As a young professional, it is not necessary to revolt against paying taxes in order to protect your hard earned income. As important as it is to have independent financial advice when starting out your career, so too is continual tax planning. By understanding the tax implications of your financial products and investments, you will be in a better position to maximise your income and grow your wealth.
The Income Tax Act 58 of 1962 contains various incentive provisions that can help you to take control of your earnings early on in your career. This article aims to explain the differences between pre-tax and post-tax incentives and to provide you with a few examples of each.
Pre-Tax Incentives
Pre-tax incentives are designed to allow you, as the taxpayer, to lower your annual taxable income in one of two ways, by either deferring the payment of tax to a later date, or reducing your tax liability in any given tax year.
The popular and most common pre-tax incentives are Pension Funds, Provident Fund and Retirement Annuity Funds. These structures can have the effect of reducing your annual income tax payable, by up to R157,500.00 per year, depending on your tax bracket, and the amount invested (regulated by Section 11F of the Income Tax Act). Lump sums received from these funds, at retirement, are taxed at a lower rate than your normal income tax rate. More specifically, in the case of Retirement Annuities, annuity income would generally also be taxed at a lower rate than your normal income tax rate.
Interest on savings are often overlooked. A simple savings account remains an attractive way for young professionals to kick-start their careers, and retain access to their funds for unforeseeable expenses. Currently, an exemption of R23,800.00 of the interest earned on a savings account within the Republic can be deducted from your annual income.
For the more strategic investors, investments in terms of Section 12 J of the Income Tax Act are extremely popular right now. This so-called deferring provision allows you to invest in small and medium business through venture capital companies. Whatever you invest is directly deductible from your annual income, and the capital amount, plus growth, is only taxed upon withdrawal, after a minimum of 5 years, as a capital gain. Depending on your financial position and investment amount, you could defer your entire tax liability until the investment is withdrawn. Most of these venture capital companies require a minimum investment of R500,000.00.
Post Tax Incentives
Post-tax incentives allow you, as the taxpayer, to reduce your tax liability on gains made after you have already been taxed on income.
Tax free savings accounts (TFSAs), in terms of Section 12T of the Income Tax Act, need no introduction. This post-tax savings incentive allows you invest up to R33,000.00 annually and R500,000.00 in a lifetime. The gains made on these investments are tax free.
Gains on long term investments are generally taxed as capital gains and not income. This is important because the capital gains tax rate is lower than the income tax rate. You are also entitled to an annual capital gain allowance of R40,000.00 which can reduce the tax on your gain even further.
Acquiring your own primary residence also has benefits in terms of the Income Tax Act. When selling your primary residence, should the value of your property have increased, you are entitled to claim a primary residence exclusion of up to R2,000,000.00 on the increase, effectively allowing you to retain a larger portion of return on investment.
Conclusion
Proper tax planning is essential to ensure that you get the most out of your income and assets. The Income Tax Act contains various provisions which allow you to protect your earnings, without resorting to a tax revolt.
This article does not constitute investment or legal advice, for legal advice on any of the above topics, please feel free to contact us.
By Dewald Claassen and Charlotte Clarke
