How can I earn higher investment returns and pay less tax?
Earning a higher ROI and paying less tax
There are lots of factors to consider when making investment decisions. You can never entirely avoid tax,
but when you pay it, and how much you pay, can have a significant impact on your long-term outcome.
There are lots of factors to consider when making investment decisions. Tax benefits are one piece of the puzzle. You can never entirely avoid tax, but when you pay it, and how much you pay, can have a significant impact on your long-term outcome. The infographic summarises the impact of tax on your investment return.
Tax in a unit trust
Unit trust investments are the most flexible of all products as they don’t have any contribution or withdrawal restrictions.
Investing in local unit trusts
You invest in a unit trust with after-tax money and then pay tax on interest, dividends and capital gains. Interest is taxed at your marginal tax rate and dividends are taxed at 20%. You also pay capital gains tax (CGT) when you withdraw from unit trusts. Forty percent of the capital gain is taxed at your marginal tax rate, but your first R40 000 per year is exempt. You do not pay capital gains tax when your investment manager buys and sells underlying assets within the portfolio. You trigger a capital gain or loss on unit trust investments only once you sell the units (e.g. when you switch between unit trusts or withdraw).
If you invest in a rand-denominated offshore unit trust you pay tax on all gains on your original rand investment, regardless of whether those gains are from capital growth or currency movement. You also 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.
You can take up to R1m offshore annually without having to apply for a tax clearance certificate, but if you want to invest more you will have to apply for tax clearance from SARS. If you invest directly in foreign currency with a foreign manager or through an offshore platform, you don’t pay tax on currency movement while you are invested. When you sell assets bought in a foreign currency, the foreign capital gain or loss is first calculated and then translated into rand using either the average exchange rate (available on the SARS website) or the exchange rate on the date of sale.
Tax-free investment accounts provide a decent alternative (but note the restrictions)
If these figures leave you wondering how you can earn a similar return but not suffer the tax sacrifice, a tax-free investment (TFI) account may be the answer. As with a unit trust investment, you invest in a TFI account with after-tax money – the key difference is that all interest and dividends are tax-free and you pay no CGT when you withdraw. This is the same as in your retirement funds (as described below) – but TFIs allow you access to your investment whenever you need it. While this flexibility is appealing, it is not necessarily a good thing when you are trying to be disciplined. And the true benefit of this product will be experienced in the long term. There is a catch. The maximum amount you can currently invest is R33 000 a year with a lifetime maximum of R500 000. If you exceed these limits you will incur a 40% penalty on the excess amount.
"If you can handle the restrictive rules, endowments are another option."
If you are a high-income earner, you can benefit from a favourable tax rate if you invest in an endowment. An endowment is a policy issued by a life insurance company. When you invest in an endowment you effectively swap your tax position for that of the policy. The big deal here is that for higher taxpayers, instead of paying tax at 45%, you pay tax at the rate that the life company must apply, which is 30%. The downside is that the life company can’t give you your exemptions – so you pay tax, albeit at a lower rate, on all of the interest income and capital gains. Dividends are subject to a 20% dividend withholding tax. Endowments have restrictive rules regarding contributions and withdrawals, and should only be considered if you are willing to lock your money in for five years.
Rossouw, C. (2019). How to earn higher investment returns and pay less tax this tax year (2018/19). Cape Town: Allan Gray, pp.2, 3.