Wanna invest tax-free? Here’s how you can do it like a pro

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Nonhlanhla Kunene | 07 February, 2017

The tax year-end is around the corner, bringing with it familiar calls from tax-free savings providers urging investors to maximise their investments and meet their R30,000 annual limit.

From 1 March, a new cycle begins and investors are faced with that all-important decision about where to stash their hard-earned savings in the 2017 tax-free cycle. Will you be keeping your cash account? Are you going to be leaving it to the pros this time with a unit trust investment, or finally indulge your appetite for risk and go all out with an aggressive investment on the stock exchange?

The possibilities are almost endless and given the volatile economic times, making good financial decisions is a tricky endeavour. At savetaxfree.co.za we’re all about making your life easier and to reduce the stress of your decision-making process, we’ve engaged a few experts on the tax-free front to find out how you can play your cards right in 2017?

Considering the challenging economic climate and given the limited investment options available to tax-free investors, what would be most ideal strategy for investors in the 2017 cycle?

Peter Hugo, MD at Prudential Investment Managers, says the “best” strategy for 2017 would be one where tax-free products are fitted within a long-term investment plan.

To be more specific, he says Prudential has gone into the first quarter overweight on SA bonds, SA equity and SA listed property in its multi-asset class portfolios. “These are attractive relative to their long-term history and offer the best chance of outperformance over the medium term.”

Prudential remains neutral on offshore equity and underweight in offshore sovereign bonds, SA inflation-linked bonds and SA cash. Hugo says these are trading at expensive levels compared with their long-term history.

ETF strategist and advisor at ETFSA, Nerina Visser, says for her, the rule of thumb is for investors not to use their accounts for short-term goals. “I don’t particularly agree with the way tax-free savings are advertised as a vehicle to for short-term savings that one can deposit and withdraw at any time. Tax-free savings should not be viewed as vehicle for “parking cash” for children’s education, vacations or other such short-term goals.”

Building real capital takes time, which is why Visser believes investors should ideally have a 10 year investment horizon. She suggests that investors take a more long-term approach with their tax-free investments in order to maximise and realise the full benefits of the interest, dividends and capital gains they’d be accruing tax-free.

When it comes to strategy, Visser says property remains an attractive option. “If I had to pick one stock, I would go for property. Not only for its good yields, but for it potential for capital gains.”

For greater diversification, however, Visser suggests a balanced fund, holding a broad range of assets classes to minimise risk and maximise potential for income and capital growth.

Gareth van der Merwe, private wealth manager at Resolute Wealth concurs, adding that although tax-free savings are liquid investment vehicles, they should rather be viewed as long-term retirement products. He recommends that investors diversify their portfolios by investing in three to five different funds to ensure they don’t have all of their eggs in one basket.

“In terms of which asset classes to invest in, as the tax-free savings account should be seen as a long-term investment, we recommend a high weighting towards equities, both local and foreign, up to 35% each. The remainder should consist of property, up to 15%, and the remaining 15% to be split across the remaining asset classes of cash and bonds to ensure a bit of stability within the portfolio.”

What factors should investors take into consideration when deciding on the most appropriate investment vehicle?

Before investing in any particular investment, Van der Merwe feels investors should consider the following key factors:

• Time frame: Consider the various options available for the different investment terms. For example, if you have a short-time horizon, ensure you do not lock in your money by investing in a retirement or endowment product.

• Access to funds: If you will need access to the funds in the short term, a unit trust is for you, which includes a tax-free savings account. As mentioned above, endowments and retirement annuities have an initial investment term before you would be able to access the funds, which therefore would not be an option.

• Tax benefits: If you want to reduce taxes, consider these options:

• A retirement annuity where all contributions up to 27.5% of your salary are tax deductible, up to a maximum of R350,000 per year. No tax is payable on the first R500,000 from age 55 and no capital gains tax is payable.

• An endowment policy is taxed at a flat rate of 30% within the product as opposed to taxed at your personal income tax rate. If your personal tax rate is higher than 30% and you do not need access to your funds for five years, this could be an option for you.

• A tax-free savings account where no tax is payable, as long as you adhere to the maximum annual and lifetime contributions.

For Hugo, the key to maximising investment benefits is through combining tax-free investments with other vehicles and allowances as part of a holistic, long-term investment plan. He says investors should choose long-term growth investments with inflation-beating returns and remember to invest for their families. He believes doing so can optimise your family’s overall investment portfolios quite substantially, and that the tax savings together with an optimal investment strategy could have a significantly positive impact on your long-term returns.

“For those who are concerned that the R30,000 limit per individual per year is a relatively small amount of capital on which to save tax, they should remember that children can also contribute up to the annual limit. A family of four could therefore be contributing R120,000 every year, subject to a collective lifetime limit of R2m, a substantial sum of money to invest tax-free in anyone’s book.”

Below, Hugo gives an illustration of how a tax-free investment could best be used alongside other vehicles as part of a long-term investment plan, considering a typical family of four:

• Both parents could invest up to 27.5% of their taxable income in their company retirement funds, up to a maximum R350,000 each annually.
• The family could then invest up to 4 x R33,000 annually in tax-free savings vehicles. With no retirement investment restrictions (dictated by Regulation 28), they can hold more than 25% in offshore assets or listed property, and more than 75% in equities. This flexibility could effectively counterbalance the Regulation 28 limitations imposed on retirement annuities if the family requires it as part of their long-term strategy – for example, they may need more exposure to equities or offshore assets. Also remember that they can access these funds at any time.
• The family could invest any additional savings in unit trusts in their own names, and by using their combined annual interest and CGT exemptions, this could result in another substantial amount invested effectively tax-free. For example, they could each invest up to about R1.6m in the Prudential Balanced Fund and pay no taxes on their earnings by using their exemptions. Again, no investment or liquidity restrictions apply on these investments.
• Finally, if the family’s marginal tax rate is over 30%, they can consider investing in an endowment policy.

Offering a somewhat diverse perspective, Visser believes that before investors take the leap, they should consider what investment vehicle would be most beneficial, taking into account various factors, including their current tax bracket.

“This takes us back to the age old RA vs tax-free debate. There’s no doubt that retirement annuities come with numerous benefits, including tax break and the fact that they’re protected from creditors. However, these benefits are most geared towards high net worth individuals, falling in a higher tax bracket. For people earning below a certain threshold, a tax-free savings account may actually be a more viable vehicle for retirement saving, when considering how income earned from interest and capital gains over the years will not be subject to taxation, based on your tax bracket.”