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If your marginal tax rate is 39% or higher you are probably investing wrong

by , 13 July 2017
If your marginal tax rate is 39% or higher you are probably investing wrong
There are just two certainties in life: Death and taxes. Unfortunately, these are also the two topics people find most unpleasant to think about.

For higher net worth individuals, understanding your taxes is almost as important as understanding investments. If you're a high income earner in South Africa, a return of 11% can be equal to one of 20% under the correct tax treatment.

Many readers spend hours analysing their portfolios and learning techniques to boost investment growth, but how much effort have you put into lowering your taxes?

The reason for this bias is quite simple. Investing is fun and sexy, while tax management is quite boring.

Yet efficient tax management is absolutely essential for you to successfully grow your wealth.

Let's look at the example for someone with a 45% marginal tax rate and a million rand to invest. How does this tax rate affect the type of investment you should make?

Let's look at a few examples:

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Scenario 1: Active equity trading account which generates 30% annual returns
 
An active equity trading account can be thought of as an account in which the investor buys and sells shares actively, but not on a daily or intraday basis and generally ungeared and not using derivatives.
 
The average holding period is measured in months. This is not an excessive holding period for an ungeared share account. On R1 million the investor makes R300,000 a year, but pays away 45% of this as income tax. This leaves him with just R 165 000 after tax. An actual return of just 16,5%.
 
Scenario 2: Investment account which generates 20% annual returns
 
Here the investor buys and holds shares for multiple years. Because of the holding period the investor can claim these returns as capital gains. Here the same investor would pay a tax rate of just 18% on these profits. This also leaves him with R164 000. An actual return of 16,4%.
 
Scenario 3:  Active equity trading account inside a tax efficient wrapper
 
In this case, the portfolio is identical to the portfolio in Scenario 1 but instead it is put inside a “wrapper”. The wrapper makes it easier to claim profits as capital gains and even in the case of income tax only attracts a rate of 30%. The bonus, the capital gains tax rate drops to 12%.
 
In the example above the effective tax rate would be 12%. So of your profit of R300 000, you would get to keep R264,000 after tax. An effective return of 26,4%.
 
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Bear in mind the wrapper does have some associated costs, but these are in the region of about 0,5% a year.
 
Wrappers have other advantages too. They can make estate planning significantly simpler and cheaper. In addition, if done properly, your assets in the wrapper are protected against claims from creditors. Meaning that should you declare bankruptcy these assets cannot be seized.
 
Of course, when it comes to these types of products it's difficult to make general statements. For high income earners who pay 39% or more in marginal taxes, they can be extremely effective. So, I suggest you speak to an expert to see if they are appropriate for you.  
 
Or if you would like to talk to me about this type of wrapper or estate planning, then email me on keyaccountsinvest@fsp.co.za.
 
Until next time, 
 
Viv Govender, Wealth Manager
 
P.S. Could this be the ultimate tax loophole? Learn more here….



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