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 buy a flat and rent it out. The rent you earn is subject to TAX. (There are some items you can deduct to reduce your tax bill, but these aren’t covered in this article). Also, if you sell the house, the gain in its value while you owned it (selling price – buying price) will also be subject to tax.
Please note that the tax on investment income and growth does not only apply to property. It also can apply 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.
Now how do you navigate this space? Well, the way you choose to invest will determine when and how you are taxed.
In the table below I shall consider some major investment products, 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 investing in a unit trust via a tax free savings account would be better tax-wise than a investing directly in Unit Trust that is not tax-free. The former would only be taxed at stage 1, 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 (only at stage 3), 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.
- RAs and pension funds are similar from a tax perspective as using them to invest means that (subject to annual limits) you will only be taxed at stage 3. The difference between them though is that with an RA you would have to claim your tax back from SARS since you would have invested with your income after being taxed. With pension funds it is automatic, since you invest before being taxed.
- 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.