When saving towards your emergency fund, you should also consider the most tax-efficient structure. The options you can save in are:
- your personal capacity;
- your company; or
- your trust.
The income generated from your emergency fund determines how you will be taxed. This income could be capital gains (when you sell shares to cover emergencies), dividends (if your emergency fund is invested in dividend-yielding investments) or interest (cash in the bank).
When it comes to capital gains tax (CGT), a company is probably the least tax-efficient option as it’s subject to CGT of 22.4%. Individuals, on the other hand, may only be taxed up to 18%. A trust’s CGT rate is 36%. However, gains realised by a trust are typically distributed to South African resident individuals on which they’ll be taxed at 18%. Therefore, the 36% tax rate rarely applies.
Trusts and individuals are subject to dividends tax, charged at 20%, whereas South African companies are exempt from dividends tax.
Holding shares to fund emergencies either through the sale of the shares or dividends is risky. It can either force you to sell shares when the market is down or your dividends to be received cannot fund the emergency.
For that reason, it is often recommended that your emergency fund be held in cash. Also, the interest tax exemption provided makes holding cash more favourable. For individuals younger than 65, the first R23,800 in interest is exempt from tax. For individuals older than 65, the first R34,500 is exempt. With the introduction of tax-free savings accounts (TFSAs), it’s unlikely these exemptions will increase in the future.
If you’re saving as a couple, this exemption applies to each individual and therefore allows for a more significant tax-free and relatively risk-free emergency fund.
Should your home be bonded, you can also consider paying your savings into the bond, but ensure you can always access the excess payments.
Being tax efficient is an important part of great financial management. In this blog, a group of South African tax experts share their tips and explanations on tax issues. Learn everything you need to know about tax, from deductions you never knew about to retirement savings and capital gains. The first Tuesday of every month is Tax Tuesday. Don’t miss it!
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