Coronation presents strategies to maximize the benefits of tax-free investing.
The perks of a tax-free investment make it a no-brainer, but individuals can maximize its value if they are strategic about managing it. With the tax year ending on 28 February 2023, now is the time for people to invest and maximize their benefits.
The most obvious perk of a tax-free investment is that there is no payment of local tax on investment returns, both while invested and when the investment pays out. This means zero local tax on interest income, dividends, and capital gains.
While the tax-free investment benefit is made available to all South Africans by the government, it is believed that the real value lies in understanding how to make the most of the tax-free opportunity. According to their analysis, four key strategies could potentially help individuals double the returns from the same taxable investment over the long term.
Strategy 1: Stick to the first-in/last-out principle
When referring to ‘first-in’, it is meant that individuals should start by using their tax-free allowance before considering other investment options. Coronation allows individuals to begin investing with as little as R250 per month or a lump sum of R5 000 per year, up to the maximum contribution of R36 000 per year.
When referring to ‘last-out’, it is implied that individuals should remain invested for the long term. The power of compounding means that investments have the potential to grow exponentially for every additional decade that they remain invested. To harness the full power of tax-free investing, it is recommended to resist the temptation to access or withdraw money invested in a tax-free investment. This means not using it as an emergency fund or a savings account for holidays and big-ticket items such as a car.
Strategy 2: Invest in a growth-oriented multi-asset fund
It is important to understand that tax-free investments are not bound by geographical or asset class constraints. As a result, long-term investors could consider being fully invested in equities, which are known to provide the highest expected returns over time.
However, for most investors, they may prefer a less volatile investment experience while navigating market ups and downs over multiple decades. In this case, choosing a growth-oriented multi-asset fund like Coronation Market Plus would be a suitable option to remain invested while achieving returns that exceed inflation.
Coronation Market Plus was established in 2001 to meet the needs of aggressive investors seeking to build long-term capital outside of their retirement portfolios. As illustrated in the diagram below, the Fund has delivered an annualised return of 14.3% since its inception, exceeding inflation at 5.7% per year. It is worth noting that, over this period, despite not being fully invested in equities, the Fund has outperformed the JSE All Share Index’s performance of 13.7%. (All performance figures quoted are as of 31 December 2022).
Strategy 3: Aim to reach your lifetime limit as soon as possible
A proven track record shows that individuals should prioritize taking advantage of their annual tax-free investment allowance as early as possible. The current allowance is R36,000 per year and R500,000 per taxpayer in total. By doing so, individuals can reap the benefits of compound growth over the longest possible period, allowing the taxes saved to remain invested for the long term.
The power of a tax-free investment lies in the higher compound growth that it provides when compared to an investment in a taxable unit trust. Over the longest possible period of time, this can double the value of an individual’s investment nest egg, as described in Strategy 4 below.”
Strategy 4: Build wealth on behalf of your minor children
The life-changing effect a tax-free investment can have on an individual’s child’s lifetime is best understood through a theoretical example (see figure below) that illustrates its potential if harnessed as early in life as possible.
Assuming the maximum annual amount (R36,000) is invested in a tax-free investment for the child from birth, the lifetime limit of R500,000 will be reached before the child turns 14 if the investment continues in this manner.
Based on certain assumptions, analysis shows that if the money is kept in the tax-free investment until the child turns 18, the value of the tax-free investment will be 22% greater than the equivalent taxable unit trust investment. By age 30, this difference widens to 42%, and by age 65, the investment would be more than double the value of the same taxable unit trust investment.
The results demonstrate that by avoiding the urge to withdraw from a tax-free investment, an individual’s investment can accumulate and be used to fund various expenses such as their child’s tertiary education, purchasing their first home, or even investing in their retirement, depending on when the disinvestment occurs.
Moreover, this theoretical analysis highlights the remarkable impact of compounding over long time periods. Investing R500,000 over 14 years and leaving it untouched for 41 years can result in an investment worth R17 million in present-day value by age 65.
If you don’t have a tax-free investment, start your journey with coronation today
The benefits of a tax-free investment are numerous, and it is important to consider various strategies to optimize one’s investment. In light of this, the question arises: why should one choose Coronation?
- There are no initial or admin costs attached to opening a tax-free investment with Coronation.
- Investors can start investing with Coronation with as little as R250 through a monthly debit order or can make lump-sum investments ranging from R5 000 to R36 000 per year.
To select the funds that suit your needs, speak to your financial adviser, if you have one, or go to Coronation’s tax-free investment page before the end of February 2023.
Coronation is an authorised financial services provider.
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