Last week, we considered how you can utilise your Tax Free Savings Account and your interest exemption for planning your personal finances effectively from a tax perspective. In this week’s article, we will look at how capital gains tax can be managed strategically to take advantage of tax incentives as well as how contributions to your retirement funds can help you decrease your taxable income.
Capital gains
Let us briefly remind ourselves how capital gains for individuals are calculated. Firstly, we must remember that it is actually not a separate tax, but rather forms part of Income Tax. When an asset is sold, we deduct the base cost from the proceeds received.
We do this for all assets sold which are then aggregated, meaning that all losses are deducted from the total profits made during the particular tax year which we then call the gross capital gains. If the losses exceed the profits, such losses are allowed to be carried over to a following year of assessment. If the profits, however, exceed the losses we can deduct the annual exclusion of R40,000 from such gains giving us our Net Capital Gain.
This is then added to our taxable income which will be subject to the marginal tax rate as per the tax bracket that applies to your taxable income. Now that we are on the same page of how to calculate Capital Gains, we can look into how to use this to our advantage when planning our finances.
Firstly, determine what your current Gross Capital Gains will be and whether you will have a loss or a profit at the end of the financial year. If you have a profit that is less than R40,000, it is advised to consider taking some additional profits up until your full R40,000 exemption is utilised in full as the benefit of this exemption cannot be carried over to the next year of assessment.
Although a capital loss can be carried over to a future year of assessment, it is advised to assess your current and future financial situations to plan whether it may make sense to utilise the full, or even part of, the capital loss during this assessment year. Going through this exercise will allow you to approach your financial decisions proactively.
Another consideration is that if you had a substantial capital gain during the current year of assessment, you may want to try and bring your marginal tax rate down if it is at all something that is within your control.
This can possibly be done by utilising the profit that was made from selling the asset for living expenses rather than receiving income from other sources. People that have their own business may draw down less for their salaries whereas people that receive annuity income may possibly be able to lower their drawdown rate.
Top up your retirement fund
Contributions made to any retirement fund can enjoy a tax deduction up to a certain limit. The reason for the deduction is twofold – firstly it is to encourage South Africans to save towards their retirement and secondly when you do earn an income from your retirement funds it will be taxed as such, therefore this mitigates the risk of being taxed twice.
You can contribute up to 27.5% of your taxable income towards a retirement fund each assessment year, although this is limited to an amount of R350,000. This means that if you contributed the maximum of 27.5% of taxable income towards a retirement fund, and this contribution amount exceeded R350,000, then your contribution deduction will be limited to R350,000 for this year of assessment and the remaining amount will be carried over to the next tax year to possibly be used as a deduction.
Another benefit of contributing towards a retirement fund is that, similar to a Tax Free Savings Account, growth within the product is not subject to being taxed as it is with other investments. It is however important to remember that when you do save money in retirement funds such investments are always subject to certain limits set out in Regulation 28 of the Pension Funds Act.
These limits are meant to mitigate the risk associated with using retirement funds for high-risk investments, but it can then also mean that you can’t align these retirement investments with your investment risk appetite or your preferred asset classes and financial goals.
With the end of the tax year right around the corner, make it a priority to strategically manage your financial affairs to take full advantage of the tax deductions and exemptions that are available to you.
