Introduction

Benjamin Franklin (the American inventor, journalist, printer, diplomat and statesman) made the following statement on 13 November 1789:

“Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes”.

There are however tax concessions which SARS makes available which lessens the tax burden substantially, and especially with regards to investments and the use of different investment vehicles. 

Interest investments (money market, fixed deposits and government bonds)

The first R22,800 (or R33,000 for individuals older than 65 years) of interest income received is exempt from income tax. These exemptions are increased annually to take inflation into account and are the total for a tax year (it cannot be applied separately for different financial products).

Individuals must therefore make optimal use of the annual interest exemptions. For example, a couple both younger than 65 who have an investment which yields an income of 10% per annum can invest R456,000 therein to receive R45,600 (R22,800 per individual) as income, free of any income tax. A couple both older than 65 who have an investment which yields an income of 10% per annum can place R660,000 therein to receive R66,000 (R33,000 per individual) as income, free of any income tax.

No Capital Gains Tax (‘CGT’) is applicable with interest investments.

Collective investments (‘unit trusts’)

The conduit principle is applicable to unit trusts and individuals are taxed annually on interest and foreign dividends which are declared, irrespective if income is withdrawn or re-invested.

Unit trusts have different compositions of interest investments and shares, and the income generated through these instruments is treated differently for income tax purposes:

• interest declared from local sources above the normal exemptions stated above is taxed at an individual’s marginal rate of income tax for the year in which it is declared;
• dividends received from locally listed companies is, based on current legislation, not taxable in the hands of individuals;
• the first R3,700 of foreign interest and dividends is tax free and this exemption forms part of the total interest exemption as discussed above.

Individuals are only liable for CGT on gains made within a unit trust if units are sold or if portfolios are rebalanced. In such a case the first R20,000 per annum of capital gains are exempt from CGT. All gains above R20,000 are then taxed at 25% multiplied by the individual’s marginal rate of income tax.

To take advantage of the annual CGT exemption individuals can switch the funds within their unit trust portfolio every year. By doing this they will create a new basis point for future CGT liabilities. The CGT exemption can however not be carried over to future years, and it is only applicable to a specific tax year in which the gain was made.

Retirement funds (pension-, provident, retirement annuity and preservation funds)

There are currently no income tax and CGT implications with regards to income (interest, dividends and rental income) which is generated within a retirement fund, and this is a massive advantage over unit trusts where individuals are taxed annually on the income generated, irrespective of whether it is withdrawn or re-invested. When the new proposed taxation on dividends is rolled out soon it will also not be applicable to retirement funds.

Individuals can contribute the highest of the following limits annually to registered pension funds and RA funds (not preservation funds) and deduct it for income tax:

• 15% of non-pension funding income; or
• R1,750; or
• R3,500 minus any contributions already made to a pension fund.

When individuals withdraw their fund benefits at their employer before they retire they will be taxed as follows:

Amount	Rate
First R25,000	0%
Between R25,001 and R660,000	18%
Between R660,001 and R990,000	27%
More than R990,001	36%

Fund benefits can however be transferred to a registered preservation fund or RA fund without any tax levied on the transfer.

When individuals retire they will be taxed as follows on the lump sum benefit which is taken:

Amount	Rate
First R500,000	0%
Between R500,001 and R700,000	18%
Between R700,001 and R1,050,000	27%
More than R1,050,001	36%

Fund benefits can however be transferred to a guaranteed annuity or investment linked living annuity (‘ILLA’) without any tax levied on the transfer.

Life assurance endowment policies (‘endowments’)

Endowments are governed by the Long Term Insurance Act of 1998 and are taxed according to the “four funds approach”. These four funds refer to separate pools for individuals, companies, corporate entities and non-taxable entities, and each of these are taxed differently.

Rental and interest generated within endowments are taxed at a flat rate 30% per annum. The interest- and dividend exemptions available for individuals are not available within endowments.

Capital gains generated are taxed at a flat rate of 7.5% per annum. The CGT exemption available for individuals are however not taken into account when the 7.5% calculation is done.

Above taxation is paid on behalf of the individual who is the owner of the endowment, and when the endowment matures at the end of the term the proceeds will not be subject to any tax because the gains were taxed within the vehicle through the term of investment.

Therefore, in our opinion, individuals only benefit by investing in endowments if they have already used their interest exemption on other investments and their marginal income tax rate exceeds 30%.

Endowments were sold extensively in the past by financial advisers because of the high commissions which they earned on these sales, in contrast to the relatively low commission structures which unit trusts offer. Many individuals still have endowments which are not suited for their needs.

These policies can however be cancelled prematurely and the proceeds can then be invested elsewhere (interest investment, unit trust or retirement fund). The life assurance companies may however levy penalties on the early termination and individuals should ask for quotations before these policies are cancelled.

Illustrative example (also refer to attached schedule with calculations)

A 25 year-old individual invests R2,500 per month from 1 January 2010 to 31 December 2029 (investment term of 20 years) in the following investment vehicles:

Type of investment	Investment fund
Interest investment	Allan Gray Money Market
Unit trust	Allan Gray Stable Fund
RA fund (contributions deductible)	Allan Gray Stable Fund
RA fund (contributions not deductible)	Allan Gray Stable Fund
Endowment	Allan Gray Stable Fund

The following variables were applied consistently throughout the investment term:

Investment contributions:	R2,500 per month, no escalation
Yield on investments:	10% per annum
Tax rate on endowments:	30% per annum
Tax rate on local dividends:	0% per annum
Marginal income tax rate:	20% per annum
Interest exemption:	R21,000 per annum, escalating at 10% per annum through the investment term.
“Income comprises of:	Interest investment - 100% interest Unit trust, Retirement Fund, Endowment - 90% interest, 10% local dividends

Fund values at the end of the 20 year investment term:

Type of investment	Fund value
RA fund (deductible contributions)	R2,277,175.01
RA fund (non-deductible contributions)	R1,914,242.27
Unit trust	R1,902,310.83
Interest investment	R1,880,369.37
Endowment	R1,324,764.37

It is worth noting that the RA fund would have performed the best over the investment term of 20 years, despite the negative perception which the public and the media still have over this type of investment.

Conclusion

There are many factors to consider with the choice of a specific investment of which taxation is only one.

Please contact us if you want to re-balance your investment portfolio or if you require more information about the above article.