You're listening to Strictly Business Podcast with Lindsay Williams. With me today is Mark Lindley, Product Specialist, 91 Investment Platform in Cape Town. We're going to talk about burning issues. And first of all, Mark, welcome. And secondly, welcome to the first installment of Advisor Pulse, in which we'll bring insights from 91 experts to help make financial advisors'lives easier. And from recent conversations, Mark and his team have had with various wealth managers.
They've compiled a list of the top 10 things that keep investors, especially older investors with foreign assets, awake at night. We're not going to get through all 10, but let's address a few of them. And Mark, we need to make some people sleep better at night. Can we start with this first one? What are the most tax efficient solutions for the lazy cash in the bank account? Hi, Lindsay, thank you for having me first and foremost.
Absolutely, this is a... big problem that's facing a lot of people here in South Africa at the moment. If you look at the stats, there's around 1.7 trillion rand of that lazy cash that's sitting in household deposits at the moment. So not all of that is what we would class as lazy cash.
But when we refer to that, what we're talking about is the excess money that's sitting in people's bank accounts that they're not living off month to month and that could potentially be earning more money elsewhere. I think you've got a couple of issues.
People have been scared of investing in the markets recently, but also since the Ukraine-Russia crisis and the inflation issues that materialized around the time, central banks around the world have been increasing interest rates, which has meant that the return on cash has been a lot more attractive. But when you look at the sort of investments that people hold, cash is not the most tax efficient because whatever growth you do, you're not going to be able to make a lot of money.
get is subject to fairly small exemptions. So if I'm below the age of 65, which I am, my first 23,800 Rand of interest that I receive in the bank will be free of tax. And then anything over and above that will be taxed at my marginal rate. So for many of the clients that we deal with, that means that 45% of the growth above that will be subject to tax.
So maybe if I can just put that into perspective, if you go back to the 2021... to 2022 tax year, a person below the age of 65, if you assume that they were earning the repo rates, could have around 634,000 rand in cash before they would pay any interest on that. But since rates have gone up in the most recent tax year, that's now dropped to below 300,000 rand. So people are suddenly realising that they're paying a lot more tax on this money than they have been in the past.
So that's really the problem, I guess, that we're trying to deal with here. Okay, so there's two different types of cash. There's the cash that isn't lazy and the cash that should be working for you. In other words, turn lazy into working for you. And obviously, your advisor will tell you how to do that, as you've just so well explained. Correct, yeah. So I guess we would always say use those exemptions available to you.
So, you know, even if the amount you have in your bank account is more than you need, to pay your expenses every month, then it does still make sense to carry a certain amount of cash, just to make sure that you're utilising that exemption that I've just mentioned. And that amount is £34,500 for anyone above the age of 65. So you do get more relief as you get older. But then the question is, well, what do you do with that excess cash that sits over and above that amount?
So you may well have heard of a concept of a what's a policy wrapper, so either an endowment or a sinking fund. And they are life company administered products that provide various tax and estate planning benefits. So if I'm a higher rate taxpayer, and my marginal tax rate is 45%, by utilizing that policy wrapper, and even if I just continue to hold money markets, so I don't need to increase my risk above cash in order to improve my outcome.
But now the the yield on that cash is getting taxed at 30% within the policy rather than 45% in my own hands. And that tax arbitrage opportunity creates a massive compounding benefit over an extended period of time. Plus now, these investments are being held effectively by a life company, which reduces the volume of assets that I have in my own hands and can reduce the amount of tax that I'm paying elsewhere.
Okay, if I thought cash was fairly complicated, trusts are even more complicated, because over the years that I've been broadcasting, Mark, trusts and the rules around trusts seem to change all the time. This is the second question now, the second burning issue, the second keep you awake at night situation.
Trusts were a popular way, it says here, to protect assets for the next generation, but since the introduction of Section 7C of the Income Tax Act, it has become a challenge to... transfer both local and foreign assets to trusts without incurring punitive taxes. So we've got to go to Section 7C. Please explain. Yes, correct. So I'll just recap what you said there, because trusts are ultimately designed for succession planning purposes.
So it's a way in which, you know, they've existed for a very long period of time. And it's a way in which someone's legacy can sort of continue for the benefit of their family. after their death. But what has happened is there's been various sort of tax and estate planning benefits that have come and gone over time.
And I think when SARS kind of cottoned on to the fact that people were using them more for tax planning purposes than for succession planning purposes, they've targeted them more aggressively in recent years. So before we even get to 7C, if you look at the rates of income that a trust pays, income tax is at 45%. And And then if you're in growth assets, then 80% of any gain you experience will be the tax at that same 45% rate. So that means 36% effective capital gains tax paid by the trust.
But then SARS have even gone a step further by introducing 7C of the Income Tax Act in recent years. But to break down what that means. So first of all, if I'm going to create a trust for the benefit of my family, I have to fund that trust in some way. You can either do that by way of donation, but that can have some negative consequences to it. Or the more popular way of doing that is actually to loan the money to the trust.
And what 7C did was that a lot of people in the past had funded those trusts via interest-free loans. And SARS wanted to eliminate that practice. And that's where 7C came in. So now you have to pay interest on that loan at a market-related rate. And the income that you would have received then creates a tax liability in your own hands. So for local investments, that's been quite problematic. But for offshore trusts, this has become more of a problem in recent years.
Because if you think about the interest rate environment post the financial crisis, interest rates have been incredibly low. in developed worlds especially, for a very long period of time. And then what's happened is in recent years, since central banks have been tackling that same inflation problem that I talked about earlier, now rates have gone up.
So, if I was funding an offshore trust and the rate of interest was close to zero at that point in time, what SARS require for these agreements is to add a 1% spread over whatever the 12% LIBOR rate is in that particular area. country. So the amount of tax that was being paid for the benefit that was being received was relatively low. But in a higher rate interest rate environment, now the amount of interest that's being paid is significantly higher.
And subsequently with that, the amount of tax that's being paid is also a lot higher. And now people who have these arrangements in place are considering whether it is the most effective solution for them going forwards. Seems to me... Mark, as an aside, that the whole trust environment is a very dynamic one. And it depends on the fortunes of the Republic of South Africa as to whether, you know, they change the rules. When I say they, I mean the financial authorities.
And you have to keep on your toes and keep in touch with your advisors in order to keep up. You do. Correct. That's 100% correct. So these rules are changing all the time. Of course, we can only plan within the parameters that are allowed by legislation at any particular point in time. But I guess the thing is that if people are using these vehicles for their intended purpose, then I think the receiver will be fairly, well, they'll be fair in terms of the way they deal with them.
But if they feel some of those benefits are maybe being abused, then I think that's where the changes in legislation come in. Right, we've answered two questions of the 10 that were identified, as I said in my introduction. And there's one word that came in, number one and number two, and it's tax. And I think we've got a little bit of time for a third question now. And tax again comes in. We may have time for this last question.
So I want to ask you, how do I ensure a tax efficient income for myself in retirement? So important. Yes, definitely. The process of retirement starts a long time before the actual D-day, where you work your last day for your employer and then you convert whatever retirement savings you've accumulated into a post-retirement product and start drawing an income from it. So, I think the first thing is obviously ensuring that you've saved sufficiently.
to provide for that income before we even get to tax we need to ensure that the amount you're able to withdraw is sufficient to to fund your needs in retirement and then i think really it comes down to well what vehicles did you save that money into and again coming back to the point that i raised earlier about using exemptions that are available first and foremost so that money can be taken out of those solutions without negative tax consequences
But then also using things like tax-free savings accounts in combination with your pension or provident fund that you've accumulated or your RA, using things like the sinking funds or endowments that I mentioned, where the tax that you draw from that can be at a lower rate than in your own hands. So I think the key is really using all of those different products in combination with one another and then optimizing. what you draw from and when.
Because your benefit of your retirement products are that when you made the contributions to them, you got a deduction at the time. So it was pre-tax money that you were typically investing. Whereas with your tax-free savings accounts or your sinking funds or endowments, that's post-tax money that you're allocating. So you didn't get a benefit on the way in.
But maybe the tax on withdrawal is less than your withdrawals from your retirement products, where you will get taxed as per the PAYE tables on anything that you draw from it. Very well explained, Mark. Thank you very much. And I'm sure we're going to speak again in the future because we only took care of three of the 10 burning questions. And we'll be sure to address some more of these burning questions in our next Advisor Pulse. Mark Lindley is Product Specialist at 91 Investment Platform.
in Cape Town, and that was Advisor Pulse. The views and opinions expressed in these podcasts are those of Lindsay Williams and various contributors and do not reflect the policy, position, or opinion of any other agency, organisation, employer, or company associated with StrictlyBusinessPodcast.com. Assumptions made on the analyses are not reflective of the position of any other entity other than the speaker or the author.
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