Unpacking Retail Savings Bonds
The government recently increased the rate that individual investors can earn on retail savings bonds. The interest rates are extremely attractive:
| Term | Rate |
|---|---|
| 2 Years | 7.75% |
| 3 Years | 9.0% |
| 5 Years | 11.5% |
These look extremely attractive and if used correctly, can add a lot of value to your financial plan.
The key word here is plan. No investment should be done in isolation – it needs to form part of a broader plan.
Tax
The first R23 800 of interest is tax free if you’re under 65. This increases to R34 500 if you’re over 65. After this amount, the interest income is taxed at your marginal rate.
So if you invest for 5 years, you will get 11.5% a year in interest. This full amount will be tax free if you invest less R206 957 if you’re under 65 and R300 000 if you are over 65. These are the investment amounts that will take you above the tax free threshold.
| Interest income | Investment threshold before tax will be paid | |
|---|---|---|
| Under 65 years | 23,800 | 206,957 |
| Over 65 Years | 34,500 | 300,000 |
Above these amounts, you will be taxed at your marginal rate. When you apply your marginal rate to the 11.5%, the effective return reduces to:
| Marginal Tax Rate | Effective return of the 11.5% |
|---|---|
| 36% | 7.360% |
| 41% | 6.785% |
| 45% | 6.325% |
These are still decent risk free returns but no longer have the wow appeal that we initially had before we took tax into account.
Below the tax thresholds, I would certainly consider including these in my client’s investment plans. If they have more than R206 957 / R300 000 to invest I would consider looking at the following:
- Tax free investments
You are allowed to invest R36 000 a year up to a maximum of R500 000 over your lifetime in a tax free investment. Here the investment buildup and the proceeds are totally tax free.
There are a number of vehicles to use here ranging from conservative bank savings plans to extremely aggressive investments – I have, for example, put a number my younger clients with longer investment horizons into the 4th Industrial Revolution portfolios that invest in Apple and Tesla.
- Retirement annuities
The tax breaks on a retirement annuity are extremely attractive. You can contribute up to 27.5% of your taxable income to a retirement annuity and have your taxable income reduced by this amount.
This is an underappreciated financial planning tool – especially when you invest in one of the new generation retirement annuity plans that enable you to invest in a wide range of investment vehicles at a low cost.
Over the past year, your wealth would have decreased by the following amounts if you were fully invested in the following indices.
| 17 April 2020 | open | close | 1 year return |
|---|---|---|---|
| FTSE | 4 115 | 3 190 | -22.0% |
| JSE All Share Index | 59 544 | 49 134 | -17.4% |
However, if you were paying tax at the maximum marginal rate of 45%, a R100 000 investment in an RA would have cost you R55 000 after you got your tax break. This equates to an immediate return of 81.8% before any investment growth (or loss in the case of last year).
| 17 April 2020 | open | close | 1 year return |
|---|---|---|---|
| FTSE | 4 115 | 3 190 | -22.0% |
| JSE All Share Index | 59 544 | 49 134 | -17.4% |
| 45% tax payer | 55 000 | 100 000 | 81.8% |
| 41% tax payer | 59 000 | 100 000 | 69.5% |
| 36% tax payer | 64 000 | 100 000 | 56.2% |
To Summarise
If you need an income or want to have money in the bond market for portfolio diversification, the retail savings bonds have a lot of merit up to a point. The ideal solution for someone under 65, the low hanging investment fruit would be would be to:
- Invest R206 957 in a retail savings bond.
- Invest R36 000 a year in a tax free savings account.
- Invest 27.5% of their income into a retirement savings vehicle.
After this, your financial planner would be able to advise on what would be the most appropriate investment for your needs.