How to reduce your personal tax liability before 28 February 2021
BY: VIV GOVENDER
AS WE approach yet another tax year-end, many South Africans are again thinking about ways to minimise their tax liabilities.
While the wealthiest individuals can use sophisticated avoidance techniques (such as zero-cost collars, linear derivative hedges, and offshore company and trust structures), these more complex structures are outside the reach of most people. For the median SA investor, the best option is to look at the current allowances.
Fortunately, SARS has reasonably accessible tax-exemptions. Maximising these allowances can dramatically lighten the tax burden you’ll face this year. Even if you do use more complex structuring tools, making sure you have a handle on the basics is useful.
Capital Gains Tax (CGT)
When it comes to investing, the best tax is no tax. However, if you must pay tax on your investment growth, you want it to be Capital Gains Tax (CGT). For South Africans, this is the best of a bad set of options.
The amount of the capital gain to be included in your income tax calculation is 40% of the total capital gain made on your investment (if your investments are in your personal name). This means you’ll face a maximum tax rate approaching just 18% for individuals (45% marginal rate x 40% inclusion rate = 18% final rate). This is far below the 45% maximum income tax rate—and better even than the 20% dividend withholding tax rate.
I say ‘approaching’, because there is some additional relief:
- The first R40 000 of capital gains are exempt annually. If you’re not using this full exemption, you might consider trimming and switching a few equity positions.
- If you’re selling your primary residence, the first R2-million is exempt. Probably not a quick fix before tax-end, and most financial planners don’t consider your primary residence to be part of your investment portfolio. Nevertheless, the savvy (and more nomadic) investor can use this exemption to reduce their CGT tax bill further.
- If you’re over 55 and selling a business worth less than R10 million, the first R1.8 million of capital gain is exempt.
- Death and taxes may be the only certainties in life, but if this is your final year on earth, you may be pleased to know that you will get a R300 000 CGT exclusion in the year of your death.
Before we get into the juicier ways you can reduce your tax bill, you should also consider your longer-term plan to reduce your overall tax liability in future. After all, intergenerational transfer of wealth can be incredibly expensive. However, you can use this year’s allowances to reduce the bill your heirs will pay on inheritance.
An individual can transfer wealth into the name of their descendants in one of two ways. Firstly, the money is distributed from the estate after the individual passes away or secondly, this transfer of wealth can take place in the form of a donation before death.
Both methods have tax consequences in the form of estate duty and donations tax. They’re both calculated in the same way: 20% of the amount up to R30 million, and 25% of any amount above R30 million.
As an individual however, in your lifetime you can donate R100 000 per tax year to someone without paying any donations tax. It’s therefore a useful estate planning tool to act generously with children.
If you trust your children and are in a position to begin moving money across to them during your life, it can be wise to make use of this tax break yearly. You can send up to R100 000 their way before 28 February 2021, and you’ll be able to do it again next year—tax-free.
Of course, no donations taxes are paid on transfers between spouses—so you can be even more generous with your spouse.
The first R23 800 of interest earned each year is tax-exempt. If you are over 65, this increases to R34 500. This is not insubstantial given the current low interest rate environment. At the interest rate paid by most banks on savings, you would most likely need over R500 000 sitting in an interest-bearing account to be in danger of paying taxes on interest payments.
However, this allowance has become less prominent in recent years, as the government has not increased the allowance since 2016—the same year that tax-free savings accounts were introduced to the country.
Yet when you’re planning your tactical asset allocation for next year, bear in mind that this value places an upper limit on the efficiency of frictional liquid cash. You can easily adjust this by looking at holding hard currencies like US dollars, Euros, and Swiss Francs.
These currencies may not pay an interest rate, but the foreign exchange movements on average will compensate you thanks to inflation differentials between South African and foreign countries. This can simply be achieved either via offshore bank accounts or foreign currency accounts.
If you’re reorganising your financial allocation and haven’t used your full interest exemption, you’ll have some leeway on higher cash loads as you go into the end of the year.
Tax-free savings accounts (TFSAs)
Since their introduction five years ago, these accounts have grown in popularity (though by no means as much as they should). If used correctly, they can significantly reduce your tax burden.
Currently, an individual can deposit up to R36 000 per a year of after-tax money into TFSAs. This is up from R30 000, when they were first introduced. Any deposits above this level are heavily penalised, and you’ll have to pay 40% of the excess to SARS—so ensure that you’re investing the correct amount.
You’re also limited to a total R500 000 contribution during the course of your lifetime. However, unlike the annual allowance, the lifetime allowance has never been increased. That said, even if you deposited the maximum allowed amount each year, it would take almost 14 years to hit the lifetime limit.
Once inside a TFSA, your investment selection is limited. You can’t buy indi-vidual shares, for instance. Generally, most investors are limited to fixed deposits, retail savings bonds, unit trusts and exchange-traded funds (ETFs) that are classified as unit trusts, linked investment instruments, and some allowed endowments.
That said, the power of these little accounts are not to be underestimated—especially for middle- and lower-income taxpayers.
All growth, dividends and income within the account is tax-free. This allows for astonishing tax savings if you consider the effect of compounded returns in a longer-term investment. Also, since you can open these accounts for children, the potential investment period is extremely large (65 years or even more versus 30 to 40 years for most RAs).
Some back-of-the-envelope calculations show that, if you were to invest the full allowance for an infant from the year they were born, when the child hits 65 years old, the account could be worth a staggering R700 million in nominal terms. This is of course assuming you invest in an Index ETF such as the Satrix 40 or S&P500, and market returns continue to match historical norms.
Now we all know that tax rules are ever-shifting, but given today’s set of rules, your tax saving on long-term growth is eye-watering.
Unlike retirement annuities (which we discuss next), TFSAs have almost no downside as you can withdraw your funds partially or fully whenever you wish. Unfortunately, a withdrawal does not reset your limits.
If you’ve yet to contribute to a TFSA this year, you can set them up for you and your kids in a matter of hours at Rand Swiss, which is currently ranked SA’s top TFSA provider by the Financial Mail.
Retirement Annuities (RAs)
RAs are perhaps the most popular investment vehicle in SA, and have helped create our multi-trillion-rand pension system. The main benefit of an RA is that you can fund it with pre-tax money. This means that a contribution to an RA comes off your taxable income.
Your contributions are, in most cases, limited to 27.5% of your income or R350 000 (whichever is smaller). The size of the allowed contribution does depend on your remuneration structure and income profile, and are governed by Section 11F of the Income Tax Act.
Remember, your taxable income still includes the taxable portion of your capital gain as well as other income. If you’re interested in further reading, remuneration is defined in the Fourth Schedule. However, for example, someone on the maximum tax rate of 45% making a R100 000 contribution to an RA would achieve a tax saving this year of R45 000.
To put it another way: If your income was R1.7 million this year and you haven’t contributed yet, R100 000 before tax would mean you’re left with R55 000 after tax. By contributing to an RA, you immediately get the full benefit of the R100 000 saved and invested. This is almost like an instant R45 000 profit on a R55 000 investment. You might even argue that this is an instant return of over 81% for using this savings vehicle. Unfortunately, nothing is for free in this world—and there are drawbacks to an RA.
For starters, except in special circumstances, you cannot access your funds until you are at least 55 years old (except in the case of preservation funds, in which case you will pay a massive tax penalty). However, even after you reach 55, you can only take out up to one-third as a lump sum—the remainder will need to be used to purchase an annuity.
You’re also limited in terms of asset allocation. You can’t have more than 75 % in equity, and no more than 30% can be invested in offshore assets.
It is the 30% offshore limit that in recent times has been the greatest drawback. Many commentators have slammed retirement annuities as an investment tool, simply because the SA stock market has significantly underperformed the global average in hard currency terms. If the differential continues for much longer it would negate even the massive initial tax benefit of the RA.
Before investing in an RA you need to weigh up your liquidity requirements, personal investment views and current income profile.
Viv Govender is a senior portfolio manager and wealth specialist at Rand Swiss.
There are a number of legitimate ways in which ordinary taxpayers can reduce their tax bill.
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… said no-one, ever (except perhaps your tax practitioner, or SARS Commissioner Edward Kieswetter).
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