The tax implications of 3 popular investment vehicles

Renowned author Mark Twain once quipped, "What's the difference between a taxidermist and a tax collector? The taxidermist takes only your skin."

Witticisms aside, investing wisely is serious business, and knowing which investment choices are more tax-efficient than others could profit you well.

Your ultimate investment choice should take into account various factors such as your reason for investing, the timeline of the investment and your risk profile. Here's a short guide to the tax implications of three investment vehicles: retirement funds, endowment policies and unit trust funds.

1. Retirement funds – retirement annuities, pension funds and provident funds

Tax-deductible contributions to retirement funds are capped at 27.5% of taxable income or a rand amount of R350 000 per year, whichever is the lower. When you retire, you'll receive two thirds of the retirement interest of your pension, pension preservation or retirement annuity, in the form of a regular pension or annuity amount.

• If the income from the annuity exceeds the tax threshold, you're then liable for tax on that amount. The tax thresholds for the period from 1 March 2018 to 28 February 2019 are as follows:
  • If you are under 65, you don’t pay tax on the first R78 150 earned per year.
  • If you are between the ages of 65 and 75, you don’t pay tax on the first R121 000 earned per year.
  • If you are 75 and older, you don’t pay tax on the first R135 300 earned per year.

The remaining one third of the retirement interest that is paid out to you on retirement is subject to a lump sum tax as follows:

Source: South African Revenue Services (SARS), 2019 tax year (1 March 2018 - 28 February 2019)

Remember that while retirement funds are earning investment returns, that is,. in the period between when you take out the investment and when you retire, you do not pay income tax, capital gains tax or dividends withholding tax on any of these investment returns.

2. Endowment policies

If you take out an endowment policy, you'll receive the benefit on maturity as an after-tax amount. This is because during the term of the investment, the life assurance company pays tax in the portfolio at a rate of 30% for interest, 30% for all rental income (from property investments) and capital gains tax (CGT) at a rate of 12%.

This effectively means that an endowment policy makes the most sense if your marginal tax rate is higher than 31% – provided that you've already used your annual tax-free interest exemption of R23 800 for taxpayers under the age of 65 and R34 500 for taxpayers over the age of 65.

You also need to take into account your CGT rebate of R40 000 a year. Finally, one of the more attractive benefits of an endowment policy is that if you choose to nominate a beneficiary, you won't have to pay executors' fees on the proceeds of the endowment policy.

3. Unit trust funds

When you invest in a unit trust fund, you become liable for tax on the income generated from the investment at your marginal rate of tax. Other taxes you may need to consider include dividend withholding tax and capital gains tax (CGT).

If you dispose of underlying shares in the investment, or even if you transfer your investment between different funds, you may also be liable for CGT. A net capital gain for the current year of assessment is multiplied by the inclusion rate applicable for you to arrive at the taxable capital gain.

For example, let's say you invest R500 000 in a unit trust fund over a five year period. The tax implications are as follows:

• There is an exemption on the first R23 800 of interest earned.
• There is a withholding tax of 20% on dividends earned – this is usually paid by the investment company on your behalf.

When you sell out of the unit trust fund, you won't need to pay any CGT on the first R40 000 worth of gains (the difference between the amount you sell for and the original investment value of R500 000). The inclusion rate for individuals for 2017/2018 is 40%.

Consult with your financial adviser to determine exactly which products within these three investment vehicles are best suited to you. You can also find tips on how to invest in a low growth environment here and the best ways to achieve portfolio diversification here.

This article is meant for information purposes only and should not be taken as financial advice. For tailored financial advice, please contact your financial adviser. Discovery Life Investment Services Pty (Ltd): Registration number 2007/005969/07, branded as Discovery Invest, is an authorised financial services provider.