Many investors often ask what is the most efficient way for them to save? It is a good question and one well worth asking. Over the years people have placed their life savings in a variety of investment structures and/or policies. Diligently investing on a monthly basis only to be left absolutely disappointed and disenchanted when their investment finally matures.
There are two main components to any investment, the underlying securities or instruments that make up the portfolio and the investment structure which houses the investment.
In today’s world of new generation investment structures, the underlying securities that make up the investment can range from a personalized direct share portfolio to unit trust funds, exchange traded funds or a combination thereof. The transparent nature of investments today means that within reason, any type of underlying investment can be held within any structure.
The investor should take care to ensure that the underlying securities in which one is invested:
- Is aligned to the desired objective,
- Is fairly priced, and
- The asset allocation is appropriate to the risk profile.
However, the structure within which an investment is housed can make a material difference to performance. In South Africa, the most efficient way to invest is via a retirement funding vehicle. This would include either a retirement annuity, pension, or provident fund. The main reason behind this assumption is the tax savings or subsidies that can be obtained by making contributions to these structures. Contributions to these structures, under very generous criteria, are subsidized by tax savings to a maximum rate of 45%. That means that if R1,000 is invested into a retirement annuity fund, the actual cost to the investor will only be R550, (assuming one is one the max marginal tax rate) the balance being a saving on taxes that would otherwise have been paid.
Within a retirement funding structure, the underlying investment portfolio is not subject to income tax, dividend withholding tax or capital gains tax being levied. This effectively means that the investment is free to grow without the liability of any tax consequences. Income tax in South Africa is levied at a maximum rate of 45%. In addition, 40% of all realized capital gains of a person’s investment portfolio are also added to taxable income and taxed at the appropriate rate. Dividend withholding tax is currently levied at 20%. These onerous taxes are totally avoided within a retirement funding structure and over time this tax free factor greatly increases the overall investment return.
But, there are two sides to every coin. The main downside of investing in a retirement funding structure is liquidity. The rules around when an investor can realize these investments are rather complex. The overall rationale is that these are long term savings that are intended to fund one’s retirement and there are prohibitions and/or penalties on early exit before the age of 55.
The maximum annual contribution one can make to a retirement funding structure is 27% of your taxable income or R350,000, whichever is the lowest! This is calculated over a tax year, which in South Africa ends on 28 February each year.
It is vitally important to get professional advice in order to get the best out of your retirement savings. Make an appointment with any of us at Activ8, before the end of February, and we would be more than happy to advise you;
- What opportunities there are for you to exploit,
- What investment portfolio will maximize your returns, and
- What amounts qualify for a contribution tax break?
It is also important to review existing structures and decide whether or not they are still optimal or relevant.
