Hi,
I like your thinking, you've clearly put a lot of thinking in to this analysis. It is however a complex area, touching on both taxation and investment principles. Some pointers/corrections though, followed by suggestions.
1. Your return on unit trusts, will potentially be a mix of dividends, capital gains and interest. In all likelihood, in the scenario you have pitched (general equity unit trust), your returns will probably be a mix of dividends and capital gains.
2. Any dividends and interest are, depending on the rules, distributed monthly, quarterly, semi-annually or annually. You can elect to re-invest your distributions. This essentially enables you to compound your return.
3. The tax treatments on these difference streams of income are;
3.1 Interest. Taxed annually, and after deducting a annual interest exemption, effectively taxed at marginal rates. Which could be up to 40%.
3.2 Dividends. Subject to a dividends tax of 15% on declaration. For a individual investor, this will be unavoidable.
3.3 Capital gains. Subject to capital gains tax annually when your unit trusts are disposed (NB) of. Effectively, and depending on your individual tax situation, this could be taxed at (after deducting an annual exemption) at anything from a rate of 0% to 13.3%
4. Note that the annual exemptions identified in 3.1 and 3.3 are not carried forward if not used. I.e. If you retain all your unit trusts in year 1 and 2 and dispose of them all in 3. You are only permitted to deduct the annual exclusion of 30k. (yes, it may be in your benefit to sell and re-invest some unit trusts annually).
5. Almost forgot, you get no direct tax benefit of paying your bond off first. But you do get the indirect tax benefit of this "return" being effectively tax free.
None of the above changes the facts in your scenario though. You essentially are comparing the after tax effects of either;
1. paying off your bond. This way you effectively "earn" tax free interest of 8.25% (24 750/300 000).
vs
2. Or earning income (or capital gains) of 13% pre tax. As discussed above, this would be taxed differently, depending on how its earned. For comparison purposes, lets take the worst case scenario (for the tax calc) and assume the entire 13% return will be returned via dividend distributions. This means your after tax return will be 11.05% (13% return minus 15% tax) . Compare this to your 8.25% return indicated above.
This comparison will only get better if you start doing the same calculation with capital gains tax rates and utilization of annual capital gains tax exemptions.
However, this doesn't mean you must run out and buy unit trusts immediately......
1. Long term return on the JSE is probably around 12.5% to 13.5%. Knock off a 1% or 2% for unit trusts management fees, and you're probably looking at a real return of of anything between 10.5% to 12.5%. If you choose (or guess badly) and end of on the lower end of the scale (10.5%). Deduct (say) 15% tax, and your return is hovering at just under 9%. Making it marginal over the bond.
2. There is risk in investing in unit trusts. Whereas investing in your bond is relatively safe. The risk in equity unit trusts are as follows.
2.1 Volatility. Your return on unit trusts won't be a smooth 13%, the return will change as the market moves. It is possible for the value of your investments to drop in value over the short term. Over the long term, it will probably return to the 13% return you referred to. The risk here, is that you need to access the monies (i.e. pay for a deposit on your next house), at the same time as your market has lost (and your unit trusts) have lost value. Wait it out, and the value will recover...... But the opportunity to buy the house may be gone.
2.2. You may in fact invest in a "dog" of a unit trust, and you get nowhere close to the 13% you are looking for.......
Stick it in to the bond, and you don't have the above risks.
I'm not familiar with your personal investment portfolio, retirement plan and aptitude to risk, so i'm loath to make recommendations, But some considerations for you.
1. If you have an access bond, you may want to place the majority of your monies in to your bond. And then invest piecemeal in to unit trusts. This will give you time to familiarize yourselves with the industry, returns and your aptitude to risk....
2. Consider investing in a low cost index tracker unit trust (or ETF). This eliminates the risk of picking a "dog", whilst obtaining market equivalent returns
3. Consider your investment time horizon before making the choice between unit trust or bond. I.e. if you reckon you're going to need the money earlier than the 3 years referred to, then weight your investment in the bond. If greater than 3 years, then start looking at unit trusts etc.
4. Also note that there will be a new tax exempt investment vehicle to be made available next year. This will be subject to contribution limits, but all returns are tax exempt. It might be worth leaving some monies in your bond to make use of this savings vehicle (note that there is nothing stopping you selling/transferring from unit trusts into this vehicle).
5. Consider the business cycle before making your investment. My opinion is that the equity market is overvalued currently (this view is debatable). But if true, this will result in reduced returns on your unit trusts over the short term. On your bond front, we are definitely in a rising interest rate cycle, so unless you've had your interest rate fixed, interest on the bond are going to increase and in the short term, close the gap in interest returns vs equity returns. Increased interest rates will also increase your monthly installments, putting pressure on disposable income. So it may be worth having overpaid on your bond.....
6. Tax legislation changes from time to time. For example, i am expecting an increase in tax rates in higher income individuals next year. Ditto for CGT rates.
My last bit of advice, DO NOT make your choice purely on the tax effect of either investment choice. Yes, consider it and let it be a factor, but don't let it choose your investment for you......
