Different investment products are subject to different tax rules. To win over the long term, you should be aware of the rules that guide different investments and take full advantage of suitable tax savings that are available on both pre- and post-tax products. You can take advantage of the following benefits:
Pre- tax savings
Investing in a retirement fund is by far the most common and effective way to save income tax. The South African Revenue Service (Sars) encourages South Africans to provide for their own retirement by offering savers tax deductions on their contributions to retirement funds. In addition to tax-free contributions, retirement fund investments are exempt from income tax, capital gains and dividends tax on the investment returns earned.
South African taxpayers can reduce their income tax and contribute to long-term retirement benefits by contributing up to 27.5% of the higher of gross remuneration or taxable income, subject to an annual limit of R350 000, to a retirement fund.
There are other advantages to retirement funds, such as the fact that your pension fund will not be considered for estate duty purposes. The full terms and conditions should be discussed with your financial advisor.
Post-tax savings vehicles include those that are exempt from any one of, or a combination of, capital gains tax (CGT) or tax on interest or dividends. Alternatively, they could be taxed at a lower rate.
- Tax-free savings accounts (TFSAs): These accounts were introduced by Sars in March 2015. Contributions to TFSAs are not deductible for income tax purposes. However use of these vehicles ensures that investments are exempt from income tax, CGT and dividends tax. A wide range of underlying investment types are possible when using the TSFA, including fixed deposits, unit trusts, retail savings bonds, certain endowment policies, linked investment products and exchange traded funds (ETFs). As of 2018, each taxpayer is allowed to invest R33 000 a year, up to a lifetime contribution of R500 000. Investments into TFSAs can also be made on behalf of minor children or grandchildren.
For more on tax-free savings products, click here.
- Unit trusts: If equity investments are housed within unit trusts, no trading tax applies and CGT is only payable when units are sold. Unit trusts are thus more tax-efficient than direct holdings in shares.
- Endowments: The higher your tax rate is above 30%, the more you stand to benefit by investing in an endowment from a tax perspective. Endowments are taxed in terms of what is known as the ‘five funds tax’ rule. In addition, endowments are not subject to executor’s fees when paid out to nominated beneficiaries.
- Living annuities: A living annuity is essentially a vehicle designed to produce a monthly income after retirement, where the funds come from a retirement fund. The assets of living annuities are not taxed while invested. Income drawn from a living annuity is subject to income tax, but annuitants benefit from preferential tax treatment if they are over the age of 65. When you die, there are no executor’s fees when a beneficiary is nominated in a living annuity as well as being outside your estate for estate duty purposes
In addition, South African taxpayers can pay less tax by managing exposure to interest-generating investments and making better choices when investing offshore.
Managing exposure to interest-generating investments
Taxpayers who are below 65 years of age are permitted to earn R23 800 in interest per year without paying any tax on it, while over-65s can earn R34 500. This amount can be increased if investments that attract interest are spread to a spouse. Note that all interest received from a foreign source by a South African resident will be fully taxed. The interest exemptions described above only apply to local interest. For more on this, click here.
Rand-denominated versus foreign currency-denominated investments and tax on interest, dividends and CGT
There are two ways South Africans can invest offshore. You can either invest in a rand-denominated offshore unit trust offered by a local manager, or invest directly in foreign currency with a foreign manager or through an offshore platform.
If you invest in a rand-denominated foreign fund, you pay tax on interest and dividends. Foreign dividends are included in your taxable income and are taxed at an effective rate of 20%. The full value of foreign interest is included in your taxable income.
Both investment routes require SA residents to pay tax on capital gains on the investments when they are sold. However, if you invest in rands, you pay tax on all gains on your original rand investment, regardless of whether those gains are from capital growth or currency movement. If you invest in a foreign currency-denominated fund, you could save on CGT as you don’t pay tax on currency movement while you are invested.
Reducing your taxable income by taking advantage of rebates
The Sars website lists 21 different types of tax which South African residents are likely to pay, ranging from value-added tax to estate duty tax. Some rebates (note that this is not an exhaustive list) include the following:
- Medical scheme fees tax credits reduce the normal tax you pay if you are a member of a medical scheme. The credit is non-refundable and any portion that is not allowed in the current year can’t be carried over to the next year of assessment. For more, click here.
- A wide range of taxpayers are eligible for additional medical expenses tax credits. These are rebates calculated against qualifying ‘out of pocket’ medical expenses paid by you, the taxpayer, either for yourself or for any dependant. Over 65s and disabled dependants are eligible for a rebate of 33.3% of the qualifying medical expenses paid on an out-of-pocket basis. Taxpayers who are younger than 65 are also eligible for medical expense-related rebates; they can claim for 25% of the amount by which the sum of the amounts paid for qualifying medical expenses, (either in or outside South Africa) exceed 7.5% of their taxable income.
- As in many other countries, South Africa allows taxpayers tax-free donations between spouses and donations to approved public benefit organisations. Taxpayers are also permitted to donate up to R100 000 a year to other individuals. For more, see here.
- One of the main challenges to the growth of small- and medium-sized businesses and junior mining exploration is access to equity finance. In 2009 National Treasury, via Sars introduced Section 12J rebates, tax incentives for investors in these companies on condition that they invest through a qualifying, approved venture capital company (VCC). The VCC regime is subject to a 12-year sunset clause, recently extended to June 2021. For more on Section 12 J rebates, click here.
- Due to the housing shortage in South Africa, National Treasury, through Sars, has introduced a number of incentives to encourage taxpayers to invest in residential property. Section 13 Sex of the Income Tax Act allows for a tax deduction of 5% of the cost of the building, improvement or acquisition of any new and unused residential units, if the taxpayer owns at least five units situated in South Africa and uses them solely for trade purposes. For more on Section 13 Sex, click here.