Early Retirement & Tax Optimisation - Urrrghhh!
Some people have an irrational fear of clowns, Some people believe in the bogeyman or monsters under the bed. I have an irrational fear of.......................... the TAXMAN!
(DUN DUN DUUUURR!)
Just in case he's reading this (I am that afraid of him); I have zero reason to fear him, I have dutifully paid my taxes honestly and fairly my entire life in fact I've probably paid much more tax than I should because I don't claim for anything that might be deemed questionable in preference of having a peaceful nights sleep without dreaming about being clapped in irons because I put the decimal point in the wrong place 20 years ago.
This fear has been compounded by three things in the last few years, the first being our move to South Africa. Having grown up in the UK, one gets to have a basic understanding of how tax works and the British tax system is pretty easy to understand and follows broad logic. You pay tax on your income (after the first R250,000/ $16,500 / £12,500) and if you have any side hustles you pay tax on your profit after reasonable expenses (which are clearly defined) and If you have investments you pay capital gains on your profits after a pretty reasonable allowance (currently R246,000 / $16,400 / £12.300 per year).
The other big advantage is the UK is mahoosively more technologically advanced than SA from a governmental perspective so when you need to do your tax return you pop onto the government website and follow a nice little online step by step wizard that completes your return for you and saves each section as you go so you can do it in a few sitting as and when your ready.
South Africa isn't massively different on the rules side but they somehow manage to turn the arrogance up to 11 and put all the onus on you to get it right, know what to do and when to do it. It is completely your responsibility to know the entire tax rulebook which is huge, complicated and they change it as and when they feel like it without really telling you they've done it. They of course update their rules online but the website is not what you'd call easy to navigate. There is no online wizard, just a weird website full of pdf forms and complicated terminology.
The second problem is FIRE. There is no employer anymore doing the lion's share of the tax burden and this year I will have some salary (I resigned during this tax year), some investment income, some side-hustle income, capital gains both on domestic and international investments to figure out from a FOREX perspective and a whole bunch of solar panels paying rental every month. It's a big bowl of spaghetti!
The third problem is, and if you live in South Africa and are following a FIRE lifestyle or trying to get to one, this is important; The law changed this year and now ignorance is no defence. If you make a mistake even innocently on your return and it results in you underpaying tax, you will be prosecuted and could face jail time.
Jail time? in South Africa? Me? No way Jose!
Many of you will possibly be rightly thinking now:
"Mr H, stop being a wimp! Nut up man! You're not going to jail for making a mistake on your tax return"
And you may be right but in my defence I did say my fear was irrational!
So the way I see it is if I want to face my demons and be able to sleep at night, I have three options:
Become a SA FIRE Tax Ninja of note
Employ an SA FIRE Ninja of note
Emigrate back to whence I came where you don't need to be a Tax Ninja of note
Now I'm a great believer in never say never but right now, leaving South Africa, the country we've made our home and love despite all of it's idiosyncrecies feels a bit nuclear, so we'll put number 3 in the "not now" pile.
Number 2 feels like instinctively the right thing to do. Find a human,who is the equivalent of the love child of Hypatia (Google it) and Archimedes and sit back while they keep me tax efficient and out of Alcatraz.
However, my experience of tax practitioners over the last few years has left me somewhat unimpressed with the profession.
This fear of tax lead me to employ a tax practitioner on my arrival in SA and whilst she was extremely efficient. I swapped emails and a spreadsheet or two with her once a year and she would send me a bill for R21,000 / $1,400 / £1050. Having not spoken to her, it felt hard to see how she was able to save me anything so the whole process felt expensive especially when you double it to include Mrs H.
My second and current experience is with my current accountant for my side hustle. To be fair to them, they haven't really had chance to prove themselves yet but so far, I have had to explain SARS directive 12b (renewable energy) to them, they were late with my VAT registration and don't seem to complete the actions we agree to. This is now actually compounding my fear of a ball and chain fitting instead of reducing it so that whole thing is up for debate. They also charge me a monthly subscription which is equal to R20,400 / $1,360 / £1,020 per year.
So what have we learned from this? We have learned that spending R62,400 / $4,160 / £3,120 gets the basic tax returns for myself, Mrs H and my side-hustle business done, just. What it doesn't include is anyone taking a detailed look at my financial affairs and optimising my position so I pay the right amount of tax, and only the right amount and give me the comfort that I am as tax efficient as I can be holistically and that there is zero chance of jail time.
So could option 1 be my only option? Should I actually do it myself? Do they serve lasagne for dinner in South African Jails?
I think I'm going to give it a shot, just for one tax return and see how much of a harrowing experience it is.
I have done my SA tax returns before, just not in a fully FIRE environment. I've always used a nifty little online robot doohickey called TaxTim which is kinda like the wizard that the UK government uses so it sort of gives me comfort. What it doesn't do is actually help you very much with the bits I don't understand like what I'm allowed to claim against tax (if anything).
Bugger it, faint heart never won fair lady, I'm going to give it a shot. I'm sure I'll still be able to blog from a jail cell.
I'm going to leave the accountant to do the business stuff, just because VAT is even more scary than income tax so I'll go through one cycle and learn what's involved. I'm also going to actively look for the SA Tax Ninja but set myself a limit of R36,000 / $2,400 / £1,800 a year for tax affairs for Mrs H, myself and the business, and the dude/dudette better be as sharp as Gordon Ramsey's meat cleaver.
So the way I see it is there'll be a list of different tax categories, and they will be:
Income Tax From Employment - I had a couple of months and Mrs H has worked all year. Due to my "Golden Goodbyes" like bonuses, stock options and unpaid holiday, I go straight to 45% income tax and Mrs H is right in the middle of the 41%. That should be easy to calculate and we should both get IRP5's (same as a P60 in the UK)
Tax on Business Profit - This is the accountants bag but should also be easy as I don't take a salary from that and because I do mostly consulting, costs are fairly minimal other than office equipment, travel and a the odd dinner with clients.
Capital gains on Domestic Investments - One of the best things in SA is the fact that companies have to send you a tax certificate each year which should make this manageable. This is where I kick myself for having investments with so many companies instead of consolidating with one provider. A decent spreadsheet should cover it but I'm going to need to check, check again and triple check the formulas and stuff to make sure I don't screw that one up. Capital gains has an allowance (R40,000 / $2,666 / £2,000) and then everything is 18% tax so calculating the tax shouldn't be too complicated.
Capital Gains on Foreign Investments - This is where the fear sets in. I need to study hard to find out how to do the FOREX conversion as the Rand is all over the place throughout a year. Do you use the exchange rate on the day you buy, sell or an average for the year? Homework required. Other than that should be simply realised profit at 18% capital gains tax
Solar Panel Rental Income - This is where things get a little more tricky. I own solar panels on 25 buildings now and they all got installed at different times and pay different rates of rental so that needs some close scrutiny. There is also a load of VAT questions which I'll simply have to get a professional opinion on. More complicated though is reclaiming the cost of the panels against tax. Section 12b of SARS rules says you can claim back 100% of the cost of the equipment in the same year they get installed. I need to get this right as this is big money having spent close to R2,000,000 / $133,000 / £100,000 in the last year. I believe I'm actually allowed to claim that over 3 years also so I need to figure out what's most efficient.
Deductibles - This is the total black hole for me but it's also where I must lose R1,000's every year. I end up claiming nothing because its all just too scary and complicated. This year though I have to put my big boy pants on and man up. I have dedicated home office space and stuff like that so I need to understand what if anything I can claim and if it needs to be part of the business expenses or the personal ones.
Urrrgh, I feel like I need a drink and a lie down just thinking about all of that!
At the end of the day though, that's just all admin.
The truly important part is to get a holistic view so I can forward plan my taxable events like a proper FIRE proponent, and that is why I think it's worth facing my fears and doing it myself. If you're going to win at FIRE you have to be fully immersed in the game.
For those of you now wondering what I'm blathering on about, let me try and explain in a concise fashion.
One of the cornerstones of FIRE is to be tax optimised. Let's be very clear, that is not tax avoidance, it's tax efficiency. One of the superpowers of FIRE is you're living off your own money so you can control when to pay yourself and when (or when not) to liquidate assets, sell shares, take a salary, pay into a pension etc. etc.
And by having this level of visibility and control, you can optimise your tax position more effectively.
Let me give you an example of a tax optimisation strategy.
One of my personal favourites is Capital Gains Harvesting. This is complicated to get your head around but super simple once you do. Remember that in most countries you get a capital gains allowance. In the UK it's R250,000/ $16,500 / £12,500 which is a great amount but most people don't achieve that amount of profit in a year so don't' really have to worry about it. Although this also means they leave some of their tax allowance unused. Capital Gains Harvesting fixes that for you.
Imagine you have shares in an index fund worth, say, R5m / $330k / £250k and it grows at 10% per year and you never sell any or buy anymore you just keep holding the investment and watch it grow. It's your only investment. As lovely as that may seem, if you live in the UK you are passing up the opportunity to reduce your future tax on the profit of that investment every year.
At 10% growth, the investment is producing R500k / $33k / $25k of profit each year which you will only pay when you sell the investment. At 18% tax rate, that means if you do nothing you're creating a future tax bill of R90,000/ $6,000 / £4,500 every year. That's a whole lot of cash for the tax man one day.
But if you intentionally use your allowance and sell R1,388,888 / $92,592 / £69,444 of your index shares and use the money to buy another index that also pays 10% returns, you will in fact create a Capital Gains Taxable Event that would create a tax bill of R250,000/ $16,500 / £12,500. Coincidentally, that taxable event is exactly the same amount as your tax allowance and therefore you don't need to actually pay any tax for the investment in that year.
The important part though is you have realized a gain of R250,000/ $16,500 / £12,500 which means you know longer owe that tax when you sell the investment further down the line. You can repeat this year after year to reduce your tax exposure during your retirement.
Clever huh? Hopefully it makes sense. All you are doing is living to your allowance so as not to incur tax. And there is nothing sinister or backhanded about that strategy, you are simply following the rules laid out by your country's revenue service.
And that is probably the best example I can give of tax optimisation, but there are many tax optimisation strategies for early retirees living off their savings and I intend to apply as many as I can.
So whilst far from being an exactly exciting topic or post, hopefully it explains whilst the taxman is my nemesis (although I'm sure in real life he's a thoroughly nice chap) if you really want to put some fuel on your FIRE, you really do need to understand your finances in minute detail and how they pertain to tax optimisation.
If any of my readers in South Africa happen to know a Tax Ninja who understands FIRE and would like to gain a new customer, then hook a brother up in the comments! I'm not doing this tax stuff for fun, purely of necessity!
Finally, please don't take any of my inane ramblings as tax advice or financial advice, talk to someone who is not as dumb as an ox and get some proper guidance.
Until next time, keep living