With some careful planning investors’ tax liabilities could be vastly reduced by combining the two investment vehicles.
For individual taxpayers, retirement annuities (RAs) and Section 12J investments (12J investments) are effective annual investment options which allow taxpayers to reduce their income tax or capital gains tax liabilities.
Given the significant upfront and backend tax benefits associated with RAs, it’s no wonder that wealth managers have for many years encouraged clients to max-out their RA contributions each year. With a sharp increase in 12J investments, as an additional tax shielding mechanism, wealth managers have started to combine 12J investments with RA investments, to further reduce their clients’ tax liabilities (in some cases to zero). An excellent example is one introduced to me by seasoned wealth manager, Craig Gradidge of Gradidge-Mahura Investments who explained to me that:
“Depending on various personal circumstances of each client, I would look to invest R800 000 in a Section 12J investment. This would allow the client to claim a refund of approximately R360 000 from Sars. I would then allocate R350 000 into an RA, which will allow the client to claim a refund of approximately R157 000.
By balancing an RA and a 12J investment, the net effect is that the client’s asset of R800 000 would have grown to R1 317 000 just through the refunds paid by Sars.”
The combination of investing in both RAs and 12J investments is not limited to the tax benefit, wealth managers can balance their clients’ investments to ensure that funds invested are accessible before the age of 55. This is as a result of 12J investments only having to be held for five years in order to enjoy the full tax benefit. 12J investments also provide dividend income streams through the duration of the investment. This careful balancing mechanism can create liquidity prior to retirement.
In addition, the 12J investments market is extremely diverse with taxpayers having the option of investing in high growth riskier investments, mid-tier conservative investments and low-risk capital preservation investments. These options allow wealth managers to balance their clients’ risk profiles together with their RA contributions.
Unlike RAs, 12J investments are not vanilla investments and have historically been notorious for charging taxpayers high performance fees and in some cases, have failed to invest investors’ capital timeously. The market has since developed, with new alternative 12J investments starting to gain in popularity, allowing wealth managers to diversify their clients’ exposures across a number of 12J investments. Even though the market has started to mature, taxpayers would be well advised to consult their wealth manager before making an investment.
From a tax planning perspective, wealth managers and taxpayers should understand the intricacies of 12J investments to minimise the amount of tax payable by their clients. Below is a comparison of some investment characteristics, between 12J investments and RAs:
|12J investment||Retirement annuity|
|Term||5 years||Age 55|
|Deduction||100% deductible||100% deductible|
|Underlying investments||Private equity (hotels, asset rental, private equity investments into SMEs etc)||Limited by regulation 28|
|Offshore exposure||Zero – prohibited by law||Max 25% of total funds invested|
|Dividend/income stream||Dependent on the type of underlying 12J investment. Usually, dividends for low-med risk investments are expected to be paid within 18 months from the date of investment||No income stream until retirement|
|Tax implications during term||Dividends withholding tax on all distributions||None|
|Tas implications on exit||Dividends withholding tax on all distributions and capital gains tax at a base cost of zero on exit||Retirement withdrawal tax (R500 000 tax free with 18-36% banded thereafter)|
|Risk||Medium to high (depending on underlying investment)||Low to high (depending on fund choice)|
|Maximum||Treasury has proposed to cap deductions at R2.5 million p.a for individuals/trusts and R5 million p.a for corporates.||27.5% of remuneration capped to R 350 000 p.a.|
|Minimum||R100k to R1 million||No minimum|
|Returns||Target of 15% to 40% p.a., risk profile dependent.||Fund and time horizon dependant. Low risk = CPI +2%. High risk = CPI + 5%|
|Fees||Typical: 2.5% p.a and 20% performance fee||1.5% – 2.5% p.a and a possible performance fee above hurdles|
|Withdrawal||No legal restriction when funds can be withdrawn||Only after term and only 1/3 can be accessed in cash. 2/3’s must be contributed to a compulsory annuity.|
|Last date to invest||30 June 2021 (unless extended)||N/A|