How to cut hefty taxes on share options

Many directors and senior employees accumulate much of their wealth in unexercised share options in their employer companies.

They are reluctant to exercise these options as the gains are fully taxable, mostly at the 40% maximum marginal rate.

If the worst comes in the budget speech on February 26, we could even see an increase in the maximum marginal tax rate above 40%. The implications of increasing the VAT and corporate tax rate are so severe they just cannot be considered. Other taxes are too small to patch up the national deficit.

Despite the JSE’s gains of the past 18 months, the downside exposure created by gloomy growth rate forecasts and looming elections cannot be ignored. And even if the JSE does continue to perform, this must be tempered by the effects of a declining rand.

If share options are exercised in the 2014 year of assessment, 15% of the gain can be contributed to a retirement annuity fund tax-deductible. This reduces the effective maximum marginal tax rate from 40% to 34%. From the 2015 year of assessment, total tax-deductible retirement fund contributions will be capped at R350 000 a year. So February 2014 is the last big chance to flip a portion of one’s share options into a RAF.

The cash after-tax proceeds of the share options and the RAF contribution can then be placed in a diversified portfolio that hopefully anticipates JSE and exchange-rate volatility.

Unexercised share options accumulate both income-tax and estate-duty exposure. The modern RAF controls both.

The cost structures, if you shop around, are a fraction of what they used to be. And the living annuity principle can leave the actuary and life expectancy out of the picture.

Perhaps wealth creation is not so much about how much you made in good times, but rather, how much you didn’t lose in bad times. Thus, diversifying investment portfolios against obvious risk is essential. Holding onto a stash of share options in one company simply does not achieve that.

Donations in lieu of this free advice can be made to any SPCA office. Better still, adopt a mutt and name it RAF.

Originally published in the Sunday Times: Money & Careers Tax Talk column.

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