NFB FINANCIAL UPDATE Volume63 Jul2012
FROM THE CEO’s DESK
W
e have been through a period of remarkable volatility in Global Markets, led by Europe, but certainly not their preserve. The euro, as a major currency has been beaten up, many of their markets have given up remarkable value, the key borrowing rates of the Club Med countries have gone through the roof and yet Germany is able, as a major player in the "contagion zone", to record negative interest rates when borrowing two year money in the capital markets. Someday, not necessarily soon, these unusual events and markets will reverse. For more risk tolerant investors, this will signal a superb buying opportunity as equities and bonds, as well as property, begin to pay decent dividends, rentals or income, and banks, both commercial and Central, begin to balance their books. An alternate outcome, most feared by Governments and Central Banks alike, is a Japaneselike meander through nowhere! The Nikkei has been a sad tale for over twenty years now. Returns in any form are difficult to find, but impossible to predict, and cash or property offer little respite. Interestingly though, as is almost always the case, the Nikkei has not been flat for twenty years. Although the outcome is desperate should you have remained invested in it, if you were able to trade, the Nikkei has offered, similar to Europe and the Western markets in current times, significant volatility and accordingly, opportunities to profit.
Quite obviously, the sad tale of mis-timing this strategy is equally true, so I am not for a second motivating our clients to go out there and take on the European markets! What NFB continues to strive towards, is the correct blending of investment strategies where we
successfully blend aggressive traders with those who seek out deep value or high dividend paying stocks, and do so both on a local as well as global basis. These are further blended with experts from the cash, fixed interest and property sectors to arrive at an outcome best suited to individual investor's needs and appetite for risk. The 21st century, I feel, will continue to generally muddle along for quite some time. It will suit Central Bankers and Politicians alike to favour cheap money remaining the order of the day. This in turn will at some point bolster inflationary pressure as consumers and corporate,in typical boom and bust style, fill their coffers with cheap money, triggering the unavoidable consequence, i.e. demand side inflation. A further global inflationary risk will, I feel, be triggered should China cease it's subsidy of many inputs into Chinese production. If they raise taxes, costs of utilities, public transport, or any number of inputs, this could rapidly need to be passed on to global consumers, triggering further “push” inflation. Inflation, if controlled,is not all that bad an outcome for the Globe. It will diminish the size of the hole, making it easier for countries to repay the extraordinary and unprecedented levels of debt created in the recent meltdown. The danger is hyper inflation where control is lost of the increase in prices and great harm is done, particularly to less wealthy communities and countries, and notably to people in retirement, unable to invest in typically inflation proof or protected assets. Central Banks have an important role to play in this space, managing money supply and accordingly managing the market and economy and diminishing these risks. In the current environment, tax efficiency remains important, as retention of as much of the meagre, predictable return available is important. Clever use of dividends from shares, preference shares or drawings from tax efficient investments, rather than from taxable sources, such as pensions, can alleviate your tax position. This needs detailed assessment and I would advise this being discussed with your investment advisor or accountant.
IN THIS ISSUE From the CEO’s desk Unit trust or a retirement annuity? SAIF remains SAFE
financial services group ® Mike Estment, BA CFP CEO, NFB Financial Services Group
Image credit: 123RF Stock Photo
UNIT TRUST OR RETIREMENT ANNUITY? I was recently asked, which is a better investment: a unit trust or a retirement annuity? This type of question is at least, a pain in the neck and, at most, an opportunity to help a layman investor better understand the pecking order in the world of investments. By Marc Schroeder, NFB East London, Private Wealth Manager
The Unit Trust In the world of investments, you get building blocks or base elements that all structures comprise of; these are the typical asset classes, i.e shares, bonds, cash, property, commodities. Probably the biggest revolution in the investment world was the creation of what is known as the unit trust. The unit trust is not a base element, but rather is a connection of base elements; as such it can be considered on the same level as the base elements. The unit trust did to the investment world, what Apple did for the world of technology. Where before it was difficult to buy a government bond, a stake in Warren Buffet's company, a nugget of gold and a section of a viable commercial property without some serious ammo, time and research, now you can change the volume on your hi-fi, using your iphone, while on the loo as you skype call your mom in Australia. The base elements have different tax consequences, as follows: = Cash: taxed at marginal rate, exemptions apply. = Property: rentals taxed at marginal rate, CGT applicable on gains. = Local Equities: dividends now taxed in your hands at 15%, CGT applicable on gains. = Offshore Equities: dividends taxed at marginal rate,
small exemption available. CGT applicable on gains. = Offshore fixed interest: distributions fully taxable. A unit trust is taxed according the base elements it comprises of.
The Retirement Annuity The next major development that I wish to highlight, although not as much of an extreme innovation as the unit trust, is what we know today as the retirement annuity. The retirement annuity by itself is just a structure; it is made up of nothing but tax legislation. It is a parking bay, in which we can place assets, the most popular 'parker' in the bay being the unit trust. The most significant attraction to the retirement annuity is that allows the assets (unit trusts) parked within it to flourish untaxed. The two cannot be compared, just as a Ferrari being compared to a garage just doesn't make any sense. However, we can argue where the Ferrari is better off: out tearing up the highway, or being polished up in its show room. As long as the Ferrari on the highway is being compared with a similar or identical car as in the garage, there are grounds for comparison. This brings me to my major talking point in this article, which is better: a unit trust housed within, or outside of a retirement annuity? Putting your foot down on the pedal, or keeping her preserved for a later purpose.
If you haven't picked up already, the Ferrari is a metaphor for an investment. For my article the investment I am going to analyse is what is referred to as the balanced blend in the graph that follows, courtesy of I-Net Money Mate (Please see graph 1 below). The balanced blend comprises of some of the longest standing balanced, asset allocation type unit trust funds in South Africa, the breakdown is as follows: = 40% Investec Opportunity = 30% Allan Gray Balanced = 30% Coronation Balanced Plus The portfolio is illustrated by the red line. The JSE is in Blue, the sector average is in yellow and inflation in green. The returns have been remarkable: the portfolio has averaged 17% per annum since January 2001, a vast outperformance over the equity market (avg 14% per annum), but with significantly less risk. So, which is better? Holding the investment directly, or within the RA? I trust all understand now the difference here between asking this question and 'which is better, a unit trust or a retirement annuity?' It's a subjective call, but here are how the stats stack up assuming a R100,000 lump sum investment on the 01.01.2001, assuming a marginal rate of tax of 35%, for purposes of the CGT calculation. Direct Holding R 610, 200 marginal rate Dividends withholding tax yes - 15% CGT Yes Net CGT R 550, 736 Access Full Estate Duty Included Protected from Creditors No Protected from scorned ex wife No Current Value Tax on income
Graph 1
RA Holding R 610, 200 retirement tax, now at 0% not applicable No R 610, 200 Partial* Not Included Yes No
*Note that while you will not have access to the full amount invested within the RA, on your death the full amount can be accessed by your beneficiaries subject to retirement tax tables. We can see that from a purely rands and cents perspective, there is no more tax-efficient savings structure than the retirement annuity; no investment will outperform its twin if the twin is housed within the retirement annuity, even more so now considering that dividends are received tax-free into retirement funds. So why not put all your money into the RA? The problem is that South Africa is one seriously volatile investment destination, with our currency sailing in the wind like a kite, and with the political outlook as stable as Shaik's latest medical report, it would be foolish to relinquish total access to your funds. The ANC have made suggestions that pension funds should start investing in 'government developmental projects'; how serious this is to be considered, only time will reveal. It seems the drive is for government to be encouraging people to invest for their retirements, not dissuade them, evidenced by retirement fund's tax being reduced to 0% and tax deductions permitted on contributions. For this reason, I would advise anyone to maximise the tax-efficiencies offered by retirement annuities and pension funds. Over and above that, investing directly into well managed unit trust funds is probably the safest, surest and cheapest way of generating wealth over the medium to longer-term. Considering the quality managed unit trust solutions out there, whether you are the park and polish investor, or love screaming over the highways, there is no reason why your 'car' shouldn't be a Ferrari. So, next time instead of asking, “Which is better? A unit trust or a retirement annuity?” Rather ask, “How long is a piece of a string?”
SAIF remains SAFE In February 2011, I wrote about the Sanlam Alternative Income Fund (SAIF) as a potential alternative to cash and money market type instruments. More than a year later, SAIF still offers the conservative investor an enhanced after tax yield over these types of investments. By Nina Joannou, NFB Gauteng, Paraplanner.
Under the spotlight Dividend income funds have been under SARS investigation. Particular emphasis has been placed on eliminating the use of the conduit structures and the criteria that need to be met to generate tax free dividends: ! Preference shares: ! Must be held for longer than three years ! May not be secured by any financial instrument. ! Third party backed shares: ! The proceeds must be used to fund equity and not debt ! The party backing the shares may not own more than 20% of the equity shares of the issuer of the preference share. Consequently, of the five major dividend income funds, three have been closed including Prudential, ABSA and Investec while SAIF and Stanlib have remained open.
The replacement of STC with DWT Secondary Tax on Companies (STC) was replaced by Dividend Withholding Tax (DWT) on the 1st of April 2012, aligning South African Corporate Tax with international standards. In essence, the tax liability has been passed from the corporate to the beneficial owner (shareholder / investor) of the dividend. Although it was expected that DWT would be introduced at 10% (equivalent to STC), during the budget speech it was announced that DWT would be levied at 15%.
Previous Practice When declaring a dividend, the corporate paid STC on the dividend whilst the dividend received was tax free in the hands of the beneficial owner.
Image credit: 123RF Stock Photo
Current Practice The corporate no longer pays STC, however, the beneficial owner is now liable to pay 15% Dividend Tax (DT) on the dividend received. The process of paying the DT is not onerous on the beneficial owner as the DT is withheld by the corporate or regulated intermediary and paid to SARS on behalf of the beneficial owner. Due to the corporate no longer having to pay STC it is possible, however, not obligatory, for the corporate to "gross up" the dividend by 10%. This will cushion the additional burden of the 15% DT to some extent.
Prior to 1 April 2012
Post 1 April 2012
The corporate declares a dividend of R100
The corporate declares a dividend of R110 (Dividend of R100 grossed up by R10 (R100 x 10%))
The corporate pays 10% STC: 15% DT is withheld on behalf R100 x 10% = R10 of the beneficial owner: R110 x 15% = R16.50 In total, the corporate pays: R100 + R10 = R110
In total, the corporate pays R110 as they are no longer liable to pay STC
In total, the investor receives In total the beneficial owner R100, as dividends are tax receives: free in the hands of the R110 - R16.50 = R93.50 beneficial owner Certain investors are exempt from DWT. Some of these include South African companies, retirement funds, public benefit organisations, government, provincial administration and municipalities. A complete list may be found on the SARS website. The fund managers of SAIF had "gross up" clauses built into their agreement with the issuers of preference shares prior to the transition from STC to DWT, and thus dividends received by the fund after the 1st of April 2012 were grossed up by 10%, thereby partially reducing the impact.
Enhanced “SAIFty� Dividend income funds offered investors with high marginal rates of tax an alternative option to cash and money market type instruments. With the majority of dividend income funds closed, SAIF has shown its secure place in the conservative investment space. For the individual investor, DWT has slightly reduced the after tax yield, but SAIF still offers an enhanced after tax yield over cash and money market type instruments and a further enhancement for corporate investors due to their exemption from DWT. In an interest rate environment that has continued to remain subdued, SAIF remains a compelling proposition in an investment portfolio. For more information, please contact your NFB Financial Advisor.
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