The current high-interest rates mean a lot of investors are putting money in bond ETFs yielding +10%, or RSA Retail Savings Bonds with the current five-year option fixed at 11.0% and we have an idea for reducing tax on interest earned.
Both offer attractive equity-like returns but with a lower risk of government debt. However, bond ETFs and RSA Retail Savings Bonds pay interest and this has tax implications.
Currently, the first R23,800 of interest is exempt from tax and if you’re older than 65, the first R34,500 is exempt from tax. This has remained unchanged since 2015 when tax-free investing accounts were introduced and is unlikely to be adjusted higher.
Any interest earned above these limits is added to your taxable income and then taxed accordingly by SARS.
So, how do we go about reducing tax on interest earned?
For bond ETFs, use the interest exemption detailed above. Then you can put them into your tax-free account and avoid any tax on that income.
However, RSA Retail Savings Bonds cannot be included in a tax-free account and you may well be earning above the exemption threshold, so then what?
Here’s a cunning hack: Take the interest earned above the exemption limits and put that into a Reg28 investment. Anything within the Reg28 limits is then deducted from your income.
So here’s an example:
Say your interest earned is R55,000 for the year. You’re under 65 so the excess above the exemption is R31,200.
i.e.
R55,000 – R23,800 = R31,200
Transfer the R31,200 into a Reg28 product (i.e. a pension, provident or retirement annuity). While the interest earned will increase your taxable income by R31,200 the Reg28 contribution will reduce it by the same amount, leaving you with no extra tax obligations.
Remember that the annual Reg28 limits are R350,000 or 27.5% of your income, whichever is lower. Anything in excess of these limits can be rolled into future years, reducing taxable income in years to come.
If you’re married you are allowed to donate a limitless amount between spouses. For example, if one spouse has a lower tax rate, or is not contributing fully to a Reg28 product, you can transfer the money into their name to be invested into interest-earning products.
Importantly this must all happen in the same tax year that runs from March to February.