Tax Savvy Guide: Maximize Tax Efficient Investment Decisions Before End-Feb 2021

by | Feb 1, 2021

The famous statement by Benjamin Franklin reminds us of the two certainties in life – death & taxes. There is little control we have over the first, however the second can be managed by following the correct strategic approach. The South African government has introduced several incentives to encourage long-term saving, these incentives can be highly attractive, especially when assessing how the value compounds over time.

With the end of the 2020/2021 tax year nearly upon us, there is little time left for investors to maximize their tax benefits. There are several investment products available, with the tax implications and flexibility varying.

Retirement Funds

Retirement Funds (RAs, pension and provident funds) win on the tax front but are the least flexible in terms of liquidity. The key reasons why these products are most suitable in achieving tax benefits is that – firstly, investors do not pay capital gains tax (CGT), dividend withholding tax or income tax on retirement funds – potentially meaning that investment growth over a long period could be far greater than discretionary unit trusts based off the fact growth isn’t taxed. Secondly, contributions are tax deductible up to the lesser of R350 000 per year or 27.5% of the greater remuneration of taxable income.

However, investors should be aware of the two limitations of these products. Retirement Funds offer little withdrawal flexibility, the RA product for example only allows the investor to have access to the cash from the age of 55. Secondly, due to government regulations (Reg. 28) retirement funds have limited exposure to higher risks assets, such as local and offshore equities. These restrictions can restrain growth as riskier assets often yield higher returns.

Tax Free Savings Account (TFSA)

The TFSA provides investors with great tax benefits, all growth incurred on the investment is free of tax – a big win if you invest long term. The TFSA is highly flexible too allowing investors the ability to cash in their funds as frequently as they like – although this is not recommended.

Contribution limits constrain investors to only add a maximum of R36,000 per year. The annual contribution allowance works in conjunction with the tax year, meaning that investors are still able to maximize their contributions before 1 March 2021 – the new tax year.

The power of tax-free compound growth is depicted in the graph below. The blue line illustrates the 10-year return of the Ninety One Global Franchise Feeder Fund (This fund has a 25% allocation in our RWM Tax Free Portfolio), while the orange line reflects the return an investor would receive after tax – although of course these returns differs for everyone based on personal tax rates and circumstances.

Endowments

The endowment policy is most suitable for high income earning investors, with a tax rate greater than 30%. Due to this policy being issued by insurance companies or via investment management company’s life licenses, investors effectively swap their tax position for that of the policy. Essentially meaning investors with a marginal tax rate higher then 30% should consider this policy – provided all annual tax allowances are already utilized. The downside of this policy is that the money will be locked in for a period of five years, investors are granted the opportunity to effectively withdraw the funds twice, through an interest free-loan and a surrender. After the five-year lock-in period, investors can withdraw as frequently as they would like.

It is important to note that on the Retirement Funds, TFSA and Endowment products beneficiaries can be nominated. This can result in significant savings for the nominees, as estate duty costs could potentially cost up to 3.5% (excl. VAT) of the total investment upon death if the investment was to fall apart of the investors estate.

Remember if you have not contributed 27.5% of your taxable income to your retirement funds or haven’t maximized your contribution limit of R36,000 to your TFSA, you have until the 28th of February 2021 to do so and maximize your tax savings.