Tax efficient cash funds. A low risk way to add value

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Tax efficient cash funds. A low risk way to add value

  • Recent history has reminded investors of the importance of maintaining adequate cash reserves.
  • However, low interest rates and tax on the interest earned put investors under pressure to look for alternative options.
  • Sanlam’s tax efficient cash funds may present an appealing option for those wealthy individuals, trusts and companies sitting on discretionary cash reserves.

Following the COVID-19 outbreak that reached South Africa’s shores earlier this year, the government took the proactive decision to aggressively cut interest rates in order to support the economy, with the Repo rate declining from 6.25% in March 2020 to 3.50% in July 2020. This series of rate cuts may have assisted those with debt to service, but it has also impacted on the performance of cash, an asset class seen as a haven in these uncertain times. Coupled to this, the interest income earned generates an income tax liability.

Many investors are now actively seeking ways to unlock better returns on that cash but are nervous to move up the risk curve, as capital preservation is key. But there may be a way to address these investor concerns in a low risk manner.

Consider the type of return earned on cash
It is generally assumed that the only type of return earned on cash is interest. And whilst this is the case for conventional cash options, such as money market funds or fixed deposits, there is an alternative available to those investors with discretionary cash reserves.

Tax efficient funds aim to produce predominantly dividend returns, which is significantly more tax efficient than interest. In the case of the Sanlam tax efficient funds, the dividends are derived predominantly from redeemable variable rate preference shares issued by high quality credit issuers such as the major retail banks and large financial institutions. These provide the funds with reliable, contractual dividends that track the short-term interest rate cycle.

A closer look at tax efficiency
For ease of example, assume an individual investor is considering either a conventional interest-bearing cash option or a Sanlam tax efficient fund. The conventional cash option may produce a relatively attractive pre-tax return, until one considers the impact of income tax on that return. In the case of a wealthy individual, they may be paying away up to 45% in income tax. By contrast, Sanlam’s tax efficient cash funds are designed to target both 1) improved after-tax performance; and 2) reduced income tax liability on discretionary cash, thanks largely to the predominantly dividend component of the return, which is taxed at a flat rate of just 20%.

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The above illustration assumes an individual investor with a dividends tax rate of 20% and income tax rate of 45%.

Suitable investors
The Sanlam tax efficient funds are designed for wealthy individuals, trusts and companies with discretionary cash reserves. They are astute investors, seeking capital preservation, liquidity, and improved after-tax performance at low risk. The funds are suitable for those individual investors that are in higher income tax brackets and have utilized their interest exemptions. Corporate investors also derive value from these tax efficient funds, as the dividends earned are exempt of Dividends Withholdings Tax for South African Companies.

If you would like to find out more about the Sanlam tax efficient funds talk to your Financial Advisor, or contact TBI Investment Managers on Jonathan Whittaker on 021 948 0322 or email support@tbi.co.za.