Tax-free investments – The impact of withdrawals

Tax-free investment products went live on the 1 March 2015 and early signs are that they are proving to be quite popular. There has however been a lot of confusion regarding the threshold contributions and more especially the impact on those thresholds when an investor decides to make withdrawals.

Contribution thresholds

Sec 12T (4) of the Income Tax Act states that:

“Contributions in respect of tax free investments shall be –

(a) limited to an amount of R30 000 in aggregate during any year of assessment;

(b) an amount in cash; and

(c) limited to an amount of R500 000 in aggregate.”

The annual R30 000 threshold applies across all tax-free investments with product providers, as does the R500 000 lifetime threshold. Sec 12T (7) states that any over-contribution on either threshold will be taxed at a flat rate of 40% regardless of the investors marginal rate of tax.

Why would a withdrawal matter?

Any withdrawal ‘replaced’ in the same year of assessment will form part of the annual R30 000 threshold as well as the R500 000 threshold. If the investor contributes R25 000 in Year 1 and decides to make a withdrawal of R10 000 in the same year, the investor would only have R5 000 of their annual R30 000 threshold remaining. Should the investor then decide to ‘replace’ the withdrawn R10 000 in the same year, the contribution amount reported to SARS will be R35 000 which will constitute an over contribution of R5 000 taxed at 40% (R2 000 tax paid). Further, the over contribution of R5 000 in the same year will have the effect of reducing the lifetime R500 000 threshold from R475 000 to R465 000.

It is for this reason that treasury introduced in the regulations released on the 20 February 2015, an obligation on a product provider to limit the contribution by an investor to R30 000 during any one tax year of assessment. Nedgroup Investments has therefore changed its processes and systems to accommodate such a restriction.

The problem however lies with an investor who decides to take out tax-free investments across various product providers. In such a scenario it is near impossible for product providers to restrict contributions across product providers to R30 000 when they cannot stop an investor from taking out another tax-free investment with a peer. It is therefore important for financial planners to warn potential investors of the impact of over contributions and withdrawals. While tax-free investments are rightly regulated to be liquid investments, it is vital that an investor understands the impact of such withdrawal. Ideally, an investor would want the contributions to remain invested for as long as possible, in order to benefit from the tax-free returns. Remember that the threshold caps apply to money going in and not the money coming out of the investment.

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