As an investor, it is quite important to understand when and how your money could be taxed. Understanding the basics of tax is a key component to helping you maximise the value of your investments.
Very simply put, your money could be taxed at 3 stages.
Stage 1: The money you actually use to invest.
The money you earn from your occupation will be taxed. If you, subsequently, use this money to invest, you should consciously account for the lost money the taxman has already claimed before you even invested it.
Stage 2: The growth on your investment.
The growth of your investment is subject to tax. If for example you invest in property directly and receive rental income, the rent you earn is indeed subject to tax. If you sell the property, the gain in its value while you owned it (selling price – buying price) will also be subject to its own kind of tax (Capital gains tax).
Please note that the tax on investment income and growth does not only apply to property, but to your other investments as well (e.g. unit trusts, direct share investments etc).
Stage 3: The eventual benefit of your investment
You can be taxed even as you receive the benefits of your investment. As an example; should you withdraw your retirement fund -as a lump-sum- you would pay some tax. In addition, when in retirement and receiving your pension, you would also be taxed on this income.
Depending on the method you use to invest, you can avoid being taxed at some of these stages.
In the table below I shall consider some major investments and which stages they are taxed at.
Tax-free savings accounts
Other Investments: (not tax-free or retirement savings)
Important to note:
- Golden rule: It is better, from a tax perspective, to put your money in an investment that is taxed at fewer stages, AND that is taxed later rather than earlier.
So, a Tax Free Savings Account Unit Trust would be better than a Unit Trust that is not tax-free, because the former would be taxed only at stage 3, while the latter would be taxed at stage 1 and at stage 2.
Secondly, even though both Retirement Annuities and Tax free savings accounts are only taxed at one of the three stages, RA’s are better from a tax perspective because you pay tax later, and quite possibly on a lower income – meaning a lower tax bill.
- Provident funds are interesting:
- Your investment contribution used to be from after-tax money: (taxed at stage 1), but after tax law changes on 1 March 2016 (retirement reform) your contributions are tax-deductible (no tax at stage 1)
- The growth from your investment would not be taxed (no tax at stage 2)
- Upon withdrawal at retirement, your benefit be taxed
- Tax-free savings allows you to use your after-tax income to invest in a manner that reduces your tax bill (compared to investments other than Pensions and RAs) up to 33k in a year, and 500k lifetime.
- Other types of investments are the least beneficial in terms of tax payable. The amount of tax you pay on these, however, depends on the assets you invest in (eg shares, or property or bank account), and the amount of money you make in your investment.
*Please note that there are limits to the tax benefits you can get from your contributions into Pension, Provident and RAs. Your contributions are only tax deductible to 27.5% of your gross annual income.