Investing for a monthly income below the tax threshold.

How much do I need to invest to have a monthly income that is below tax threshold, if any? I am a 64-year-old male, with no underlying illnesses. The investment term will be 10 years. What is the capital investment amount and the expected monthly income?

This question was sent to Rosebank Wealth Group financial advisor Alwyn Smit and was first published by Moneyweb.

First, some background.

All investors are liable for tax when they earn money on their investments in the form of interest, dividends or capital gains. The amount of tax that investors have to pay depends on age, applicable rebates, marginal income tax rate, the type and amount of investment income and capital gains earned.

In the 2022 tax year, income earners (either via salaries/ earnings or via investments or interest earned) under the age of 65 start paying tax when their income breaches R87 300, over 65s start paying tax at R135 150 and those who are 75 and older start paying tax at R151 100.

Over and above the primary, secondary and tertiary age-related rebates described above, interest earned from ‘fixed interest investments’ such as bonds, interest bearing unit trusts and/or cash in the bank is subject to income tax and is taxed at your marginal tax rate. Dividends received by investors in South African companies are generally taxed at a rate of 20%, and paid directly by the companies concerned to SARS, so there are no further administrative tax obligations.

Individual taxpayers are eligible for an annual exemption on South African interest income they earn. For both the 2021 and 2022 tax years, this rate of interest exemption has been set at R23 800 for individuals under 65 years old, and R34 500 for individuals 65 years and older.

If you earn more than the exempted interest income in one year, you will be taxed on the difference and taxed according to your tax bracket. Note that any interest from the money in your Medical Savings Account of your medical scheme is also liable for tax.

This means that if you are 66 and earn R140 000, R40 000 of which is interest (and you have no accumulated interest in your medical savings account), you will pay tax at the 18% level. You will be eligible for interest rate rebate of R34 400 and the balance (R600) will be taxable at 18%.
To answer the reader’s question, we have had to make a few assumptions.

• We have assumed that the reader would like the capital to be intact at the end of the year and it should therefore be invested in lower-risk investments.
• We have assumed that no interest is payable on a medical savings account.
• The reader should be aware of the fact that the tax threshold for interest changes when he/she turns 65.

The following table offers a guide on the amount of capital that would be necessary to earn R23 800 / R34 500 at different interest rates. Costs of investing have not been taken into account.

An investor requiring a fixed interest investment has a number of choices. An important aspect to take into account is that interest earned in fixed interest investments should outperform inflation.

Statistics South Africa expects that the current inflation rate of about 3.34% to rise to 4.5% as we get closer to 2025. To earn above-inflation interest, investors should currently aim for an interest rate of above 3.5%, but expect that in the future, a higher interest rate will be required. For more on this, click here.

  • Investing with retail banks in fixed deposits

Banks offer a sliding scale of interest rates, depending on the length of time the money is invested, whether interest is payable annually, semi-annually or at the end of the investment term, and of course how much money you invest. Rateweb, a South African website offers a comparison of interest rates which can be viewed by clicking here.

  • Investing in RSA Retail Bonds

A second option would be to invest in RSA Retail Bonds. These come in two types; fixed rate bonds and inflation linked bonds. You can also choose to invest for either a two-year period, a three-year period or a five-year period. RSA Retail Bonds are currently offering a fixed rate return of 7.25% a year, or inflation linked rate (inflation plus 4.75%) for a period of five years. For more on this see here.

  • Investing in fixed interest unit trusts

Investors who require low-risk investments but don’t know how to choose between bonds, the money market and similar investments, can opt for interest bearing unit trusts. Interest bearing funds are those that invest exclusively in bond, money market investments and other interest earning securities. There are three types of interest-bearing unit trusts; 1) Interest Bearing – Variable Term, 2) Interest Bearing – Short Term and 3) Interest Bearing – Money Market.

The first type, Interest Bearing – Variable Term invest in a combination of relatively longer-dated securities as well as real estate securities and preference shares, and will change over time to reflect the manager’s assessment of interest rate trends. Leading asset management companies in this sector have produced annualized returns of just over 10% over the last five years, excluding payable fees.

The second type, Interest Bearing – Short Term portfolios also invest in bonds, fixed deposits and other interest earning securities, but the weighted average modified duration of the underlying assets is limited to a maximum of two years. The best performing portfolios in this sector have produced returns in the between 8.5% and 8.9% annualized over the last five years, excluding fees.

The third type, Interest Bearing – Money market portfolios invest in money market instruments with a maturity of less than thirteen months. The average duration of the underlying assets may not exceed 90 days and a weighted average legal maturity of 120 days. Top performing portfolios in this sector have produced average annualized in the ranging from 7.33% to 7.44% over the last five years, excluding fees.

It is unusual for banks to advertise fixed deposit rates for periods of ten years, as required by the reader, and the maximum period available for SA Retail Bond investments is five years. There are no set terms for investors in fixed interest unit trust; investors are free to buy and sell to suits themselves. 

Monthly income earned in interest varies depending on the amount of capital invested, the term of the investment, the nature and quality of underlying holdings and the degree of flexibility afforded to the asset manager.

While interest bearing funds are considered to be safe investments, it is possible for investors to lose their capital. Some of African Bank’s investors suffered capital losses in 2016, which had a created a ripple effect in interest bearing portfolios of other financial institutions.

Rosebank Wealth Group has developed good relationships with fund managers of interest-bearing investments and the company is well positioned to advise clients in this regard.

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