The basic philosophy of investment and retirement, and estate planning: 2013

Matthew Lester discusses National Treasury’s outlook for South Africa and a basic philosophy to deal with challenges facing investment, retirement and estate planning.

Investment strategy

Latest indications are that National Treasury has accepted that the individual’s income tax burden cannot be increased any further. In short, there are only about 63 000 South Africans earning over R1 million per annum and they are already scheduled to pay R96 billion of the R306 billion budgeted individual tax collections. Increasing the super-tax rate above 40% will achieve very little.

Individual taxpayers only pay about R3 billion per annum in Capital Gains Tax (CGT). Thus increasing CGT rates will also not solve South Africa’s problems.
Dividend Tax has been introduced with effect from 1 April 2012 at 15%. This is an international benchmark that National Treasury would be reluctant to disturb.

Unless there is a radical change in National Treasury’s policy it would seem that personal tax rates would remain unchanged in the foreseeable future. If more tax is needed it will have to come from new forms of taxation such as Carbon Emission Tax.

The result is that, from an investment perspective, the individual’s tax profile remains king, in particular:

  • The individual enjoys the lowest rate of CGT at 13,3% – compared with 26,66% for trusts and 30% for companies (dividends tax included).
  • Current dividend yields, even after allowing for dividend tax at 15%, are very similar to after tax interest yields for high net worth South Africans.
  • Small concessions remain in the form of annual tax-free interest and CGT allowances.
  • Where the individual’s taxable income exceeds R300 000 per annum, taxation can be contained through the use of endowment policies (maximum inherent tax rate 30%).

Grappling with family trusts and investment holding companies, from an income tax perspective, seems to be a challenge from our past. However, estate duty considerations must still be considered.

Retirement Planning

During 2012 National Treasury released a series of discussion papers addressing concerns within the retirement planning industry. Many of these concerns address the enormous numbers of employed South Africans who have no retirement plans at all.

The principle concern relevant to existing retirement plans is the ease with which South Africans can withdraw their existing retirement savings even if they incur substantial taxation in doing so.

In particular National Treasury has expressed extreme concern at the maximum annual withdrawal ceiling for living annuities of 17,5% per annum. It can be expected that this limit will be reconsidered within the medium term.

On a more positive note, it would seem that there would be no draconian change to the tax deductions granted on contributions to retirement funds. In fact, for many South Africans, the contribution levels ranking for tax deduction will be increased.

With effect from 2015 the maximum tax-deductible employer contribution will be increased from 20% to 27,5%. And the overall ceiling for contributions will be set at R350 000 per annum, regardless of the taxpayer’s age.

There are no plans to disturb either the complete tax-exempt status of retirement funds or the estate duty exemption applicable to death benefits paid by retirement funds.

All of the above is encouraging progress. Retirement funds remain the only legitimate means of investing pre-tax income in a tax-free growth environment. This allows the investor an enormous benefit over the many years it takes to accumulate an adequate retirement fund portfolio.

Estate planning

Estate duty and donations tax continue to yield very little for National Treasury. However, the stark reality remains that political considerations are such that there is very little prospect of their repeal.

Most South Africans have little exposure to either tax:

  • The unlimited donations tax exemption granted in respect of the reasonable maintenance of the taxpayer’s family is generally sufficient to cover most circumstances.
  • The unlimited inter-spouse exemptions and rollovers granted in respect of donations tax, estate duty and CGT allow the family to delay the taxes until the death of both spouses.
  • On death each spouse then receives the R3,5 million estate duty abatement. If a spouse does not utilise the allowance, it is then transferred to the surviving spouse, thus ensuring that each family receives a R7 million estate duty abatement. In most instances this is sufficient to protect families from estate duty.

The active management of an estate plan is generally all that is required to manage estate duty exposure.

However the above does not cover: 

  • Premature death where taxpayers have not lived long enough to dissipate the estate.
  • Single taxpayers who cannot make use of the inter-spouse concessions.
  • Ultra high net worth individuals who have no prospect of dissipating their assets within their lifetime.

In spite of the imminent assault on the income tax benefits available through trusts, the estate duty advantages remain intact.

Other considerations:

Interest and exchange rates

National Treasury considerations cannot be viewed in isolation. The impact of an increasing national deficit and the decline in the balance of payments current account affects all South Africans, particularly as there seems to be reluctance on the part of the Reserve Bank to increase interest rates. This leaves the rand extremely vulnerable against the general basket of currencies and inflation.

Other taxes

National Treasury now seeks to implement other forms of taxation, mostly taxes on consumption. The introduction of Carbon Emission Tax from 1 January 2015 is of particular concern as it has the potential to become the fourth largest form of tax in South Africa.

Taxpayers concentrate on income tax and estate duty matters while doing very little to curb their expenditure, thereby incurring VAT, Sin tax, fuel and electricity levies.

Financial Planning Philosophy

1. The flight to equities

The partial taxation of investment returns from equity growth, CGT, is far preferable to the receipt of fully taxable interest. The limited earnings of interest should be sheltered from tax by the annual savings exemptions and the potential introduction of the tax preferred savings accounts scheduled for implementation from 2014.

South Africans have to accept that it is virtually impossible to build a financial plan based on prevailing interest rates that are currently below the inflation rate.

The danger is that throughout the world investors are flocking towards equity markets, thereby driving markets to record levels even though we have far from recovered from the aftershocks of the global credit crunch. Thus the prospect of substantial market adjustments cannot be discounted. Professional management of portfolios is thus essential to manage the downside risk.

2. The individual taxpayer is king

Personal financial planning is no longer a process of establishing a family trust or investment holding company. This could lead to paying higher taxes and is extremely expensive to administer.

For most South Africans, the tax considerations of investment strategy is a process of maximising the annual tax allowances offered to the individual and thereafter causing income to accrue as a partially taxable capital gain.

Insurance policies remain an attractive prospect for taxpayers with a marginal rate of tax exceeding 30 percent.

3. Retirement funds

If a tax deduction and tax-free environment is available, use it!

But work on the assumption that the investment will be tied up until retirement. Tax-free lump sum benefits thresholds are unlikely to be increased.

South Africans need to separate their investments between what can be locked away until retirement age (currently 55) and what needs to remain accessible prior to retirement.

4. Estate planning

South Africans who are not affected by the HIV/AIDS pandemic have an increased life expectancy and will probably dissipate their savings during the retirement years of both husband and wife. Thus the management of estate duty exposure can be achieved through a properly considered last will and testament.

However, ultra high net worth or single individuals who cannot spend their wealth in a lifetime are the exception. Trusts remain the answer for the management of estate duty, even if the income tax benefits of trusts may be curtailed by 2014.

Recognise that the biggest estate duty exposure is a premature death and consider that life insurance may be necessary to protect an estate in such event.

5. How we live

The more you spend the more tax you will pay!

For as long as retirement savings remain within the retirement fund they will enjoy a tax-free status.

The withdrawal of benefits from a retirement fund not only attracts taxation, but also attracts further taxation when spent. Thus, integral to a retirement plan is a living plan that allows the investor to contain living expenses while wealth continues to grow within the tax sanctuary of a retirement fund.

This article originally appeared in The basic philosophy of investment and retirement, and estate planning: 2013 in glacier by Sanlam, The {Inside} Story


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