A new way to look at financial planning in 2014

In an election year the national budget speech is usually seen as a non-event − perhaps not this time.

The South African economy is not looking good, with growth rates for 2013/14 below what were forecast a year ago.

In October 2013 the National Treasury predicted that tax collections were within R3 billion of budget. But much has changed since then.

South African retail trade figures for the 2013 festive season showed worrying trends. The mining sector is beset with strike action and there is not much favourable news within corporate South Africa. This could have a substantial effect on the final outcome of state revenue collections. We can only hope that an excess collection of personal tax, caused by wage settlements that are higher than inflation rate, will somehow make up the shortfall.

All this simply means that even if the outcome of the 2013/14 tax collection is more or less on track, South Africa is not making much progress in reducing its borrowing requirement below 5% of annual Gross Domestic Product (GDP) level.

Reduced corporate tax collections are the principal reason for South Africa’s higher-than-comfortable national debt levels. In February 2012 Minister of Finance Pravin Gordhan made the commitment to reduce the national debt level from +5% of GDP to ± 3,5% by 2015. In February 2013 meeting the target of 3,5% of GDP was pushed to 2016.

The target to reduce debt levels to below 3,5% of GDP by 2016 now seems way off. South Africa has borrowed more than R1 trillion since 2008 and there seems to be no end to the ever-upward national debt trajectory.

If coupled with the uncertainties of elections and labour disputes, a further downgrade in South Africa’s sovereign debt rating in 2014 is a very real prospect. This would lead to a substantial outflow of funds from South African markets.
But what does this mean for South African citizens and particularly private wealth creation, and are there any steps that could be taken to anticipate the national budget speech?

Tax rate increases 2014/15

The possibility of tax increases, either in 2014/15 or 2015/16, cannot be discounted. In this regard the following predictions may be relevant:
Taxation exposure can be contained at the current maximum marginal rate of tax of 40%. This could increase in the 2015 tax year.

  • The critical point remains that South Africa has three major taxes: Corporate Income Tax, VAT and Personal Income Tax which make up more than 80% of total tax collections. If there is a problem with any one of the Big 3, the remaining smaller taxes can’t make up the difference.
  • Many commentators suggest the solution to South Africa’s tax shortage would be to increase the VAT rate from 14% to 17,5%. There is merit to this argument as South Africa has a comparatively low rate by international standards (17,5%−20%.) However, this argument is perhaps academic as an increase in the VAT rate is not a politically palatable prospect for most South Africans.
  • The corporate tax rate can’t be increased. Not only are companies under extreme pressure, South Africa’s reliance on corporate tax collections is already far too high by international standards.
    The recent weakening in exchange rates has placed fuel prices under severe pressure. This leaves little room to increase the fuel levy.
  • The implementation of carbon emission tax by 1 January 2015 seems to be an ambitious target, with many questions regarding legislation still to be answered.
  • Sin tax collections have been severely dented by the contraband cigarette fiasco.

Therefore, if there is to be a tax increase this year or next it will have to fall on the individual taxpayer. This could take the form of the introduction of a new super-tax marginal rate of 42−45% or a reduced level of fiscal drag adjustment for the lower-income taxpayer.

The vulnerable rand

South Africa’s financial woes have led to a substantial decline in exchange rates throughout the past year. Some say worse is on the way; others say uncertainty is already priced into the markets. Significantly, very few people are predicting a recovery of the rand.

Although the JSE indices performed well in rand terms during 2013, the indices actually declined when measured in foreign currency. This trend could well continue with the uncertainties that lie ahead.

Conclusion

Even if an investment portfolio is keeping abreast of the JSE (net of costs), the investor is still losing ground against major currencies and, in particular, energy prices.

Suggestion 1 – Rand hedge

There is no time like the present to review any investment portfolio to ensure it is appropriately positioned to cater for the inherent risk of the rand.

Suggestion 2 – Retirement fund portfolios

With effect from 1 March 2015 ‘capping’ will come into effect for all tax-deductible contributions to retirement funds. For the lower-level income taxpayer, the overall level of tax-deductible contribution will increase to 27,5% of taxable income. But taxpayers with income exceeding R1,27 million per annum will potentially be ‘capped’ by an overall tax-deductible contributions ceiling of R350 000 per annum.

In spite of this, retirement funds remain the only prospect of achieving tax-deductible contributions and a tax exemption on future growth within the fund. Then comes the final bonus that death proceeds from retirement funds are exempt from estate duty. These factors are essential components that must be built into a financial plan if there is to be any prospect of achieving real long-term growth.

Suggestion 3 – A last chance at bullet premium retirement annuity fund contributions

The high-income taxpayer has a last opportunity to make a contribution of 15% of non-retirement funding income before 28 February 2014.

Most relevant are the cases of employees with substantial accumulated share options in their employer companies. Many refrain from exercising these options due to their taxation at full revenue rates in terms of Section 8C of the Income Tax Act.

However, the employee who exercises share options prior to 28 February 2014 stands to benefit in the following ways:

  • 15% of the taxable income created through the exercising of share options can be contributed, tax-deductible, to a retirement annuity fund to unlimited extent. This reduces the maximum overall tax exposure from 40% to 34%. This benefit won’t be available to the high-income taxpayer from 1 March 2015.
  • The proceeds from the share option can be reinvested to take account of the vulnerability of the rand. This can’t necessarily be achieved where share options remain in the employer company only.
  • The portion invested in the retirement annuity fund will immediately become exempt from estate duty and Capital Gains Tax on death.

Suggestion 4 – Geared retirement annuity fund contributions − the tax aggressive strategy to retirement planning

Many South Africans have grown accustomed to the convenience of ‘saving’ by making advance payments on their home loan facilities. This habit developed in times when interest rates ranged between 15 and 23%. Therefore, the risk-free return on advance home loan payments could not be beaten.

Today, however, home loan rates range between 7 and 9%. Simply put, the long-term prospects of equity returns exceed the home loan interest rate.

Added to this is the tax deduction inherent to a retirement annuity fund contribution that is not available on a home loan repayment.

Logically, it makes sense to withdraw a portion of the advance payment of a home loan and make an additional tax-deductible contribution to a retirement annuity.

There is a downside to the above suggestion. The retirement annuity fund can’t be withdrawn until the investor reaches 55. Therefore, the investor has to be extremely careful not to over-extend this practice.

Suggestion 5 – Actively monitor a portfolio

In uncertain times it is most important to actively monitor a portfolio so it can be repositioned to take account of new developments. Gone are the days of a casual annual review. More attention is needed from both investor and financial adviser.

This article originally appeared in A new way to look at financial planning in 2014 in glacier by Sanlam, The {Inside} Story


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