Our Minister of Finance announced in the budget proposals this week an increase in withholding tax on dividends from 15% to 20% which further erodes the returns you receive from being invested in shares. This gives you even more reason to be invested in a tax free savings account (TFSA).
If you move quickly there is still time to get invested before the tax year end on the 28th February.
If you are invested in unit trusts or exchange traded funds you should consider the comparative advantage of having the exact funds invested through a tax free savings account.
Tax is applied to all sources of returns If you are invested in a balanced unit trust fund, you are probably attracting tax on interest from money markets and bonds, rental income from property investments and tax on dividends from shares. These deductions erode the return on your investment.
Beef up your compounding effect Growth on your investment is largely dependent on compounding of your returns over time. If you reinvest the growth every year you effectively achieve growth on growth into the future. Over time this becomes a mathematical phenomenon rocketing your investment value over time.
So it stands to reason that if you invest in the exact same unit trust through a tax free savings account your return will be that much bigger because not tax is deducted. Compounding on this higher return simply means more for you in the future on the exact same fund. A no brainer!!!
Capital Gains is neutralised If you disinvest your current unit trust and reinvest in a tax free savings account up to the maximum annual allowance of R30 000 (next tax year R33 000) you will significantly beef up the performance of your investment. The potential Capital Gains Tax which will be applied to selling off your unit trust will be offset against your annual exclusion amount of R40 000.
So if you made the investment before the end of February you have taken full advantage of the tax break for the year on CGT and maximised your allowance for investing in the TFSA into the future.
The road to financial independence is a journey. You know you have arrived when you find the stage in your life where you work, live and do the things you really want to because you are not reliant on being on a payroll.
Imagine the freedom to do what you want to because you have sufficient income to maintain your lifestyle which comes from the savings and investments you have acquired over time.
Very few of us achieve this in our life times and yet it can be attained with the right approach.
Work on earning interest instead of paying it
If you are borrowing to maintain your lifestyle your standard of living is too high relative to your income. You should be able to service your debt comfortably after having firstly set aside the appropriate amount for savings.The cost of your total debt should not exceed 30% of your monthly income. If it is higher then you probably should be living in a smaller house or driving a cheaper car. The higher your debt the more you are paying the bank instead of yourself. The opportunity is lost in diverting interest repayments to compounding investment returns.
Don’t rely on luck
Many of us dream that one day in the future we will strike it rich in some business or win the lottery.
We then don’t see the need to save along the way which ends up in starting to save to play catch up and often ends up being too late.
The only realistic way to have a chance of building enough capital is to take full advantage of compounding. The sooner you start saving the less it will cost you as the power of compounding increases exponentially the longer you save. Its the only magical way to reach financial independence, but it does need time to make it happen.
Keep it real
Ignoring the value of money now and into the future will stand in the way of being financially independent. Many of us are more ready to spend now rather than save for the future.
Be realistic with your lifestyle needs and keep close to how your investments are keeping pace with inflation. Your financial independence will be greatly affected by the ravages of this enemy into the future. Investments over time will need to perform at a higher rate of return than the inflation rate.
Your financial independence relies on setting aside enough over time compounding at a higher rate of inflation.