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By Gavin Butchart*
With the tax season upon us, you might be wondering what your options are to lower your tax liability and maximise your savings. You have until end-February to submit your provisional tax returns for the 2023 tax year, which doesn’t leave you much time to come up with a plan.
The 28 February deadline is important because you can lower your tax liability if you make additional contributions to approved retirement or tax-free investments.
In a sense, you’re fortunate that you don’t have an overwhelming selection of instruments to choose from. Making a decision should therefore be a little easier, even if the universe of investment opportunities within these tax-efficient options is still quite vast.
In a nutshell, your three best options at this time of the year are a retirement annuity (RA), a tax-free savings account or a discretionary investment.
The pros and cons of a retirement annuity
Retirement funds and retirement annuities (RA) are the most common instruments used to save for retirement in South Africa. If you belong to a company pension fund, then your contributions will automatically be deducted from your paycheck every month. An RA performs the same task, and is most often used if you don’t have a company pension fund, or want to make extra provision for your retirement.
One of the biggest benefits of both these options is that you’re entitled to a tax deduction on these contributions of up to 27.5% of your taxable income. Limited to a maximum of R350 000 a year, any overpayments will roll over to the next tax year and won’t be lost.
In addition, you don’t pay any capital gains, interest or dividend withholding taxes on the growth of your retirement investments.
These tax benefits aren’t without their downsides.
For instance, any retirement fund or RA that wants to offer these tax deductions has to comply with Regulation 28 of the Pension Funds Act. This clause places certain restrictions on how much exposure these funds can have to equities, and offshore investments.
This clause restricts how the funds invest, placing limits on much exposure they can have to asset classes like listed equities and infrastructure projects. The amount of offshore exposure is also restricted as a way to avoid funds taking on too much risk. These limits have had the effect over the past few years of stifling returns compared to discretionary portfolios.
The pros and cons of tax-free savings accounts
This class of investment was introduced nearly a decade ago to incentivise South African households to save more. The deal is simple, you can put away up to R36 000 a year and R500 000 in your lifetime into registered tax-free instruments.
In exchange, your savings and gains are exempt from the usual investment taxes on capital gains, dividends and interest. Over a lifetime, that could amount to a considerable saving.
One of the benefits of approved tax-free instruments is that they include unit trusts, fixed deposits, and REITs. This means you can build diversification into your tax-free strategy in the same way your discretionary portfolio or retirement savings are tailored to your risk profile.
The incentive is sweetened further by allowing families to create a separate tax-free portfolio for every family member. The same annual and lifetime limits apply to each individual.
This is a great way for individuals, parents and grandparents to donate to their loved ones and still remain within the R100 000 annual individual tax-free donations threshold. By making the maximum annual contribution into their loved ones’ tax-free account, the lifetime limit of R500 000 will be reached in just 14 years.
The pros and cons of discretionary investments
A discretionary investment portfolio is essentially investments that you make outside of retirement fund or RA contributions. There are many reasons you may decide to do this, including growing your wealth outside of the confines of Regulation 28. You might, for instance, want aggressive growth from higher exposure to equities, or unlisted instruments that offer higher growth potential but are riskier.
These are decisions that are best made together with a financial advisor who is able to plot a path that will get you to your goal without undue risk. The restrictions in Reg. 28 are there specifically to prevent undue risk in your retirement savings, which is a philosophy you can carry through in your discretionary funds.
A growth-at-all-costs approach is not only cavalier, but it is also not suitable for everyone. The best use of discretionary investments is to spread your risk further by investing in assets or geographies that your tax-efficient funds cannot.
This benefit does come at the cost of having to pay capital gains, dividends and interest taxes on your discretionary investments. However, the potential for returns to outpace taxes in a successful discretionary portfolio easily outweigh the
However, the potential for a successful discretionary portfolio to produce returns far higher than your tax liabilities is where the big appeal lies.
Discretionary investments aren’t held to any deadlines and can be done at any time throughout the year as there is no tax benefits one would receive on these investments.
In conclusion, deciding whether to invest in a retirement fund, tax-free savings account or invest in a discretionary investment is dependent on the individual’s needs, and risk profile and seeking the advice of a qualified financial planner is the best person to assist with this decision.
You don’t have much time to make your decisions as the deadline for your provisional tax returns (28 February) is looming. More importantly, your funds should ideally be paid by the 20th so that they reflect in the necessary account or fund by the 28th.
So, rather than waiting until the last minute, I suggest you speak to your financial advisor so that you can get an accurate picture of your position and your options.
- Gavin Butchart is the financial director of Brenthurst Wealth and head of the company’s operations in Mauritius. [email protected].