Interest rates, SARS and your tax return

Simple and compound interest

Interest on a savings account is the amount of money a bank or financial institution pays a depositor for holding their money with the bank. This interest is expressed as a percentage and quoted per year. Accrued interest is the amount of money accumulated daily until it is paid to the customer when the payment date is reached. Payment dates are specific, but the period between the dates can vary. Common periods for interest payments are as follows:

• Monthly
• Quarterly
• Half-yearly/Bi-annually
• Annually
• At maturity

The simple interest calculation is one that takes a sum of money (principal) and calculates regular interest on this amount only. Suppose you invest R1 000 into a fixed deposit account for 1 year at an interest rate of 2% per annum. The interest you earn after 1 year would be R20 (R1 000 x 2% x 1). Investments that use this calculation are term deposit accounts where the interest and terms are fixed. No additional funds can be deposited into these accounts until maturity or expiration of the investment. These products’ interest rates are usually higher than savings products. This is in direct contrast to compound interest, where interest is calculated and accumulated periodically (so that you accumulate interest on interest).

Suppose again you invest R1 000 but this time into a compound interest savings account with a 2% interest rate. After a year, it will become R1 020. But the following year, your 2% interest will be paid on the original sum (the principal R1 000) plus accrued interest (R20). 2% of R1 020 is R20.40, so the compounding interest is 40 cents more than the interest paid on the same principal deposit the previous year. It will continue to increase by a greater amount every compound period, even when no further deposits are made by the investor.

Some of the products using this formula are PureSave, MarketLink, Society Scheme, Tax-free Call and other call deposit accounts such as MoneyMarket Call and MoneyMarket Select. Some of the advantages of these accounts are that there’s no fixed savings period and customers can access and deposit funds anytime. The more money they contribute, the higher the return.

Nominal interest rates, effective interest rates and inflation

The nominal interest rate (sometimes called the base rate) is the figure used before considering inflation; This is usually the interest rate quoted on financial products but once adjusted for inflation, can go up or down in real terms. Inflation is the process by which the same good or service becomes more expensive over time. The effective rate is how much interest you will really receive once compounding is considered.

SARS

Income from investments must be reported to the South African Revenue Service (SARS) as part of the annual income tax return. Section 12T of the Income Tax Act provides that amounts received by or accrued to a natural person from a tax-free investment will be exempt from normal tax. A natural person may contribute R36 000 per tax year to such funds, and lifetime contributions are capped at R500 000. Income from other investment accounts (non-tax-free) have a tax benefit as well. The first R23 800 (R34 500 if over 65 years of age) of interest income in relation to a natural person is exempt. That means you could invest up to R350 000 (R530 000 if over 65) in a South African fixed deposit or savings account at 6.5% per annum and receive interest income that is tax free.

The tax season

The tax season (the period when your tax return needs to be submitted) for individuals usually opens on 1 July and closes on 31 October. During this period, the customer needs to submit an income tax return (ITR12) to SARS. Non-compliance penalties are levied if the return is not submitted on time. Tax certificates reflect the income earned by a customer in a tax year. We will provide a tax certificate (IT3(b) or IT3(s)) for each tax year, on or before the end of June, to enable the customer to complete their tax return. Third parties, including Standard Bank, are required to report certain information to SARS. SARS compares this information with the customer's tax return for accuracy and completeness.