For our last entry in the “5-problems in life” series – we will dive into the mysterious world of tax and inflation – the silent assassins of any poorly drafted financial plan. Do you know how to protect and minimize the effects of inflation and tax on your finances?
Inflation and Tax – do you know what tax and inflation are and how you can minimize their effects?
Inflation is often referred to as the ‘worst tax’ because the impacts of inflation often go unnoticed by most people – however inflation can devastate an investor’s portfolio if not properly planned for. As most of us know, tax is a compulsory contribution to the revenue of the country by its’ workers and businesses and there are forms of taxes added to the cost of goods, services or transactions.
What is inflation and what are its effects?
We can define inflation as the continuous increase in the overall price of goods and services within the economy over time. Inflation rates are not consistent across all product groups or services – but there is generally an overall increase in the price of goods and services. In South Africa economists measure inflation through the consumer price index (CPI). The way CPI is determined is by totalling the costs of a predetermined “basket of goods” and some services your average South African would consume.
Naturally, inflation affects the cost of living for everyone. Over time as prices go up – you spend more money each year to cope with the increase. If you work, you should try to grow your salary at least in-line with inflation so that you can maintain your quality of life. Be aware that not all costs go up at the same rate, so always review your budget and reallocate expenses if need be.
Inflationary periods promote spending and investing as people realize that their money will only lose value over time. However, more spending and investing ultimately leads to more inflation that could possibly create a major inflation surges if it continues for a prolonged period. Inflation has numerous other effects that include reducing unemployment due to more economic activity, increases economic growth from spending and investing activity happening and it can also weaken or strengthen a country’s currency. It all sounds very complicated, and it can be, but the main takeaway should be that inflation will ultimately erode your spending power if you are not proactive about protecting and maintaining it.
There are a couple of mechanisms to reduce your exposure to inflation, the first one is investing in local or global equities. Investing in equities over the long-term is a brilliant way to stay ahead of inflation. Another option would be to invest in tangible assets such as gold or real estate. Gold has always been seen as a great hedge against inflation. These are some options to consider when you are looking to minimize the effects of inflation. However – chatting to a financial professional might be your best option to make sure you truly understand inflation and how it will affect your money.
How you can benefit from tax and contribute towards a better financial future
Contributing towards a retirement fund allows you to receive tax deductions of up to 27,5% or R350 000 per year of your taxable income. This limit applies to contributions made to retirement annuities or pension and provident fund. You could look at opening a tax-free savings account which means that all returns you receive will be tax-free. There is a R36 000 contribution limit per tax year and a single tax-free saving account has a limit of R500 000. You are not limited to one tax-free savings account, but you are limited to the R36 000 yearly contribution level. Contributing to a medical scheme will also give you certain tax rebates according to how many dependents you have on your scheme. There are several other benefits individuals can receive from being tax savvy – for example keeping a logbook if you receive a travel allowance or drive a company car and commission earners can claim commission related expenses.
Tax and inflation are very tricky subjects to grasp and consulting financial professionals is always a great way make sure all your bases are covered.
If you want to learn more about inflation and tax – contact IWCP at 011 678 8904 or visit our website https://www.iwcp.co.za/.
If you haven’t read the rest of this series – check them out here.
