Khalid is a contractor and a single male in his mid-30’s. Each year, he receives a SARS refund, primarily driven by retirement annuity (RA) contributions and other items which he can claim based on his line of work. For illustrative purposes, let’s assume an annual pre-tax income of R1 Million and that, based on TaxTim calculators (2020), he paid R307 813 in PAYE taxes and received a refund of R50 000. He wonders, what is the best way to spend this money?
He knows his options consist of the following:
- Reinvest into an RA;
- Settle his credit card debt which attracts interest of 15% and has an outstanding balance of R44 000 (currently serviced at R2500 per month); and
- Invest his money into a tax-free unit (keeping in mind that his current financial plan does not have provision for withdrawals)
His financial responsibilities include paying towards a home loan and vehicle finance. His home loan of R1 million, has an outstanding balance of R650 000, with a tax rate of 6.75%. It is assumed that the bond is paid at a top-up, which means that he pays a total of R10 000 per month. Additionally, his vehicle finance repayments are R350 000 at 12.75% fixed, with a term of 36 months remaining.
Khalid’s scenario is in relation to reducing debt or investing into his refund. Considering the numerous options of saving vs settling debt, Jesse Morgans (Asset Protection International, 2020) provides the following insight:
Interest rates on credit cards are relatively high. This rate is typically significantly higher than one pays as interest on a bond. Therefore, it stands to reason that it may be more beneficial for Khalid to pay off his credit card debt over his additional bond repayments.
Consumers need to be mindful of behavioural finance. If one decides to reduce credit card debt levels, resulting in saving on interest repayments, one need to be diligent enough to keep one’s credit card debt to a minimal thereafter. This can be best achieved by reducing one’s credit limit with the bank, to force appropriate financial behaviour.
Reinvesting the refund
Reinvesting can be done through additional retirement annuity contributions or through a tax-free savings account.
A bond repayment is structured, long-term, with favourable interest rates that one would not typically default on this repayment. On the other hand, credit card debt attracts a minimal monthly repayment, that is unstructured and expensive. Thus, it is advised to prioritize settlement of a credit card before bond repayments.
The benefits of a tax-free savings account make it an ideal investment vehicle to use up to the maximum annual contribution of R36 000. Investors should ideally max out their annual contributions each year. This is something to consider going forward.
Khalid is advised to consider using the tax repayment to settle his credit card debt. This stands to reason as the most prudent thing. Thus, the R2500 that he is currently using to pay off the credit card should then be re-directed to a monthly debit order investment. This will build up quickly to become a meaningful sum of money that will allow Khalid to get the benefit of Rand cost averaging (investing over time) versus investing a lump sum.
It is advised to have 3-6 months’ worth of income in an emergency fund, should one find oneself in a position where they have a relatively large, unexpected fund. A tax-free investment is a great investment vehicle to use when building up either an emergency fund or for the purpose of pure wealth building.
A variety of investment platforms allow for minimum balance requirements, which can be discussed with a financial advisor. Our financial experts have been unpacking and providing practical advice on the best ways to preserve your financial freedom. Contact our financial advisors to ensure that you are receiving shariah compliant finance advise.
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(Source: Moneyweb, 2020)