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IS IT BETTER TO RECEIVE DIVIDEND INCOME OR INTEREST INCOME FOR INCOME TAX PURPOSES?

April 16, 2024
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Both can have a place in your portfolio. Learn to maximize the tax benefits.

 

Local interest income

If you own bonds or have cash in the bank, then the interest you earn on this will be taxed. If you hold unit trusts then these often attract interest, which is taxable too. This interest income is subject to income tax and is taxed at your marginal tax rate.

 

Individual taxpayers receiv  an annual exemption on all South African interest income they earn, set by SARS every year. This interest exemption has remained unchanged for a number of years and for the 2023 tax year is set at R23 800 for individuals under 65 years old, and R34 500 for individuals 65 years and older.

 

South African Retail Savings Bonds and any interest from the money in your Medical Savings Account can also be taxed.

 

Foreign interest income

If you earn foreign interest, you need to report the Rand equivalent amount to SARS. Unlike local interest, there is no exempt portion, however you will be able to deduct any foreign tax you paid already. Fortunately, no double tax applies.

 

Local dividend income

For equities (excluding listed property companies), dividends withholding tax (DWT) of 20% is withheld before its paid out or reinvested.

 

Income from Real Estate Investment Trust (REIT)

The tax rules associated with listed property companies in the form of Real Estate Investment Trusts (REITs) are more complicated than other asset classes. REITs are taxed differently to other listed companies: they do not pay corporate income tax, and their investors do not incur DWT on the distributions they receive. Instead, investors pay income tax on the distributions they receive from these REITS at their marginal income tax rate.

 

I have done a few scenarios to simplify this for investors. You can look at the images attached for ease of reference.

 

SCENARIO 1: R23,800 IN INCOME

It is always best to invest the first portion of your money to receive the interest exemption of R23,800. So, if you invest R238,000 at 10%, you will pay zero tax on the interest.

 

Verdict: Interest always wins in this category.

 

SCENARIO 2: R45,000 IN INCOME

If you want to receive R45,000 in income, investing the money in dividend stocks, will automatically result in R9,000 dividend tax, leaving you with only R36,000 after tax.

 

The only scenario where you will pay more than R9,000 in tax on interest is if you are in the 45% tax bracket.

 

Verdict: Interest wins if you are NOT in the 45% tax bracket!!!

 

SCENARIO 3: R75,000 IN INCOME

If you want to receive R75,000 in income, investing the money in dividend stocks, will automatically results in R15,000 dividend tax, leaving you with R60,000 after tax.

 

The only scenarios where you will pay less than R15,000 in tax is if you are in the 18% or 26% tax bracket. This means that your total income for the tax year (including the R75,000 cannot exceed R353,100)

 

Verdict: Dividends wins in every tax bracket except the 18% & 26% tax brackets!!!

 

SCENARIO 4: R100,000 IN INCOME

If you want to receive R100,000 in income, investing the money in dividend stocks, will automatically results in R20,000 dividends tax, leaving you with only R80,000 after tax.

The only scenarios where you will pay less than R20,000 in tax is if you are in the 18% or 26% tax brackets. This means that your total income for the tax year (including the R100,000 income cannot exceed R353,100)

 

Verdict: Dividends wins in every tax bracket except the 18% & 26% tax bracket!!!

 

CONCLUSION

  1. Always make use of your R23,800 interest exemption if you can.
  2. The higher your taxable income, the more it makes sense to receive dividend income over interest income.
  3. Find your own personal mix that fits your investment style.
  • Ask for help if the numbers made your head spin. I will gladly send you the spreadsheets, so you can play around with it.

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