Small investment choices have large consequences over the long-term

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Understanding the power of compounding can be crucial for the growth of your investments. Small savings on effective tax, estate planning and investment structuring can add significantly to your wealth over the long term. In this article, we highlight some simple, yet critical actions that, when compounded over time, can substantially bolster your financial health.

Cash vs Equities

With interest rates currently high and appearing attractive over the short term, many investors have opted to place their discretionary savings in cash or fixed deposits. However, income tax can reduce these interest returns by as much as 45%, depending on the investor’s tax rate.

The graph below illustrates a net (after-tax) return comparison between investing in equities (subject to Capital Gains Tax paid only upon sale or disinvestment) and cash (subject to income tax, paid annually out of pocket). For illustrative purposes, we have assumed a R5m investment yielding a return of 9% per annum for both cash and equity investments. Additionally, we assume the investor has already used both their interest and capital gain exclusions for the year and takes an annual withdrawal of R250,000 p.a., increasing by 5% for inflationary purposes.

As indicated on the graph, the longevity of your capital is increased by ±6 years, due to the higher net return when investing in equities compared to cash or fixed interest.

While we are not advocating for investors to move all of their money into equities, a more tax-efficient outcome can be achieved with a balanced investment strategy that includes a combination of fixed interest and capital gains assets.

Assumptions Used Cash & Fixed Interest Equities
Investment Amount R5,000,000 R5,000,000
Withdrawal/Income R250,000 p.a. R250,000 p.a.
Annual Increase 5% 5%
Asset Class 100% Fixed Interest Assets 100% Capital Gain Assets
Investment Return 9% p.a. 9% p.a.
Tax Rate 40% (Marginal Rate) 16.72% (Effective Rate)
Return Net of Tax 5.4% p.a. 7.6% p.a.

 

Estate Costs

On death, your estate will be subject to estate duty taxes of 20% for the first R30 million and 25% for any value above R30 million and Executor fees to a maximum of 4.025%. The executor can also charge 6% plus VAT of the income earned after the date of death while the estate is being finalised. This includes rental income, interest, dividends and trading or farming income.

The winding up of estates can also be a lengthy process (currently 1 to 2 years) before beneficiaries receive the proceeds of an estate.

Fortunately, there are specific investment accounts that avoid Executor fees and minimize the transfer time of assets to beneficiaries. We list these accounts below with the cost savings:

Types of Investment Accounts subject to executor fees Types of Investment Accounts not subject to executor fees
Money Market, Fixed Deposits, Retail Bonds, Discretionary Unit Trust portfolios, Share Portfolios, and Offshore Investments. Endowments, Living Annuities, Retirement Annuities, Offshore Wrappers, Pension & Provident Funds.
Value of Dutiable Estate Executor Fees Executor Fees
R1,000,000 R40,250 R0
R5,000,000 R201,250 R0
R10,000,000 R402,500 R0
R20,000,000 R805,000 R0

 

Conclusion

Understanding the impact of effective tax and estate planning, as well as investment strategy structuring, can add materially to your long-term wealth. While cash and fixed deposits may seem appealing, especially during times of high interest rates, it’s important to consider the net return after tax. Investing in a balanced portfolio that includes offshore and local equities can lead to a more tax-efficient outcome and potentially increase the longevity of your capital.

Additionally, being mindful of estate costs is essential. Many investors overlook the impact of their investment choices on estate costs and the time it takes to transfer assets to beneficiaries on death. By understanding which types of investment accounts are subject to executor fees and which are not, you can make more informed decisions that align with your long-term financial goals.

Small changes in your investment strategy can have a significant impact on your financial future. Being patient and making informed decisions based on a clear understanding of the compounding effects of taxes and estate costs can help you achieve your financial goals in the long run.

Speak to one of our Client Portfolio Managers or Start your Financial Plan.

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