Which ETF for tax-free? (Dali-E)

You can just keep it simple with one ETF to rule them all, and buy your favourite broad based ETF, sit back and let time work its magic. Or try get fancy as we discuss below.

The key benefit of tax-free accounts is revealed in its name: No tax to pay on dividends, which is usually taxed at a flat rate of 20%, and no capital gains tax (CGT) liability – which can be as high as 18% if you’re in the top tax bracket.

But we can get even smarter with the potential tax by being selective when we choose the ETFs in our tax-free account.

Local property REITs

REITs (Real Estate Investment Trusts) must pay 75% of their distributable income to shareholders. In addition, the REIT doesn’t pay tax. As an investor, you receive the dividend free of dividend tax, but when you add it to your income, you get taxed.

If you earn under R226k per year, you’ll be paying only 18% tax (for the tax year ending February 2023).

But if you earn more than R226k a year the excess is taxed at 26% and can be as high as 45% if you’re in the top tax bracket.

So whereas all other dividends are taxed at a flat 20%, with REITs you might pay a lot more on tax. That’s why a REIT ETF makes great sense in your tax-free account.

There are a couple of local REITs to choose from, such as CSPROP*, STXPRO* & ETFSAP.

Tactical ETFs

By tactical we mean that you, for example, bought the Resi10 ETF from Satrix* because you’re bullish on resources for the foreseeable future. This means you’ll be selling at some point, and assuming you were right, you made a profit. But there will be tax to pay on that profit.

This is in contrast to a core ETF holding which you largely buy and forget, ideally not selling for decades or longer.

So tactical ETFs are better included in a tax-free account to avoid repeat tax as we switch, and we often also get much cheaper brokerage which gives us another saving.

The problem with tactical ETFs is that you have to make two critical decisions: When to buy and when to sell. If you get either wrong your profits could be smaller or even result in a loss. So be careful here.

Local, not offshore

In a tax-free account, we also don’t pay dividend withholding tax (DWT).

But in a JSE-listed offshore ETF, we get some—but not all—of the offshore dividend tax credited to us.

Sure the hit is small. Maybe 15% of the dividend is taxed and if the dividend has a 2% dividend yield, the ‘tax drag’ is only 0.3% of the ETF value.

My preferred GLOBAL ETF from CoreShares gets no tax credit, so the tax rate is 30% making that ‘tax drag’ 0.6% on an assumed dividend yield of 2%. But this is expected to be retified with the next dividend payment.

But to save that 0.3% (or 0.6%) by staying local works better.

We say again, you can just keep it simple with one ETF to rule them all, and buy your favourite broad based ETF, sit back and let time work its magic.

Simon Brown

* I hold these ETFs in my portfolio.

At Just One Lap, we are big fans of passive investment using ETFs. In this weekly blog, we discuss ETFs on the local market and the factors you need to consider when choosing an ETF. If you have wondered how one ETF differs from another, this is where you can find out. We explain which index each ETF tracks, what type of portfolio could benefit from holding each ETF, and how the costs will affect your bottom line.