High interest rates result in higher taxes

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With interest rates more than doubling over the last two years (the repo rate currently at 8.25%, up from 3.5% in October 2021) interest earners are paying significantly higher tax. We draw on a recent Ninety One article illustrating this point.

As interest rates have risen sharply over the last two years, they’ve put the economy and the consumer under significant pressure. But for savers enjoying a far higher “risk-free return”, their tax owing has increased at a far higher proportion relative to interest earned.

SA Repo Rate since March 2021:

SARS provides an exemption on local interest earned of R23,800 and R34,500 per annum for individuals under 65 and 65 and older respectively. These exemptions have remained the same since 2014 resulting in interest-earned thresholds declining materially with interest rate increases.

Estimated savings levels before being subject to tax

The tax-free amount that could be invested in a bank or money market account has fallen more than 50% since 2021.

Below is an illustration of how much more tax is payable over the last three years by an individual on interest earned with a marginal tax rate of 45%:

What alternatives are there?

The savings and investment universe is large and every asset class and product has its own tax treatment to be aware of.

Here are a few examples of tax-efficient products / asset classes:

A tax-free savings account: Although this is limited to contributions of only R36,000 per tax year, it does reduce tax payable, and should be viewed as a long-term savings vehicle to be invested in growth assets.

An endowment policy: Anyone with a marginal tax rate greater than 30% (earn R370,501+ per year) should consider an endowment investment vehicle as interest earned is taxed at 30% and capital gains are taxed at an effective 12%, as opposed to 18% for individuals with a marginal rate of 45%.

Growth assets: Investonline recommends that now is a far better time to invest in diversified portfolios, including equities and other growth assets, as opposed to placing your savings in the bank or a money market account to earn higher interest income.

Other examples are retirement funds, offshore wrappers and fixed bonds.

Comparing the tax effects of earning interest income versus capital gains:

Some key concerns when investing too much of one’s wealth in interest-bearing savings are:

  • Tax on interest is payable when it is earned as part of one’s annual or provisional tax returns, in contrast to capital growth assets which are only taxed when sold such as an investment portfolio withdrawal or fund switch.
  • The more interest you earn the higher your marginal tax rate becomes. This is not beneficial for investors who are still earning a salary, pension, rental or annuity income.
  • Because of the relationship between the repo rate and inflation, fixed interest won’t provide a significant return above inflation net of tax over the longer term.

The tables below provide a net return comparison between earning interest income (such as interest earned from call accounts, money markets, fixed deposits and income funds) and capital gains (such as capital growth on equities and property) for investors with a marginal tax rate of 30% or 45%.

Equities vs Cash net return (at 30% marginal tax rate)

Equities vs Cash net return (at 45% marginal tax rate)

Conclusion: Get your savings invested

Although higher interest returns appear attractive in these depressed economic times, equities are offering very attractive valuations, which over the longer term, should well outperform interest income returns.

JSE All Share Index P/E ratio

As interest rates have likely peaked, SA equities are cheap, with the JSE All Share Index valuation near a 20-year low, providing a very attractive entry point.

Improved investment returns from unit trusts and equities combined with the preferential tax treatment of earning capital gains over interest will provide a better investment outcome for investors over time.

Addendum: SA individual tax rates for the 2024 tax year (1 March 2023 – 29 February 2024)

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