Tax Considerations When Investing

How investment returns are taxed — and why after-tax performance, not gross returns, should guide your investment decisions.

It is important to take the tax consequences of investment returns into account when deciding which investment product to use. In a previous edition, we explained the difference between voluntary and compulsory investments. One of the most attractive aspects of compulsory investments — retirement products such as retirement annuities, pension funds and provident funds — is that all investment returns are tax-free while the funds remain invested. This includes both income returns and capital growth. Tax is generally only payable when benefits are eventually paid out, either as a lump sum or as a pension income.

Taxation of Voluntary Investments

In the voluntary investment space, returns may be taxed either as income or as capital gains, depending on the nature of the return.

Interest Income

For individuals younger than 65 years, interest income exceeding the annual exemption of R23 800 is taxable at the individual's marginal tax rate.

For individuals aged 65 years and older, the annual exemption increases to R34 500. Interest earned above this amount is taxable at the individual's marginal tax rate.

Dividend Income

South African companies are required to withhold Dividend Withholding Tax (currently 20%) before dividends are paid to investors. In most cases, this tax is a final tax and no further tax is payable by the investor.

Rental Income

Net rental income, after deducting allowable expenses, is taxable at the taxpayer's marginal tax rate.

Capital Gains Tax (CGT)

Natural persons enjoy an annual capital gains exclusion of R50 000. This exclusion is applied to the aggregate capital gains realised during a tax year.

When a primary residence is sold, a special exclusion applies. From the 2027 tax year, the first R3 million of the capital gain on a qualifying primary residence is excluded from CGT.

For individuals, the current capital gains inclusion rate is 40%. This means that only 40% of the net capital gain, after applying the relevant exclusions, is included in taxable income and taxed at the individual's marginal tax rate.

Endowment Policies

For individuals whose effective tax rate exceeds 30%, an endowment policy may be an attractive investment vehicle. Within an endowment policy, investment returns are taxed at a flat rate of 30% on income and 12% on capital gains (based on the life company's tax calculations), which can result in a lower overall tax burden for higher-income investors.

Conclusion

When developing an investment plan, it is important to compare investment options based on their after-tax returns rather than their gross returns. By considering both investment performance and the associated tax consequences, investors can select the most appropriate structure to achieve their long-term financial objectives.