Tax is something that we all have to pay whether we like it or not. Generally, any earnings are taxed - for example, salaries. Returns on investments and benefits paid on financial products are also taxed, but in different ways.
There are two kinds of tax on the returns offered by the products discussed in this series. In both cases, you are sometimes allowed to deduct certain expenditure to reduce the tax that you have to pay.
If the deduction is larger than the taxable benefit, the loss can be deducted from other taxable income of the same type.
Income tax
is paid on earnings
in general and is payable only when you get the money or when you become entitled
to it. Although all interest
earned is taxable, total interest below a certain amount is tax-free. This includes interest earned on a bank deposit. Capital gains tax
(CGT) is payable on any profit
you make when you sell an asset and must be paid when you receive the increased value. CGT is lower than income tax.
Long-term insurance
Different products have different tax bases.
Risk benefits:
These are the benefits paid on death and disability. Premiums may not be deducted for income tax purposes, but death benefits and disability benefits that are payable in a lump sum are tax-free. Disability benefits payable in instalments to replace a salary are subject to income tax.
Endowment benefits:
The returns earned by the endowment fund on the assets of these products are subject to both cCGT and income tax. Because the returns are taxed in the hands of the insurers, you do not have to pay any further tax when they are paid to you.
Annuities:
Annuity products pay you monthly instalments. A voluntary
annuity is bought of your own choice. The contribution is not deductible and a portion of the return earned by the annuity's fund is taxable as income. A compulsory
annuity must be bought with the proceeds of a retirement fund and is taxed.
Retirement funds
Pension Funds and Retirement Annuity Funds:
All contributions made to these funds are tax-deductible (subject to limits). The benefits must include the purchase of an annuity and a portion may be taken as a lump sum. The benefits are taxable, apart from a portion of the lump sum which is tax-free.
Provident funds:
Contributions to these funds are not tax-deductible. The benefits may be a lump sum and may include an annuity. Apart from a limited portion of the lump sum which is tax-free, the benefits are taxable.
Short-term insurance
Premiums payable on short-term insurance are not tax-deductible. Benefits paid to you in the event of a claim are tax-free.
Unit trusts
There are three kinds of returns from a unit trust investment:
- The first is an interest return which is taxable as income.
- The second kind is rental distributions on property unit trusts and those are also taxable.
- The third, the increase in the value of the units, is taxable as a capital gain, when you dispose of them.
The unit trust management company will provide you with a statement showing the taxable returns you receive every year.
Shares
Shares have two kinds of returns. Firstly, there are dividends which, are not taxed other than in special cases. Secondly, there is an increase in the value of the share which is taxed as a capital gain. However, if you were to buy and sell shares very often or regularly, you may be considered a trader and you will then have to pay income tax on the increase in the value of the shares. Income tax is higher than CGT.
Tax can be complex and it is always advisable to ask the intermediary for details of the tax implications when you invest in any financial services product.