Fin24 user Robert Benbow-Hebbert writes:
In a situation where interest on savings is taxed at a potentially high rate and interest rates available to savers are negative in real terms, saving is pure folly. If I earn a very generous 7% on money saved and am taxed at 40%, I get a net 4.2% after tax. With inflation at 6% [now 6.3% after South African Reserve Bank (Sarb) governor Gill Marcus's repo rate announcement] I will have my savings eroded by 1.8% over a year. Most savers get no more than 5.5% a year so they start off losing 0.5% before tax and after tax get a net minus 6%. Tax policy should exempt interest receipts at a much higher level than at present.
Andrew Duvenage from NFB Financial Services Group responds:
You are absolutely correct in your analysis of the current interest rate environment. One thing that must be kept in mind is that an individual under 65 is entitled to an interest exemption of R23 800, whilst those over the age of 65 enjoy a R34 500 exemption. Relating this to your example of a 40% tax payer and a 7% yield, that would make the investment threshold at which interest tax is neutral R340 000 for individuals younger 65 and R492 000 for those older than 65. Any interest generated on amounts in excess of these levels would be taxed at the individual’s marginal tax rate, thereby resulting in a net 4.2% for the 40% marginal tax payer.
This, as you pointed out, results in a negative real return of 1.8% annually (in the case of the 5.5% yield my calculations result in a net real return of -2.7%.) This has led investors to search for a tax efficient yield elsewhere and often results in a cautious investor having to take on additional risk to achieve positive net real returns.
Without assessing the current tax policy in too much depth, in a depressed economy where economic growth continues to stagnate, Economics 101 tells us that in order to drive growth you need to increase aggregate demand. This is achieved through numerous monetary and fiscal policy measures, with two of particular interest to your query being interest rates and taxes. We know that when the government is trying to stimulate economic growth they typically look for investors to save less and spend more, which makes favourable taxation on interest rates a counterproductive exercise.
This must be examined in conjunction with another economic driver you alluded to, that of inflation. South Africa is currently in a position whereby interest rates have to be increased in order to curb inflation, which again is in contrast to theory telling us to reduce rates to stimulate growth. This coupled with the fact that our net social security spend is not being serviced leads us to believe that taxes will have to increase rather than decrease in the future. We, therefore, cannot see a favourable change in the taxation on interest.
In fact, the treasury has indicated that from March 2015 the introduction of a new tax friendly discretionary savings vehicle will result in the interest exemptions remaining unadjusted for inflation, thereby making them redundant in the future.
This new product will be limited to annual contributions of R30 000 and a lifetime limit of R500 000, adjusting with inflation, and will attract zero taxes on capital gains; interest and dividends, similar to the tax treatment of retirement products.
We would therefore ask “savers” to re-examine their goals and needs to see if it is possible to adjust their tolerance for risk and rather become “investors”. It is possible to achieve positive net real returns in portfolios that actively manage their exposure to a number of asset classes, including cash; bonds; property and equity in such a way so as to limit volatility as much as possible. One such a solution would be cautiously managed unit trusts. While these portfolios will still have a large portion of the return in the form of interest, taxation on dividends and capital gains on the equity component are more favourable. We can reasonably expect positive real returns in the long run, albeit with a slight added level of short-term volatility.
To summarise, the reality is that in the current environment in order to achieve positive real after tax returns one needs to take a level of investment risk. While there may be products out in the market advertising incredible returns with no risk, it is highly unlikely if not impossible that this is the case, otherwise all the clever money would be flowing in immediately. It would be in your best interest to consult a professional independent financial advisor to assist you with your investment options.