances, the nature of your investment vehicle, and its underlying assets. Other important factors include your marginal tax rate, the rate at which you invest, and the nature of the income you earn. Because the amount of tax you pay reduces your investment returns, it is essential to understand in advance how you will be taxed.

Bonds and cash

If you own bonds or have cash in the bank, you will be liable for tax on the interest earned subject to your marginal tax rate. This would include interest earned on South African Retail Savings Bonds, in your savings account (including your medical savings account), and in a stokvel. Your marginal tax rate is determined by the tax bracket that you fall into on the PAYE tax tables. As such, the higher your marginal tax rate, the more tax you will pay.

Taxpayers enjoy an annual exemption on all interest income earned, currently set at R23 800 for individuals under the age of 65, and R34 500 for those older than 65. Remember, all interest must be declared for tax filing purposes, even if it is under the threshold. In respect of foreign interest earned, keep in mind that the annual exemption does not apply to foreign interest earnings, although you may be able to deduct any foreign tax that has been withheld. When filing your tax returns, you will need to declare foreign interest earnings in the Investment Income section of your returns.

Unit trusts

Investments made in collective investment schemes, or unit trusts, are made with after-tax money. If you own shares, any local or foreign dividends earned on your investment – which is the portion of profits that a company pays to its investors – are taxed at a flat rate of 20%, with the company automatically withholding Dividends Withholding Tax (DWT) and paying it over to Sars. DWT is automatically withheld by the company paying out the dividend, which means that the taxpayer is not required to file any further tax information.

Remember, the sale of any investment triggers a capital gains event, and it is important to fully understand the CGT consequences before selling any unit trusts. The first R40 000 of a capital gain made in a tax year on a collective investment is exempt from tax, whereafter profits are taxed at a 40% inclusion rate, meaning that only 40% of the profit you make in excess of R40 000 will be taxed. Capital gains are taxed at your marginal tax rate, meaning that the maximum CGT rate payable is 18%. Keep in mind that a capital gains event is triggered on the sale of your unit trusts and not on the sale of underlying assets in one’s portfolio. When you realise any foreign investments, any capital gain will be converted to rands using the average exchange rate.

Reits

A Real Estate Investment Trust is a listed property investment vehicle. South African Reits allow investors to invest in property investments by buying shares in a JSE-listed property company, including retail, commercial, industrial, and residential property assets throughout the country. Reits are taxed differently to other listed companies in that they do not pay corporate income tax, and no dividends tax is payable on distributions. If you invest in Reits as part of your unit trust portfolio, keep in mind that any Reit distributions must be declared in your tax returns and will be taxed at your marginal rate.

Where you hold Reits in a retirement fund, you will not be liable for tax on distributions, and the ability to reinvest and compound these before-tax distributions within your retirement fund over a long period of time is a significant benefit. As an aside, any rental income earned from an investment property will be taxed at your marginal tax rate.

Retirement funds

Pension, provident and retirement annuity funds offer the most significant tax benefits for investors because all contributions, up to 27.5% of taxable income, are tax-deductible, subject to a maximum of R350 000 per tax year. Further, investors do not pay CGT, dividends withholding tax or income tax on any growth earned in a retirement fund. As a result, investors can greatly benefit from the compounded tax benefits, especially over the long-term. When you retire from your retirement fund, you will be required to use at least two-thirds of your capital to purchase an annuity, and the income from this annuity will be taxed at your marginal rate.

Tax-Free Savings Accounts

A TFSA is a tax-efficient investment which allows taxpayers to invest up to R36 000 per year up to a lifetime maximum of R500 000. Although not as tax efficient as a retirement fund, there are still tax benefits when it comes to saving in a TFSA. While all investment premiums are made with after-tax money, no tax is payable on interest income or dividends, and no CGT is payable on disinvestment, meaning that your potential return is higher than in a standard unit trust. Because of the structure of a TFSA, frequent contributions will limit the compounding effects and your ability to save tax-free in the future, so it is advisable to take a long-term view when investing in a TFSA. Also important to bear in mind is that if you exceed your annual contribution limit of R36 000, you will be liable for tax of 40%, so it is important to keep track of your annual contributions.

Endowments

An endowment is a policy issued by a life insurance company that can provide tax benefits to high-income earners. Endowments are taxable in the hands of the insurance company at a rate of 30% which means that, if your marginal income tax rate is higher than 30%, there may be tax benefits for you as the favourable tax rate will reduce the tax payable on your investment growth. However, endowments can be quite restrictive as you are required to lock your money away for a minimum period of five years. If you own an endowment, you are liable for 30% tax on interest income, 20% tax on dividends, and CGT at an effective rate of 12%

ADVISOR PROFILE

Craig Torr

Crue Invest (Pty) Ltd

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Are foreign dividends in a TFSA, taxed at 20 percent?

Satrix MSCI is a rollup fund and does not distribute divs. The divs are reinvested.

These tax rates are quite high. Whether you save or you spend you are not off the tax hook. In days gone by (1984-1992) the bumper stickers used to read “du Plessis gives with one hand and takes with another”.

End of comments.

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