In the last of our series on the recent Old Mutual/Personal Finance Retire Right seminars, Jenny Gordon, a senior legal analyst at Old Mutual, describes how tax can affect your retirement plans and how you should take tax into account when choosing investment vehicles.
Capital Gains Tax (CGT) and residence-based tax (or income tax) affect all vehicles used to save for retirement, Jenny Gordon says.
Retirement Funds
- Currently there is a moratorium of three years on CGT for retirement funds. But, in terms of residence-based tax, funds pay tax on all net rentals, interest and dividends earned from foreign sources.
- Any capital gains you make from other investments in the year of your retirement will not be used to increase your average rate of taxation that applies to any lump-sum benefits you receive at retirement.
Normally, 25 percent of any capital gain you make is added to your taxable income for that year, increasing the tax payable at your marginal rate of taxation. Unfortunately, the tax deduction applicable to retirement annuity fund contributions cannot be based on capital gains made in any particular year.
- Foreign pensions are not taxable for three years from January 2001.
Assurance Policies
Gordon says it is difficult to quantify the full effect of CGT on investments made through assurance policies because it depends on the underlying asset mix of the portfolio.
There are also differences between domestic policies and policies bought with your once-off R750 000 foreign investment allowance.
Domestic policies
In the build-up of the funds invested in local assets and/or offshore asset swaps in the individual policyholder fund, any capital gains are subject to an effective rate of 7.5 percent CGT. Interest and net rental income as well as certain foreign dividends are subject to income tax at the rate of 30 percent in the hands of the life assurance company.
When you dispose (sell or cede) of a policy, you do not pay CGT if:
- You are the original beneficial owner;
- You are the spouse, nominee or dependant of the original beneficial owner, and no consideration is paid for cession;
- You are the former spouse, if the policy was ceded on divorce or similar event;
- The policy was originally taken out on the life of an employee or director. For example, a deferred compensation policy;
- It is a policy ceded from a retirement fund; or
- The policy is on the life of a partner or co-shareholders to buy out a partnership interest or shares of a business on death.
Offshore policies bought with R750 000 allowance
Gordon says there are two types of offshore policies: those sold by a company which is licensed and has its head office in South Africa, and policies sold by foreign life assurers without a head office in South Africa.
- Policies sold by local companies: Gordon says these policies are taxed in the same way as domestic policies with tax-free maturity benefits.
- Policies sold by foreign companies: Gordon says CGT is payable on disposal at maturity on all gains. The highest effective rate of CGT payable by an individual is 10 percent.
Local Unit Trusts
In the hands of the fund, no income tax or CGT is paid on your behalf. However, you pay income tax on interest and foreign dividends distributed by the fund at your marginal rate of tax (taking into account the R6 000 and R10 000 interest exemptions). You can only claim an exemption of R1 000 on interest and dividends earned from foreign sources. On disposal of the unit trust, you are subject to CGT.
Offshore Unit Trusts
Gordon says offshore unit trust funds fall into different categories.
- Roll-up funds. There may be taxes in the jurisdiction where the fund is registered. The after-tax income is re-invested and rolled up, increasing the price per unit instead of purchasing additional units. No amount is declared as a distribution, so it is difficult to see an accrual for tax purposes during the roll-up period. On disposal of the unit trusts, CGT is payable.
- Distribution funds. This would include money market funds which distribute interest which is subject to income tax with only R1 000 being tax free. Foreign unit trusts, including money market funds, are classified as "foreign equity instruments" and any currency capital gains made are also taxable under CGT legislation.
- Open-ended investment companies. You effectively own shares on which you will pay income tax on any net dividends and CGT on sale of shares. Shares are classified as "foreign equity instruments" and currency gains on capital will be subject to CGT.
Shares
On shares in local companies, your dividends are tax free, but you are liable for CGT on disposal of the shares. On foreign shares, your net dividends are taxed at your marginal rate subject to the R1 000 exemption. You are liable for CGT on disposal of the shares. Shares are "foreign equity instruments" and currency gains on capital are subject to CGT.
Fixed-Interest Investments
On local fixed deposits, money market funds and bonds, you pay income tax at your marginal rate and no CGT is payable. Interest exemptions apply.
On offshore fixed-interest investments made with your R750 000 allowance, you will pay income tax. The first R1 000 is free of income tax.
CGT does not yet apply on foreign currency gains.
Immovable Property
Gordon says taxation also applies to primary and other residences.
- Primary residence: First R1 million of a gain made after October 1, 2001 is exempt from CGT.
- Second property: Rentals are taxed at your marginal rate, but costs, such as repairs, are tax-deductible. CGT applies on disposal. Capital improvements will increase the base cost and therefore lower the gain.
Small Business Assets
Gordon says there is a R500 000 gain or loss concession on the sale of the active business assets of a small business when you retire. For you or your estate to qualify, you must:
- Be the sole proprietor, a partner or have a minimum of a 10 percent stake in the company;
- Be over 55, in poor health, infirm or have died;
- Have held the interest for five years prior to disposal; and
How changes to the tax laws may affect your retirement plans
Other articles from the seminar: