Tax smart investing in turbulent times
- Understanding how taxes work is an important step towards being more tax efficient with one’s finances
- Tax-free investments are one of the most powerful tax-saving tools available to savers – especially when one stays invested in them for the long-term
- We can get so focused on tax that sometimes we forget to consider the fees of an investment
At the first in a series of Nedgroup Investments webinar events, independent financial commentator, Maya Fisher-French, shared her views on how best to make use of the tax-saving opportunities that are available to all South Africans. In uncertain times being tax smart and investing optimally can go a long way to improving one’s long term financial outlook.
All investments incur taxes – but you can make this work for you
When it comes to investments, there are always certain taxes involved. However, different investments are taxed in different ways so, by choosing the best investment structure for your circumstances, there are opportunities to lower the taxes one pays when investing.
Three investment options that can be very effectively used from a tax perspective are retirement funds, tax-free investments and endowments.
Understanding the taxes on investments
Investment returns are subject to four different taxes, namely taxes on interest income, dividend taxes, capital gains tax and taxes on rental income. Understanding how these taxes work is an important step towards being more tax efficient with one’s finances.
- Taxes on interest: South Africans are entitled to a tax exemption for the first R23 000 of interest earned. For over 65-year olds there is no tax on the first R34 500. It’s for this reason that it makes more sense to invest in a tax-free unit trust to avoid using up this tax-free allowance in a tax-free savings account.
- Capital gains tax: The maximum capital gains tax allowed is 18%. Furthermore, the first R40 000 of profit is exempt from capital gains tax and all base costs can be excluded. Primary residences are allocated a R2 million exemption, which can also be effectively used.
- Dividend tax is often considered to be an ‘invisible tax’. This is because the 20% tax on dividends is paid by the company as a withholding tax before the dividend is paid out.
- Property: Rental income from property is taxed as income and is offset by interest on the mortgage.
Tax- free investments – the no-brainer of investment options
Tax-free investments are one of the most powerful tax-saving tools available to savers – especially when one stays invested in them for the long-term. A savings initiative supported by Treasury, these investments are not taxed on capital growth, interest or dividends – and there are no penalties for withdrawal (although restrictions do apply).
Currently South Africans can invest up to R3 000 per month and R36 000 per year (up to a lifetime limit of R500 000). It is however important to remember that the lifetime limit is not adjusted for withdrawals and remains R500 000. For this reason, this investment is ideal for longer-term investments where the full benefit of the compounding effect of the tax-saving on the investment can be realised.
What happens when markets fall?
When markets fall it is distressing for all investors – and understandably so, but this is also often the worst time to disinvest as doing so only locks in the losses. Don’t underestimate the power of the debit order.
It’s easier to commit your future self than it is to commit now. Set up a monthly debit order for your investments so that each month, a set amount of money will be allocated to your investments without you needing to think about it. You also benefit from the consistency of investments, effectively creating a buffer from market volatility - and all without having to consciously think about it.
Finally, don’t forget about fees
We can get so focused on tax that sometimes we forget to consider the fees of an investment. It’s daunting to decide which fund is going to generate the highest return – and often impossible. But it is possible to accurately assess what you will be paying for the investment.
Fees can have a significant effect on investment outcome and it’s important to remember that an investment is only working for you if the fees are not eroding all the tax-efficiencies you gain. Make sure you know what fees you are paying and that all the fees are disclosed before you invest in anything.
Small, simple steps to being tax smart when it comes to investing can result in much bigger financial savings.