Whether in the form of capital gains, dividends, or interest income, knowing the tax implications of one’s investments can help to maximise your returns and optimise wealth creation.

What tax is paid on bonds and cash?

The interest earned on bonds or cash held in the bank will be taxed at your marginal tax rate. Remember, income tax is calculated on a sliding scale between 18% and 45% depending on how much you earn, which means the more you earn, the higher your rate of tax will be.  The tax bracket in which you fall determines your marginal tax rate, which, in turn, affects the rate at which you are taxed on any additional earnings.

When calculating the interest earned from bonds and cash, you will need to include interest earned on South African Retail Savings Bonds, your medical savings account, stokvels and other similar investments. As a taxpayer, keep in mind that you have an annual exemption on interest income earned which is currently set at R23 800 for individuals under the age of 65, and R34 500 for those older than 65. When filing your tax returns, keep in mind that you must declare all interest income, even if it falls under the annual threshold.

What about foreign interest earnings?

If you earn foreign interest, keep in mind that you will need to declare the rand amount to Sars when filing your tax returns and that no annual exemption applies to these earnings. Once again, you will need to declare foreign interest in the Investment Income section of your tax returns, and you should be able to obtain a deduction on foreign taxes already paid.

What is dividend withholding tax (DWT) ?

DWT is tax payable on dividends received or accrued from South African-listed companies or dual-listed non-resident companies. DWT, which is levied at a flat rate of 20%, is paid directly to Sars by the company before the balance of the dividends is paid to the investor. This means that once the investor has received their net dividend, they have no further tax obligations. Note that DWT is payable after the company has paid corporate tax of 28% on its net profits.

How does DWT apply to my unit trust investments?

If you own shares in your unit trust portfolio, any local dividends earned on your investment will be taxed at the DWT flat rate of 20%. The company in which you are invested will withhold 20% of the dividends, which will then be paid over to Sars. The balance will then be paid to you, although you will not be required to file or declare any tax information to Sars.

Will I have to pay capital gains tax (CGT) when I sell units?

The sale of any investment triggers a capital gains event, and it is, therefore, important to understand the potential CGT consequences before selling any unit trust. Remember, the first R40 000 of capital gain made in a tax year by an individual is exempt from tax, whereafter profits are taxed by applying a 40% inclusion rate, meaning that only 40% of the profit you make in excess of R40 000 will be included in your taxable income.

Capital gains are taxed at your marginal tax rate, meaning that the maximum effective CGT rate payable is 18%. Keep in mind that a capital gains event is triggered on the sale of your unit trusts and not on the sale of underlying assets in one’s portfolio. Also, any unused portion of your annual CGT exclusion cannot be carried forward to the next year, so it is important to use your exemptions strategically when structuring your investment portfolio. When you realise any foreign investments, any capital gain will be converted to rands using the average exchange rate in the year of disposal or at the spot rate on the date of disposal.

What are the tax benefits of an endowment?

An endowment is a policy issued by a life insurance company that can provide tax benefits if your marginal income tax rate is higher than 30%. This is because when taking out an endowment policy, you effectively swap your tax position for that of the life insurer, which means that, instead of paying tax on interest earned at your marginal tax rate, you are taxed at a rate of 30% – although keep in mind that no annual interest or capital gains exemptions apply in this regard. However, endowments can be quite restrictive as you are required to lock your money away for a minimum period of five years, subject to some limited accessibility. If you own an endowment, you are liable for 30% tax on interest income, 20% tax on dividends, and CGT at an effective rate of 12%.

How are Reits taxed in my unit trust portfolio?

A real estate investment trust (Reit) is a listed property investment vehicle. South African Reits allow investors to invest in property investments by buying shares in a JSE-listed property company, including retail, commercial, industrial, and residential property assets throughout the country. If you invest in Reits as part of your unit trust portfolio, keep in mind that any Reit distributions must be declared in your tax returns and will be taxed at your marginal rate.

How are Reits taxed in my retirement fund?

Where you hold Reits in a retirement fund, you will not be liable for tax on distributions, and the ability to reinvest and compound these before-tax distributions within your retirement fund over a long period of time is a significant benefit.

What makes retirement funds attractive from a tax perspective?

Pension, provident, and retirement annuity funds offer the most significant tax benefits for investors because all contributions, up to 27.5% of taxable income, are tax deductible, subject to a maximum of R350 000 per tax year – with any over-contributions rolling over to subsequent years. Further, investors do not pay CGT, dividends withholding tax, or income tax on any growth earned in a retirement fund. As a result, investors can greatly benefit from the compounded tax benefits, especially over the long term.

Is there a tax deduction on contributions to a tax-free savings account (TFSA)?

No, your contributions to any tax-free investments are made with after-tax money meaning there is no tax incentive on your contributions to a TFSA.

What are the tax benefits of investing through a TFSA?

The tax benefits of a tax-free savings vehicle lie in the fact that no tax is payable on interest income or dividends, and no CGT is payable on disinvestment, meaning that your potential return is higher than in a standard unit trust. Because of the structure of a TFSA, frequent withdrawals will limit the compounding effects and your ability to save tax-free in the future, so it is advisable to take a long-term view when investing in a TFSA. Also important to bear in mind is that if you exceed your annual contribution limit of R36 000, you will be liable for tax of 40%, so it is important to keep track of your annual contributions.

In order to maximise your investment returns and achieve your long-term investment objectives, it is vital to understand how your investments will be taxed. As is evident from the above, each type of investment is subject to a different set of tax rules, and the type of tax you may be liable for can be influenced by the nature of your investment, your marginal tax rate, your age, the rate at which you invest and the nature of the income you earn. It goes without saying that the amount of tax you pay significantly affects your investment returns, and it is therefore essential that tax planning is an integral part of your investment planning.