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Tax considerations in an investment decision

A look at contributions to retirement savings and tax-free savings accounts, as well as endowment policies and Capital Gains Tax.

Tax should be one of the considerations in the investment decision process but should not be driver of the decision. For example if a share is grossly over- valued one should not delay selling due to concerns over the capital gains implications. Likewise tax breaks offered or inducements should not be the first consideration when making an investment, particularly if the investment does not fit into one’s investment objectives, timeframes or risk profile.

It is noted that South African residents are taxed on their worldwide income – so strategies need to incorporate both local and offshore assets.

Having expressed these caveats it is good to understand some of the investment tax breaks open to South African tax payers:

Contributions to retirement savings

Topical is the distinction between provident funds and pension/retirement annuities. Provident funds are of particular interest because South African Retirement Reform recommendations, which have been accepted by Treasury, have set to phase them out, through a harmonization of the compulsory annuitization rule applicable to other retirement products. Essentially the motivation is that presently provident funds give members early access to their provident fund retirement savings which defeats the objective of retirement savings – which is to provide for one’s retirement. It is noted that in the past only employers gained a tax incentive from contributing on behalf of their employees and this incentive could have been up to 20% of employee’s gross income. Employees have in the past gained no incentive for contributions made to a provident fund.

Pension funds, retirement annuities and now provident funds do offer real immediate annual benefits to employees. Generally with an employee sponsored pension fund, both the company and employee make a tax deductible contribution – for the employee the maximum contribution is currently limited to 7.5% of remuneration from retirement-funding employment. For those tax payers who do not have employer pension schemes and/or have other taxable income their maximum contribution is currently limited to 15% of this income. Recent Retirement Reform legislation has from March 1st, 2016 lifted the contribution to retirement savings to 27.5% of taxable income or remuneration capped at R350 000 per year. This cap affects tax payers who earn more than R1,272,727 p.a. The total amount of these contributions will now be effectively made by the member and therefore the tax deduction accrues to the member.

The tax advantages of provident, pension and retirement vehicles is that all the time these funds remain with these retirement savings structures, the investments incur no income, capital gains or dividend withholding taxes. In addition, for pension and retirement annuity contributions up to the limits described above there is an effective income tax deduction calculated at the marginal tax rate of the member. For example assume the member contributes R20 000 per month or R240 000 per annum and has a marginal tax rate of 41%, then effectively SARS contributes R8 200 towards the member’s monthly contribution.

NFB has undertaken an exercise which assumes a twenty year, monthly contribution period, investing equal amounts in the same underlying funds invested in a direct unit trust structure and in a retirement annuity. The bottom line is that the after tax investment return in the retirement annuity will be over 90% # more superior to that gained in the direct unit trust investment.

A 90%+ greater return is impressive but this is not the full story:

  • With a retirement annuity one loses flexibility, in that only after the age of 55 does one have the option to gain access to one third of the capital with the balance providing an annuity income, with this annuity income taxed at one’s marginal tax rate at retirement.
  • Investments into retirement annuities are governed by Regulation 28 of the Pensions Funds Act, which limits the exposure to more risky asset classes, such as equities and offshore investments.
  • With unit trusts one has the option to draw down capital as opposed to drawing down a taxable annuity income. This strategy can be effectively utilized to reduce taxable income in retirement but the effect of capital gains tax needs to be taken into account.

There are many other features of retirement annuities which need to be recognized but the purpose of this article the focus is on tax effectiveness. The argument to support this tax effectiveness is compelling and therefore it is recommended that during the working career South African tax payers should aim to contribute up to the limit which is now 27.5%% of taxable income. This is especially true for high marginal tax payers. *This however must be considered in a holistic view of your portfolio to build a diversified blend of discretionary investment products and tax efficient retirement assets, to ensure sufficient liquidity in retirement.

Contributions to tax-free savings accounts

The Minister of Finance introduced Tax Free Savings Accounts (TFSA) in his 2015 National Budget. This opportunity is ideally suited to people wishing to build discretionary savings and is the next most tax efficient vehicle, while in addition offering investment flexibility. The tax efficiency comes from the fact that although the contributions are made with after-tax money the withdrawals that are made are completely tax free.

Tactically to optimize the benefits of a TSFA one should consider this to be a long term investment and being long term one should be inclined towards equity type investments both local and offshore. This is because:

  • Equities over the long term tend to offer superior returns relative to other asset classes such as income producing assets, thereby optimising the benefits of no income, capital gains or dividend withholding tax.
  • Current rules governing TSFAs restrict annual contributions to R30 000 with a lifetime ceiling of R500 000. This means that once one has contributed the maximum no more can be added to this facility.

Endowment policies

These are contracts issued by insurance companies with a minimum term of five years with the proceeds received at the end of the contract tax free in the hands of the investor. Again beyond the scope of this article are a number of other restrictions and limitations involved with investing in an endowment wrapper.

This does not mean that the entire investment is tax free because during their term the returns are taxed in the hands of the insurer at 30% p.a. and capital gains at 10%.

With this in mind an endowment may make sense for an individual who has a marginal tax rate of greater than 31% and this may be suitable only once an individual has utilized their annual tax free interest exemption of R23 800 for taxpayers under the age of 65 and R34 500 for taxpayers over the age of 65.

Capital Gains Tax (CGT)

All capital gains and losses made on the disposal of assets are subject to GCT unless excluded by specific provisions as determined by SARS. For example one’s residential home where the capital gain does not exceed R2 million.

In the calculation of CGT one adds the realized capital gains for the particular tax year subtracts any losses which may include carry-over losses, deducts the annual exclusion of R40 000. Depending on one’s marginal tax rate determines amount of CGT payable – the maximum effective rate for an individual tax payer is 16.4% which up from 13.7% in the 2016 tax year and up from 10% in the 2012 tax year.

In conclusion

  • Tax issues are an important component of an investment decision but not the driver;
  • Investments decisions need to fit the objectives, time-frames and risk parameters of the investor;
  • All other matters being equal, retirement savings in particularly for higher tax payers offer the most tax effective opportunities for investors who are in pre-retirement;
  • Tax Free Savings Accounts offer an ideal vehicle to start discretionary savings
  • Make use tax exemptions such as interest earned up to a certain limit and the annual capital gains exclusion.


In reality, smartly utilising the available tax breaks supports the adage that if one looks after pennies then the pounds will look after themselves.

# The assumptions used in the unit trust/endowment vs. retirement annuity analysis:

Monthly contribution R10 000 escalating at 6% p.a.

Investment return 12% p.a.

41% marginal tax rate


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