How to maximise your tax breaks before end of tax year
The window of opportunity to make the most of this year's tax deductions is closing as the end of the tax year approaches, but some quick calculations will show where you could save on tax by making a contribution to a retirement fund or tax-free savings account.
If you have been investing in a discretionary investment with no tax benefits, you may want to consider switching money to a tax-free savings account and using this year's annual contribution limit as well as the annual capital gains tax exemption before the end of the tax year. Another tax break for higher earners able to take a high investment risk is to invest in a venture capital company. Here's what you need to know to maximise your tax breaks.
Each tax year you are entitled to claim a tax deduction for contributions to a retirement fund up to 27.5% of your taxable income or your remuneration - whichever is higher. The maximum deduction is R350000 a year, which only applies if you are earning a salary of more than R1.27-million a year.
Depending on your marginal tax rate, you could therefore reduce your tax payable by up to 45% of the amount you contribute with the savings being directed into your retirement fund.
As an employee, your remuneration includes your basic salary and any travel allowance before deductions.
If you are self-employed, or if you are an employee who also receives rental income, taxable interest or have made taxable capital gains, use your taxable income.
If you have not yet maximised this tax deduction, you can make an additional lump sum contribution to your retirement annuity or your employer-sponsored pension or provident fund (if the rules allow voluntary top-ups), says Carla Rossouw, tax manager at Allan Gray.
Rossouw says if your annual salary is R300000 and you are contributing 7.5% of this amount to an RA - assuming it is your only tax deduction - you will be contributing R22500 a year. If you up your contribution to 15%, or R45000, your tax will decrease from R43324 to R37474. This means the additional R22500 in retirement savings will only cost you R16000.
The above is based on the current tax tables, which will probably change for the year beginning March 1 once the 2018 budget is announced.
Savings in your retirement fund grow free of income tax, dividends tax and capital gains tax.
Remember that contributions to a pension or provident fund are only available on resignation or retirement, while contributions to an RA are only available after age 55. If you have taken out an older life assurance RA, you may have contracted to continue contributing for a term. Breaking that term could incur a penalty.
On withdrawal, you will pay tax on the amount paid out - only the first R25000 is tax-free. If you keep your savings invested in your fund or transfer to a new fund and leave your savings until retirement, more generous tax benefits are available. On retirement, the first R500000 of the one-third you can withdraw in cash is tax-free and any pension drawn from the remainder is taxed at your marginal rate.
Remember that the secondary tax rebates apply after the age of 65, which essentially lowers your tax rate after this age.
The tax deduction for amounts invested in approved venture capital companies as long as you remain invested for five years
Ideally, therefore, retirement savings should remain invested until you retire.
Remember, too, that investments in a retirement fund must conform to regulation 28 of the Pension Funds Act that limits your equity investments to 75% of your savings.
Costs on some products are high, but there are some RAs with passively managed underlying funds available with fees as low as 0.4% of your savings a year. The RA market has had bad press as a result of older products that included penalties if you stopped or reduced your contributions before the term of the contract was up. It is possible to avoid these products.
If you think you can do better investing in a discretionary investment rather than in a retirement fund, consider this: independent financial adviser Daniel Wessels has calculated that taxpayers earning between R200000 and R2.5-million a year and saving 15% of their taxable income in a retirement fund over 20 years would need a return on a discretionary investment that is 2.5 percentage points higher than that on their retirement fund to beat the outcome from the retirement savings.
Contributions to tax-free savings accounts
Savings into unit trusts, exchange traded funds or bank deposits housed within a tax-free savings account can, like retirement savings, earn interest, dividends and capital gains free of tax.
The main difference between a tax-free savings account and your retirement fund is that the contributions to a tax-free savings account are not tax-deductible. This gives your retirement fund the edge over your tax-free savings account, but the tax-free savings account offers greater flexibility - you can withdraw from it any time.
If you have not yet maximised this tax deduction, you can make an additional lump sum contribution to your retirement annuity
You can make a contribution of up to R33000 a year until the amounts you contribute each year add up to R500000 (excluding any growth on the amounts contributed).
If you do not use the R33000 in any year, you cannot contribute more than R33000 in subsequent years.
Withdrawals are not taken into account when your annual or lifetime limits are determined. For example, if, in one year, you contribute R33000 and then withdraw R10000, your net contribution is R20000, but you cannot replace the R10000 in the same year without exceeding the annual limit and paying a penalty tax - 40% of any amount you invest in a tax-free savings account that takes you above the annual or lifetime contribution limit.
If you have discretionary investments - not in a retirement fund - they may be attracting tax on the interest income and dividends, so moving them into a tax-free savings account as quickly as possible will probably benefit you.
Your savings in bank deposits or unit trust funds that mostly earn interest, such as money-market and other fixed-income funds, may not be attracting tax if your interest earned is below the current interest income exemptions - R23800 a year if you are under 65 years and R34500 if you are over 65.
At current money market yields of 8.5% a year, this means you can invest about R280000 if you are under the age of 65 and just less than R406000 if you are over the age of 65 without incurring tax.
Don't forget that any investment you sell to buy into a tax-free savings account investment will incur capital gains tax on any taxable capital gain you have made.
Capital gains tax exclusion
Every tax year you can make taxable capital gains up to R40000 and not pay capital gains tax.
If you need to make changes to your investments - you want to improve your choices or your investments are no longer aligned to the long-term allocations you require to give you the returns you need - you should make use of this tax exemption. If your capital gain will exceed the annual exemption, do one switch this tax year and one after March 1 to make the most of the exemptions.
Venture capital company investments
Investors who are able to take the high investment risks that come with investing in the unlisted shares of start-up businesses and typically have large amounts to invest - between R150000 and R3-million - can enjoy a tax deduction for being what is known as an angel investor.
The Income Tax Act provides a tax incentive to those who invest in certain approved venture capital companies, known as a section 12J tax deduction. These venture capital companies in turn provide finance to small and medium-sized enterprises in return for equity in these companies.
Since many of these ventures are not yet established, the risk of failure is high. There is some mitigation of the risks because the venture capital company must diversify across at least five ventures.
There is also the risk of not being able to realise your investment when you need to - when you want to sell your shares in the venture capital company you will have to find a willing buyer. If you need to sell quickly you may have to settle for a lower price.
There are some restrictions on the type of ventures in which venture capital companies can invest, and the companies have to meet certain requirements such as having their tax affairs in order. Many are in the hospitality, student accommodation and renewable energy sectors.
You get a 100% tax deduction for amounts invested in the approved venture capital companies as long as you remain invested for five years. If you do not, you will have to pay back the tax deduction. This means that, depending on your marginal tax rate, you can enjoy a tax deduction of up to 45%.
In addition to high minimum investments, management fees are likely to be high - a 2% fee with a performance fee is common.
Westbrooke Alternative Investments Manager says it is the largest section 12J manager in the country investing in student and tourist accommodation.
Fund manager Dino Zuccollo says over the past two years the funds have paid dividends of between 5% and 6% a year - equivalent to 10% to 11% a year after tax and fees. The total return on capital is expected to be 16% to 18% a year, he says.
The Income Tax Act currently provides for a tax incentive for investments in these companies made before June 20 2021.