What is the risk, and can I do better?
For many investors over the last few years, the predominant tendency has been to either invest in local money market funds or offshore cash markets. Investors have become more risk-averse and, in doing so, are seeking a conservative option for their offshore cash. However, they might be overlooking a few aspects by investing their funds in offshore bank accounts.
Consideration 1: Tax residency
The concept of tax residency is important because it determines where and how much tax you need to pay. South Africa implements a residence-based system of taxation where a person who qualifies as a tax resident is subject to tax in South Africa on worldwide income. Therefore, any foreign earned interest in an offshore bank account by a South African tax resident will be liable for tax in South Africa on an annual basis (depending on the applicable double taxation agreement).
Consideration 2: Where the bank account is held
This may create problems when the account holder passes away, depending on the jurisdiction of the account. Situs tax is a key consideration when investing offshore. This is equivalent to South African estate duty and is dependent on the location of the specific asset owned. The current maximum inheritance tax in the UK and federal estate tax in the US is far greater than what is payable in South Africa, meaning that your estate may have a larger tax liability to be paid than planned for in South Africa.
Offshore probate may also apply. An offshore agent may have to be appointed to wind up your offshore asset before your SA executor can finalise your estate. This can be a lengthy and costly process.
Consideration 3: Interest rates
Interest rates have recently peaked in developed countries, so the attractiveness of relatively higher interest rates in offshore markets is due to fade for investors.
Retail savings/deposit accounts are lagging behind their respective money market peers in the current environment. Investors with exposure to solutions offering the possibility of greater returns over a longer period will be in a favourable position once the imminent global rate-cutting cycle starts.
For a conservative investor, who wants to achieve greater returns over the short term by benefitting from higher cash yields, there are options available which can address the abovementioned concerns.
Investment funds, such as offshore money market funds, are an attractive alternative:
- If the underlying investments are in roll-up funds, interest income and dividends are not distributed. Instead, the investment income is capitalised, reducing the annual tax liability if funds are not withdrawn.
- These funds are available within offshore endowment or sinking fund structures. It provides greater tax relief for taxpayers with a higher marginal tax rate, addresses potential situs or probate concerns and does not form part of the estate administration process, which can enable your beneficiaries to effectively receive their inheritance without any executors’ fees being payable.
- An offshore structure and investment fund can provide an initial basis to match or outperform bank account cash rates, while at the same time providing a solution, within a conservative framework, to enhance your investment returns at an appropriate level of risk.
Tax difference – Bank account vs roll-up
With any investment, especially in offshore markets, you need to have the ability to alter your asset allocation so that you don’t limit your investment decisions to a single asset class, such as cash. Therefore, investors need to carefully consider the investment vehicle they use to invest offshore. Your investment strategy should include the appropriate exposure to a well-diversified investment portfolio to grow your offshore wealth over the long term.
Adapted article by Wayne Stevens – PSG Wealth