Re­duc­ing the bur­den of the new wealth tax

An RA re­mains one of the best ways to save on tax, with the added ben­e­fit of si­mul­ta­ne­ously sav­ing for re­tire­ment.

Finweek English Edition - - MARKETPLACE - Editorial@fin­ Devin Shutte is the head of in­vest­ments at The Robert Group, a pri­vate wealth man­age­ment com­pany.

former fi­nance min­is­ter Pravin Gord­han an­nounced in his Bud­get Speech in Fe­bru­ary the in­tro­duc­tion of a new top per­sonal in­come tax bracket where South Africa’s high­est earn­ers would pay a mar­ginal tax rate of 45%. This new tax bracket is ap­pli­ca­ble to all those whose tax­able in­come is R1.5m or more per year. This was one of the many ini­tia­tives to gen­er­ate the R28bn short­fall the fis­cus faced.

The ef­fect of this new bracket on a sec­tion of tax­pay­ers is to sig­nif­i­cantly in­crease their av­er­age or ef­fec­tive tax paid. How­ever, while these changes mean less money in tax­pay­ers’ pock­ets, there are leg­is­lated in­vest­ment prod­ucts that can re­duce this in­creased tax bur­den. In fact, the higher taxes move, the greater the tax sav­ing these prod­ucts of­fer.

What is an an­nu­ity?

The re­tire­ment an­nu­ity or RA is an of­ten mis­un­der­stood and un­der­utilised re­tire­ment ve­hi­cle. Re­tire­ment an­nu­ities (RAs) have evolved in their struc­ture over time, with the ones we have to­day a vastly im­proved ver­sion of what was pre­vi­ously avail­able.

The CFA In­sti­tute Re­search Foun­da­tion de­scribes an RA thus: “A com­pany prom­ises to make a series of pe­ri­odic pay­ments – usu­ally de­fined as a se­quence last­ing for life – in ex­change for ei­ther a large sin­gle pre­mium col­lected at the be­gin­ning of the con­tract’s term or a series of smaller pre­mi­ums col­lected be­fore the start of the an­nu­ity’s ini­tial pay­ment date.”

Re­tire­ment an­nu­ity fea­tures

RAs of­fer distinct ad­van­tages. The most com­pelling of these is the afore­men­tioned re­duc­tion of your tax­able in­come (up to cer­tain lim­its). Part of your con­tri­bu­tions to the RA comes from tax sav­ings, mean­ing that Sars is in ef­fect con­tribut­ing to your re­tire­ment sav­ings. An ad­di­tional ben­e­fit is that the growth on your in­vest­ment is tax-free. A fur­ther fea­ture of RAs is that they are in ef­fect “mini trusts”. This means your re­tire­ment sav­ings will be pro­tected from your cred­i­tors, and can be left as in­her­i­tances to ben­e­fi­cia­ries, which has estate duty and ex­ecu­tor fee sav­ings.

How­ever, RAs also have cer­tain lim­i­ta­tions. Your ac­cess to your cap­i­tal is fully re­stricted un­til age 55. Reg­u­la­tion 28 also lim­its your ex­po­sure to growth as­sets (eq­ui­ties and prop­erty).

An ex­am­ple

The best way to il­lus­trate the tax ben­e­fits of an RA is by means of an ex­am­ple. Thuli Mbete is a po­lit­i­cal an­a­lyst for a ma­jor bank and her an­nual tax­able in­come is R1.85m per an­num.

With­out any de­duc­tions, her tax li­a­bil­ity on this in­come would be R677 490 for the cur­rent tax year. This would leave her with take-home pay of R1 172 510. The tax paid means that her ef­fec­tive tax rate is 37%.

How­ever, if Thuli were to utilise her max­i­mum avail­able al­lowance for an RA of R350 000, this would have a sig­nif­i­cant im­pact on her tax­able in­come. The full in­vest­ment amount of R350 000 could be de­ducted from her tax­able in­come of R1.85m. In ef­fect, this would lower her tax­able in­come to R1.5m. Thuli’s tax would then be cal­cu­lated on this lower amount, and would to­tal R519 990, a sav­ing of R157 500 on tax paid for the year. This would trans­late into a lower av­er­age tax rate of 28% for the year. It must how­ever be noted that her take-home pay has de­creased by R194 285 to R978 225, but she owns an in­vest­ment worth R350 000.

What does this mean? In essence, Thuli paid R194 285 for an in­vest­ment worth R350 000.

One can view this in two ways:

1. Thuli in­vested R194 285 of her money, and it was boosted by 80.15% to be worth R350 000. 2. Thuli in­vested R350 000 but re­ceived a 44.5% dis­count on the ini­tial price and only paid R194 285.

By in­vest­ing in an RA, Thuli Mbete has used her tax sav­ing pro­vided by it to en­hance her in­vest­ment for re­tire­ment. This ini­tial boost to her in­vest­ment can have a sig­nif­i­cant ef­fect on the fu­ture value of the in­vest­ment. If Thuli had utilised the same in­vest­ment amount of R194 285 and in­vested it in another in­stru­ment that did not have the pre-tax ben­e­fits of an RA, the lack of in­vest­ment “boost” is sig­nif­i­cant.

On day one, the RA in­vest­ment is worth R350 000 com­pared to the other in­vest­ment’s R194 285. As­sum­ing a 10% nom­i­nal an­nual growth on both, af­ter 10 years the RA would be worth R993 797 com­pared to the R503 925 of the non-RA in­vest­ment. Mov­ing the lens fur­ther out, as­sum­ing the in­vestor held this sin­gle in­vest­ment for 30 years, the RA in­vest­ment would be worth R8 012 304 ver­sus R3 390 157 – a 136% gain.

While no in­vest­ment should be taken with­out due con­sid­er­a­tion of your in­di­vid­ual re­quire­ments, risk tol­er­ance and risk ca­pac­ity, it is im­por­tant to un­der­stand the op­tions avail­able. In the cur­rent en­vi­ron­ment of heightened mar­ket volatil­ity and in­creased tax bur­den, an RA could of­fer a sig­nif­i­cant pos­i­tive con­tri­bu­tion to many re­tire­ment plans.

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