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How to pay less tax on your investments

Posted  March 14, 2019

The recent budget means most people will pay more tax in some shape or form, but there are clever (legal) ways to reduce the tax obligation on your investments.

Government did not increase income tax rates in the February budget, but unfortunately, most people will pay more tax in some shape or form.

Corruption and irregular government spending have been a major concern, with many taxpayers asking if a tax revolt may be the answer.

The good news is that there are vehicles that can help you reduce your tax liability without landing you in jail.

But a sensible financial plan shouldn’t merely focus on reducing your tax bill, but should consider your investment goals, time horizon and risk appetite holistically. It is no use to save a few tax bucks only to lose all your money in a bad investment.

Here are three ways you can (legally) reduce the tax you pay:

1. A contribution to a pension or provident fund or a retirement annuityMany people reach retirement with inadequate savings to maintain their standard of living. To help you save for retirement (and to prevent you from becoming a burden on the state), government allows you to reduce the income on which you pay tax with your contribution to your pension fund, provident fund or retirement annuity before it calculates your tax liability. The South African Revenue Service (SARS) allows you to deduct up to 27.5% of your taxable income for contributions to these vehicles but caps the deductible amount at R350 000 annually.

Let’s take someone below the age of 65 who earns R20 000 per month. If they didn’t make any contributions to a retirement vehicle, they would pay R2 709 per month in tax (in the tax year that starts on 1 March 2019), leaving them with R17 291 in their pocket (let’s disregard UIF or other deductions to keep it simple). If the same person contributed R3 000 (15%) of their gross salary to a retirement annuity, they would pay tax on R17 000 (R20 000 minus R3 000), which means they would only pay R1 929 in tax every month. That is a tax saving of R780!

An added benefit of contributions to retirement savings vehicles is that SARS does not levy taxes while the money is inside the vehicles, which means investors effectively defer paying tax on the money until they retire. Bear in mind that you would only be able to access money in a retirement annuity once you turn 55. Although most advisors would caution against it, you can cash out your pension or provident fund when you change jobs.

2. A contribution to a Section 12J CompanyThis is an attractive tax incentive as it allows you to deduct the full amount you invest in a SARS-approved Section 12J venture capital company from your taxable income in the year that you make the investment, provided you stay invested for at least five years. The company will use the funds to invest in small and medium businesses in specific industries to generate a return.

This means that you can get up to 45% immediate tax relief (depending on your tax rate), but there are a few caveats.

  • If the venture capital company sells their investments in these businesses and pay your proceeds over to you after five or seven years (or longer depending on the investment), you will pay capital gains tax on all the proceeds (not just the gain).
  • These investments are illiquid, and you may not have immediate access to your money if the venture capital firm struggles to exit the investment.
  • The type of small and medium businesses these companies invest in differ widely. Remember that some of these enterprises may be start-ups that have a higher risk of failing. Make sure you understand what your money will be used for and that you are comfortable with the risks involved. It is no use to save lots of tax only to lose all your money in the investment. The returns aren’t guaranteed.

3. A contribution to a tax-free savings account (TFSA)You can invest up to R33 000 each tax year in a TFSA and up to R500 000 over your lifetime. While this investment will be done with after-tax money (presumably from your disposable income), all the growth in the account (dividends, interest and capital gains) will be 100% tax-free when you cash out.

Because the purpose of TFSAs is to encourage long-term savings, you can withdraw your money at any point, but you won’t be allowed to put the money back if you have already contributed the maximum R33 000 during a specific tax year. You will have to wait till the next tax-year starts.

There are numerous choices available (you can find a list here), so make sure yours is in line with your investment goals and time horizon. Find out more about the ins and outs of TFSAs here.

The bottom lineThere are clever ways to pay less tax but bear in mind that it should fit within your overall financial plan. While you will reduce your tax bill immediately by contributing to a retirement fund and Section 12J venture capital company (and over time by investing in a TFSA), the real benefit is that you’ll be rewarded for wise financial behaviour in the long run.

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