Tax

The quest for the highest after-tax returns

Income tax on your interest and earnings

What’s become more and more apparent as National Treasury takes the idea of the progressive income tax system to greater depths, is that tax is a considerable driving force behind lagging investment returns.

So it’s not surprising everyone is trying to optimize their investment portfolio or assets to provide for the highest after-tax return possible. So without further ado – we present your options.

Interest income

Current money-market yields are about 7.5% on a money market unit trust. Interest income is subject to tax at your marginal rate, which simply means that it is taxed in accordance with the tax tables. Some relief can be found through the annual interest exemption which is R23, 800. This amount used to increase every year to take into account the fact that inflation is a real fish moth in your investment cupboard.

National Treasury have paused this, with 2018’s relief being the same as 2017. We think National Treasury are trying to encourage people to take out a Tax Free Savings Account and keep cash balances in there rather.

Interest is still not a bad gig, when you consider that a husband and wife team could between them, hold about R635, 000 in cash and not pay a cent in tax.

If your marginal rate of tax was 30%, and you had earned more than your R23, 800 annual exemption, you’d be achieving an effective 5.25% after-tax return (7.5% x 70%).

Unlike shares and property, cash offers no opportunity for capital growth, because one Rand will always be worth, well…one Rand.

Dividends on shares

Dividend income was up until recently taxed at 15% through a Dividend Tax. This meant that before the company paid you a dividend, they would have to hold back 15%. This amount has as per the 2017/2018 Budget, gone up to 20%.

In order for a company to pay you a dividend it would first need to pay corporate income tax at 28% on its profits, after which you’d get your dividend return.

If a company earns R100 taxable income, pays tax of R28, R72 would then be available as a dividend. The full 72 could be declared as a dividend to you and you’d get a net 57.6. The effective cost of getting the dividend in your hands was 42.4% (100 – 57.6).

Notice how this effective cost of 42.4% is quite close to the top marginal rate of tax for a person earning a salary (45%). This is not a coincidence. National Treasury have tried to maintain a level of parity between various income streams so that one of those streams is not exploited because it’s significantly cheaper than others.

An approximate dividend yield on the JSE All Share Index is 2.9% as of today. This means that for a R100, 000 invested, you would get a dividend of R2, 900. Deduct from this Dividend Tax and you’re left with R2, 320, or an-after tax yield of 2.32%.

Yes, this is much lower than interest, but remember that owning a share brings with it the promise of a capital gain!


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Rental Income

Like interest income, rental income is taxed at your marginal rate of tax. You would generally get a deduction against your rental income for all costs associated with earning that rental income, eg: agent fees, repairs and maintenance, interest on a bond.

Unlike interest, there is no annual exemption.

If you acquired a buy-to-let flat for R1 million, let’s for arguments sake say that you earn a net rental yield of 6.5%. Net of all costs that is.

This is then taxed at your assumed marginal tax rate of 30% and you’re left with an after-tax yield of 4.55% (6.5% x 70%).

Again, this is lower than interest, but rental income too, offers the lure of a capital gain upon an eventual sale.

Unit Trusts

Tax on unit trusts returns hinge off the nature of the income that you’re receiving from the unit trust. Some unit trusts pay interest and dividends, in which case the treatment as outlined above will be applicable. We have also written an article on tax on Unit Trusts.

Conclusion

Personal finance is not as simple as finding the highest after-tax return for your money, as everyone’s needs will be different. Some folk may need the possibility for capital gains over the long term, whereas some people are completely risk averse and can’t stomach a loss. For them, a steady and safe ‘high’ after-tax income stream is worth giving up the possibility of a gain.

It doesn’t hurt though to know what to expect if you found yourself on the happy end of some investment income! Happy investing.

We’ve written quite a few other great pieces on how tax affects your various investments and retirement outcomes – here they are:

The Editors

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