New South African Investor Seeking Advice

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Topic Author
FreedomChaser
Posts: 5
Joined: Wed Feb 12, 2020 3:49 pm

New South African Investor Seeking Advice

Post by FreedomChaser » Thu Feb 13, 2020 2:24 am

Hey Bogleheads! :)

I'm new investor and brand new to the forum. I thought I new what I was doing, and I thought I'd finally created my perfect portfolio, but I've just discovered the Non-US Domiciles section of your Wiki and my little brain has exploded all over the internet and now I need help figuring out what I need to do.

My info:
Country of Residence: South Africa
International Lifestyle: Currently working abroad, earning a USD salary. Most of my life is spend outside of my home country and will definitely not retire there.
Currency: USD
Emergency funds: 6 months USD in an offshore account.
Debt: Zero
Age: 32
Desired Asset allocation: 80-90% stocks / 10-20% bonds

So, I am in a uniquely advantageous position of earning an offshore USD salary. I would like to keep my funds in dollars, since I don't spend much time in South Africa. I wont be there for much longer and honestly I don't know where I'll end up, so keeping USD's seems like a safe bet. I've been investing with Interactive Brokers for the last 6 months, but I've been doing so strictly from the perspective of a US investor (as I didn't know any better). I've been shoveling cash into the following portfolio:

70% VTI (US total market)
20% VXUS (total international exUS)
10% BNDW (total world bonds)

But, I'm now learning that it's probably not the best idea to be using US-domiciled ETFs. South Africa enjoys a 15% US withholding tax, but my concern is that I am now taking an unnecessary 15% tax hit on my international equity and bond fund distributions. Also, I'm currently not too concerned about estate tax (I have no heirs and my portfolio is still too small), but if one day I change my mind, I fear that the capital gains hit to change funds will not be worth it.

My first question is: Are my concerns valid? As a South African, should I stick with what I have, or instead, be setting myself up to be using Irish-domiciled ETFs from the get-go?

If Irish ETFs are the way forward for me, I have two follow up questions:

For my second question, I'm thinking of a portfolio of 90% VWRD/VWRA and 10% VAGU. I want to keep things as simple as possible. Is this a sufficient substitute to my current portfolio? If not, what other funds would you recommend? I know this is more weighted towards international equity than my current portfolio, which is just fine. I'm leaning towards single, global market-cap weighted fund anyway (something as close as possible to VT)

And finally my third question: I've been combing through South African tax info and can't, for the life of me, figure out if distributing ETFs or accumulating ETFS (ie VWRD or VWRA) are more tax efficient for a South African tax-payer. I just can't seem to find any resource for this. Although my goals are aggressive growth and would just reinvest either way, but my preference would be distributing to help with rebalancing and to give me options later in life, If there is a tax benefit to accumulating then I would most certainly opt for that. If someone has any insight into this, it would be much appreciated.

Thanks in advance for helping me figure out this investing stuff. :)

TedSwippet
Posts: 2646
Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: New South African Investor Seeking Advice

Post by TedSwippet » Thu Feb 13, 2020 6:41 am

Welcome.
FreedomChaser wrote:
Thu Feb 13, 2020 2:24 am
But, I'm now learning that it's probably not the best idea to be using US-domiciled ETFs. South Africa enjoys a 15% US withholding tax, but my concern is that I am now taking an unnecessary 15% tax hit on my international equity and bond fund distributions. Also, I'm currently not too concerned about estate tax (I have no heirs and my portfolio is still too small), but if one day I change my mind, I fear that the capital gains hit to change funds will not be worth it.
It depends. If your South African tax rate exceeds 15%, and if South Africa allows you a full credit against the 15% tax you pay to the US, you come out the same or slightly ahead (depending on what the ETF itself holds) if you hold US domiciled ETFs, compared to Ireland or other non-US domiciled ones. So you may be in a reasonable position already, at least from that perspective.

The biggie is of course the threat of US estate tax. South Africa does have an estate tax treaty with the US, but it is very old and the suspicion is that it does not raise the exemption beyond the standard $60k non-treaty amount. You can of course ignore this; you just have to live with the prospect of your heirs cursing you at your funeral for making an avoidable mistake.
FreedomChaser wrote:
Thu Feb 13, 2020 2:24 am
Are my concerns valid? As a South African, should I stick with what I have, or instead, be setting myself up to be using Irish-domiciled ETFs from the get-go?
As above, I think.

The other primary consideration is, which country will you end up in when you leave South Africa? And in particular, what tax treaties does it have with the US? If it lacks a treaty, or if the treaty rate exceeds 15%, Ireland domiciled ETFs may survive the move better than US domiciled ones. Or maybe the move will present the opportunity to cash out and re-buy equivalents without too much capital gains tax damage. Impossible to say without knowing where you will move to (and perhaps also very difficult to say even when knowing!).

From the sound of what you wrote though, it seems like setting up things with this future move in mind might be one of the main factors here.
FreedomChaser wrote:
Thu Feb 13, 2020 2:24 am
I've been combing through South African tax info and can't, for the life of me, figure out if distributing ETFs or accumulating ETFS (ie VWRD or VWRA) are more tax efficient for a South African tax-payer.
Sorry, no insight.

Topic Author
FreedomChaser
Posts: 5
Joined: Wed Feb 12, 2020 3:49 pm

Re: New South African Investor Seeking Advice

Post by FreedomChaser » Thu Feb 13, 2020 10:33 am

It depends. If your South African tax rate exceeds 15%, and if South Africa allows you a full credit against the 15% tax you pay to the US, you come out the same or slightly ahead (depending on what the ETF itself holds) if you hold US domiciled ETFs, compared to Ireland or other non-US domiciled ones. So you may be in a reasonable position already, at least from that perspective.
Thanks for the insight, Ted. This is something I hadn't even considered. South Africa imposes a tax of 20% on foreign dividends, taxed as regular income. I do not know if they allow a tax credit on the 15% withholding to the US. If this is the case, then my first concern is solved. Looks like I need to do some more digging.
The biggie is of course the threat of US estate tax. South Africa does have an estate tax treaty with the US, but it is very old and the suspicion is that it does not raise the exemption beyond the standard $60k non-treaty amount. You can of course ignore this; you just have to live with the prospect of your heirs cursing you at your funeral for making an avoidable mistake.
This is the big problem I'm having. Making this future-me's problem does not seem like a sound strategy.
The other primary consideration is, which country will you end up in when you leave South Africa? And in particular, what tax treaties does it have with the US? If it lacks a treaty, or if the treaty rate exceeds 15%, Ireland domiciled ETFs may survive the move better than US domiciled ones. Or maybe the move will present the opportunity to cash out and re-buy equivalents without too much capital gains tax damage. Impossible to say without knowing where you will move to (and perhaps also very difficult to say even when knowing!).
I honestly don't know where I'll end up or when. All I can do is make the best plan to cover most scenarios, which is sounding more and more like switching to the Irish ETFs are a good bet.

TedSwippet
Posts: 2646
Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: New South African Investor Seeking Advice

Post by TedSwippet » Thu Feb 13, 2020 1:27 pm

FreedomChaser wrote:
Thu Feb 13, 2020 10:33 am
Thanks for the insight, Ted. This is something I hadn't even considered. South Africa imposes a tax of 20% on foreign dividends, taxed as regular income. I do not know if they allow a tax credit on the 15% withholding to the US. If this is the case, then my first concern is solved. Looks like I need to do some more digging.
From experience, most countries allow foreign tax credits. I know nothing about South Africa specifically, but this document from SARS suggests it does, although it looks to be limited to your average (rather than marginal) South African tax rate:
The rebate is limited to the foreign tax payable and may not exceed the result of the folowing formula: Total Normal Tax in South Africa x taxable foreign income / total taxable income. If the total foreign tax paid exceeds the limitation amount, the excess amount may be carried to the following tax year. But a loss incurred in carrying on a business outside South Africa may not be set off against income in South Africa.
FreedomChaser wrote:
Thu Feb 13, 2020 10:33 am
This {US estate tax} is the big problem I'm having. Making this future-me's problem does not seem like a sound strategy. ... All I can do is make the best plan to cover most scenarios, which is sounding more and more like switching to the Irish ETFs are a good bet.
What is the capital gain cost of switching? If large, one alternative way to approach this might be to take out life insurance to the value of the potential US estate tax. That could be relatively cheap for you, given your age, and it defuses this aspect of the problem. Knowing what you now know, you might not aim to get to where you are at present. But given that you're here anyway, going back and starting again could easily be worse than carrying on. The whole US estate tax nonsense is currently a threat, but it's not a reality.

For what it's worth, the thinking that the South African and Irish estate tax treaties with the US do not raise the exemption in the same way as the estate tax treaties with other countries do, comes from this paper (it's impressive that an "overview" of US estate tax takes 51 pages to cover, isn't it?):

https://www.kplaw.com/wp-content/upload ... e-US-1.pdf

Note that for South Africa, shares of US corporations are included in the list of what the US taxes, but the section on South Africa lacks the magic "$4,505,80086 x ..." formula. It's possible that this paper's analysis is incomplete or wrong, I suppose. Maybe read the treaty thoroughly to see if you can find a better answer?

Personally, I'd be tempted to live with this and just insure against. Particularly as that may be only for a shortish period, since you don't know what country you might be in, in a few years. And until that's resolved, put new investment and dividend reinvestment into non-US domiciled funds and ETFs, so that you don't worsen the US tax problem over time.

Topic Author
FreedomChaser
Posts: 5
Joined: Wed Feb 12, 2020 3:49 pm

Re: New South African Investor Seeking Advice

Post by FreedomChaser » Fri Feb 14, 2020 7:24 am

At the moment, the capital gains tax cost of switching funds is negligible, possibly nothing, as I'm very close to the yearly tax-free capital gains amount. The cost of the initial switch now is not a concern for me, rather the long term tax-drag on distributions (which you have clarified for me) and the CGT Tax cost of switching funds some years from now.

Thanks for all this information, and the docs. I'll do some more reading on the estate tax treaty and look into insurance options, but you have most certainly eased my panic of potentially needing so switch funds as soon as possible. I think for the time being, now that I know I have some options, I will keep my US domiciled Portfolio while I look into the details of my tax situation, and potential start contributing to Irish funds.. The next question is, which ones.. :shock:

Thanks again!

TedSwippet
Posts: 2646
Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: New South African Investor Seeking Advice

Post by TedSwippet » Fri Feb 14, 2020 8:53 am

FreedomChaser wrote:
Fri Feb 14, 2020 7:24 am
At the moment, the capital gains tax cost of switching funds is negligible, possibly nothing, as I'm very close to the yearly tax-free capital gains amount. The cost of the initial switch now is not a concern for me, rather the long term tax-drag on distributions (which you have clarified for me) and the CGT Tax cost of switching funds some years from now.
That's a good position to be in. Is this annual tax-free capital gains amount use-it-or-lose-it? If yes, now could be a good time to switch, or even to sell and then later repurchase the same assets so as to rinse out the gain and use up this allowance. UK investors regularly do this, or at the very least should if they are in a position to do so. It's a bit of a fiddle, but not only does this reduce your overall tax paid without changing your asset allocation and investments, it also reduces the 'lock in' effect of holding assets with built in but unrealised gains, meaning you are freer to move funds if or when required.

As for US domiciled ETFs ... these might be a bit of a nuisance now, but if you were to move to the US in future these would be the only ones you would want to hold. For US based investors and US citizens, Ireland domiciled ETFs are an even worse US tax nightmare than US domiciled ones are for you currently. I don't know if a move to the US is something you might do, but the weirdness of US tax rules are worth bearing in mind, anyway. The US has no annual capital gains tax-free allowance.

Topic Author
FreedomChaser
Posts: 5
Joined: Wed Feb 12, 2020 3:49 pm

Re: New South African Investor Seeking Advice

Post by FreedomChaser » Sat Feb 15, 2020 4:38 am

TedSwippet wrote:
Fri Feb 14, 2020 8:53 am
That's a good position to be in. Is this annual tax-free capital gains amount use-it-or-lose-it? If yes, now could be a good time to switch, or even to sell and then later repurchase the same assets so as to rinse out the gain and use up this allowance. UK investors regularly do this, or at the very least should if they are in a position to do so. It's a bit of a fiddle, but not only does this reduce your overall tax paid without changing your asset allocation and investments, it also reduces the 'lock in' effect of holding assets with built in but unrealized gains, meaning you are freer to move funds if or when required.
Yes, it is use it or lose it. I've done some reading and I see there is potential for SARS to see this sort of 'rinsing' as tax avoidance, so I would need to get all the facts and tread carefully, however selling and buying completely new Irish funds as you suggest should be fine. The second factor is the fact that that I've held the funds for less than a year, so I need to look into the short term / long term capital gains differences from the US perspective and from SARS.
TedSwippet wrote:
Fri Feb 14, 2020 8:53 am
As for US domiciled ETFs ... these might be a bit of a nuisance now, but if you were to move to the US in future these would be the only ones you would want to hold. For US based investors and US citizens, Ireland domiciled ETFs are an even worse US tax nightmare than US domiciled ones are for you currently. I don't know if a move to the US is something you might do, but the weirdness of US tax rules are worth bearing in mind, anyway. The US has no annual capital gains tax-free allowance.
Another Extremely valid point. Although I love spending time in the US, I don't think I could settle there. The healthcare situation alone is enough to keep me away! :shock:

TedSwippet
Posts: 2646
Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: New South African Investor Seeking Advice

Post by TedSwippet » Sat Feb 15, 2020 9:17 am

FreedomChaser wrote:
Sat Feb 15, 2020 4:38 am
Yes, it is use it or lose it. I've done some reading and I see there is potential for SARS to see this sort of 'rinsing' as tax avoidance, so I would need to get all the facts and tread carefully, however selling and buying completely new Irish funds as you suggest should be fine.
Probably. The UK has these odd 'bed and breakfast' rules that disallow some gain/loss transactions if you buy back the identical thing within 30 days or so. For investors holding individual stock, that means either finding a close substitute or being out of the market for a period.

For passive index tracking fund or ETF investors in the UK though, it's pretty easy to find another fund or ETF that tracks the exact same index, so that you change the wrapper around the stocks but the actual underlying stocks remain the same. That's a standard way to rinse out gains, and if the equivalent fund or ETF is not something you want to hold long term, perhaps it has higher charges, you then simply switch back after the 30 days has passed.

Maybe SARS has similar rules. If yes, similar workrounds should be possible.
FreedomChaser wrote:
Sat Feb 15, 2020 4:38 am
The second factor is the fact that that I've held the funds for less than a year, so I need to look into the short term / long term capital gains differences from the US perspective and from SARS.
I don't know about SARS, but you can ignore the US perspective of short/long term capital gains.

Apart from real estate, the US does not tax capital gains realised by nonresident aliens who hold US situs assets such as stocks, bonds, and ETFs. In that sense then, the US definitions of short-term and long-term holdings are irrelevant to you.

Topic Author
FreedomChaser
Posts: 5
Joined: Wed Feb 12, 2020 3:49 pm

Re: New South African Investor Seeking Advice

Post by FreedomChaser » Sun Feb 16, 2020 3:53 am

TedSwippet wrote:
Sat Feb 15, 2020 9:17 am
Probably. The UK has these odd 'bed and breakfast' rules that disallow some gain/loss transactions if you buy back the identical thing within 30 days or so. For investors holding individual stock, that means either finding a close substitute or being out of the market for a period.

For passive index tracking fund or ETF investors in the UK though, it's pretty easy to find another fund or ETF that tracks the exact same index, so that you change the wrapper around the stocks but the actual underlying stocks remain the same. That's a standard way to rinse out gains, and if the equivalent fund or ETF is not something you want to hold long term, perhaps it has higher charges, you then simply switch back after the 30 days has passed.

Maybe SARS has similar rules. If yes, similar workrounds should be possible.
This sounds great, and thanks for the concise explanation. I'm certainly going to look into if a similar technique can work here in SA. I will do some digging, though it's a shame that there aren't more South African Bogleheads out there to bounce feedback off.
TedSwippet wrote:
Sat Feb 15, 2020 9:17 am
I don't know about SARS, but you can ignore the US perspective of short/long term capital gains.

Apart from real estate, the US does not tax capital gains realised by nonresident aliens who hold US situs assets such as stocks, bonds, and ETFs. In that sense then, the US definitions of short-term and long-term holdings are irrelevant to you.
Thank you for clarifying this. I was more concerned on the US side of things as I don't think SARS differentiates between the two.

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