Tax rates and investments

2012-05-21 07:36

A Fin24 reader asks:

What is the effect of the different tax treatment of products on the value of my investments?

Tom Blendulf, head of PSG Asset Management's Technical Investment Centre, responds:

MOST investors assume that they benefit when some or all of their retirement funding premiums are tax deductible. This is partly true - but only if you are subject to a lower marginal tax rate once you have retired.

If investors knew with certainty that they would pay the same tax rate before and after retirement and if the asset returns were taxed in the same manner in either voluntary or compulsory products, they would be indifferent as to which product to invest in.

What impact does compounding tax savings have on fund values?

Under current legislation, compulsory products are exempt from capital gains tax (CGT), dividend withholding tax (DWT) – which replaced the former secondary tax on companies – and income tax.

The interest you earn is therefore tax free, whereas it's fully taxable at your marginal tax rate in a voluntary product. 

I want to demonstrate the compounding effects of these taxes on the investment value of these two product categories. We base our analysis on the assumptions that:

 - Both investors invest R18 000 per year at the start of the savings period (25 years) and increase the premium each year by the same rate as inflation.

 - Both investors hold a unit trust portfolio with 75% equity and 25% fixed interest split at all times in both products.

 - Equity total returns are 15% per year.

 - Fixed interest returns are assumed to be 9% per year; the dividend yield is assumed to be 3% per year; income tax rate is assumed to be 40%; CGT inclusion rate is assumed to be 33%; DWT is assumed to be 15%.

                           Compulsory returns                          Voluntary returns

75% equity

growth at 15%       15% net growth                            12.96% net of CGT and DWT

25% fixed

interest at 9%        9% net growth                               5.4% net of income tax

Total return            13.5% per year                               11.1% per year

As can be seen from the table, under these assumptions the tax exempt nature of the compulsory product results in an increase in annual return of about 2%.

This results in the voluntary investment having a value of R3 626 762.65 after 25 years, versus the compulsory product value of R5 366 231.37.

This difference is solely due to the compounding effect of the tax saving on the underlying asset returns.

 - Fin24


  • Andre - 2012-05-21 08:55

    This totally ignores the cost in the compulsary product (admin charges, commission etc.) Assuming access to the same unit trusts, the fund manager fees would we equal

      Tomas - 2012-05-21 14:00

      Hi Andre Most LISP platforms today charge the same fee whether you are in a voluntary product or in a compulsory wrapper (RA, Pres Funds or ELLA). In addition, if you are careful in your fund selection you can on certain platforms reduce your administration charge to zero, if the platform uses its fund rebates to discount your admin fee. Unfortunately RA's have been given a bad rap by some of the older products designed by the life companies that annualized and paid commission upfront. They then recouped these fees over the term of the investment resulting in high costs on the policy which eroded fund values. Regards Tom

      Lee - 2012-06-04 08:10

      What about the post retirement tax implications on the compulsory products????????!!! Its totally point less comparing a pre-TAX retirement product with a post-TAX savings product.

      Gavin Hillyard - 2013-02-28 14:43

      Andre, please tell me ainvestment that gives 15% p.a. growth that has no charges. I want to put my discretionary capital there.

  • Gavin Hillyard - 2013-02-28 14:56

    Tomas, the fact is that provided the policyholder maintained the policy for the full investment term, it would make no difference if commissions are paid upfront (accelerated) of if they are as and when. The assurance companies capitalize the future commission stream and pay it in a lump sum, normally spread over 2 years. The problem arises when the policyholder surrenders or stops contributing to the plan during the investment term, when there would then be a recoupment from the policyholder for costs (both commissions and company admin charges) Imagine buying a car on HP, defaulting on the payments 3 years later, and expecting the car salesman to pay back his sales commission. Often it is no fault of the intermediary who has done all the work at the inception of the plan, that the plan has been stopped - loss of a job, emigration - there could be many reasons. And yet remuneration gets clawed back. Where there has been bad advice or incorrect or misleading information given to the policyholder, no problem, but a blanket clawback doesn't seem fair to me.

  • pages:
  • 1