Economy Financial Planning

Endowments for higher income earners

Until very recently, the one job that I would have avoided at all costs, was that of a crane operator. If you had to measure my fear of heights on a scale of 1 to 5, it would probably rate closer to 45. In all honesty, though, if the government offered me a job as Minister of Finance today, you will have a tough time keeping up with me as I climb the ladder up that crane to get to work.

In addition to the normal day-to-day dangers of losing his job, our current Minister of Finance, Mr Pravin Gordhan, recently had the unpleasant task of informing us as taxpayers, that the South African Revenue Service (SARS) reported a shortfall of R30.4 billion for the 2016/2017 financial year – the largest shortfall since 2009/2010.

This resulted in two major shocks: an increase in dividend tax by a third from 15% to 20% and an income tax rate of 45% for individuals earning in excess of R1.5 million per year. By the time this report is published, countless economists and tax experts would have placed the new budget under a microscope and most readers would have already decided whether the new budget is good, bad or ugly. This week, however, I would like to explore a possible solution available to an individual earning more than R1.5 million per year, who is currently considering making an investment.

In the 2015/2016 budget, capital gains tax captured the spotlight after inclusion rates for individuals were increased to 40% and to 80% for legal entities. In my column dated 11 March 2016, I pointed just how beneficial an endowment can be for a trust that only has natural persons as dependents/beneficiaries.

The problem, however, was that for individuals it didn’t necessarily offer the same benefits. Although this may not be the only reason why investors would invest via an endowment, the tax advantages attached to it certainly remains one of the biggest factors to consider it as an investment option. What this means is that a person earning R240 000 per year at an average income tax rate of 14% (and who will spend a maximum of 5.6% on capital gains tax) won’t really enjoy the full benefits of 30% income tax and 12% capital gains tax on endowment offers.

Table 1: Average Income Tax rate before and after 2017 adjustments (source: Income tax calculator, Fin24.com)

The big question now is whether the higher income groups, which will be largely affected by Gordhan’s recent announcements, won’t be able to benefit more from a tax perspective by investing via endowments?

Let’s suggest that a person who earns R2.4 million per year would like to invest R2.5 million either directly or via an endowment. For the purpose of this illustration, let’s use a 6.5% pre-taxed money market rate, a 12% growth rate on his investments and in both cases, profits will only be realised after 10 years with a balanced capital distribution of 75% to growth assets and the remaining 25% allocated to money market. By taking the new tax legislation into consideration, while everything else remains unchanged, this person’s investment should be worth R6 044 939 after taxes in 10 years’ time if invested directly in his personal capacity. Had he invested his capital via an endowment at an average endowment cost of 0.42% per year, the same investment would have a net worth of R6 135 946. If tax rates remain unchanged, you can add 1.5% in value to your investment by simply using the right investment vehicle, which in this case, is an endowment.

The trust still reaps the most benefits from this type of investment. With the maximum tax rates increased from 41% to 45%, it also means that trusts’ capital gains tax rates have been increased from an already high level of 32.8% to 36%, and their income tax rates to 45%.  By using the same example as above, the same R2.5 million investment would have had a net worth of only R5 290 051 after 10 years if invested directly. At current tax rates, a trust that did not apply the look through principle (with only natural persons as dependents/beneficiaries), that invested via an endowment, however, according to the five-fund approach, would have paid only 12% capital gains tax and only 30% income tax. Not only would that have meant a massive R846 000 more in rand-terms, but also an incredible 16% more in terms of performance.

If you, like many investors out there, still believe that endowments are worthless investment products that only add extra costs to your investments, think again. Not only as a trustee, but as an individual investor as well.


The opinions expressed in this blog are the opinions of the writer and not necessarily those of PSG. These opinions do not constitute advice. Although the utmost care has been taken in the research and preparation of this blog, no responsibility can be taken for any actions taken based on the information contained in this blog. 

Schalk Louw
As Portfolio Manager at PSG Wealth Old Oak and with over 20 years’ experience in the investment industry, Schalk has consistently delivered solid returns to his clients and has certainly become one of South Africa’s most well-known strategists. He started his career in 1994 at the stockbroking company, Huysamer Stals (later ABN Amro). He joined SMK Securities in 1997, (later became BoE Personal Stockbrokers) and was later appointed as director and branch manager. In 2001 he co-founded Contego Asset Management and managed the company as CEO up to March 2014, after which he joined PSG Wealth Old Oak. Schalk has also become a regular household name with investors, with his reports being published in many of the national press. He completed his MBA in 2008.

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