Depending on your personal financial circumstances, there are bound to be ways you could minimise you tax obligations to maximise your investment returns.
Types of investment
Investing in shares or property is generally more tax effective than investing in cash. This is not only because we are in a low interest rate environment but you will have to pay your marginal tax rate on any interest earned in a term deposit or bank account.
Alternatively, if you invest in companies on the Australian Securities Exchange (ASX) that pay dividends, you get the benefits of franking credits. When a company pays tax on its earnings, the tax you pay on your dividends is reduced by that amount. If your marginal tax rate is less than 30 per cent, you may even receive a cash refund.
Property investors can utilise the tax benefits of negative gearing to boost returns. Negative gearing occurs when the cost of owning a rental property is greater than the income it generates each year. This creates a tax loss, which may be offset against other income including your wage or salary.
If you hold your shares or property for more than a year, any capital gains will only be taxed at half your marginal tax rate. And if you have a capital loss on another asset you can offset it against your gain.
Choosing the right vehicle
Despite the recent winding back of some tax concessions, super is generally considered the most tax effective vehicle for investments for a number of reasons.
Firstly, you only pay 15 per cent tax on your superannuation guarantee or salary sacrifice contributions (30 per cent if you earn more than $250,000 a year). That means that for every $1 you contribute, 85c is invested. But if you invest outside super, it’s with after tax money. So if your marginal tax rate is 30 per cent you would only have 70c in every dollar to invest and even less if you’re on the top rate.
Secondly, tax on earnings in super is 15 per cent at most but can be less if franking credits are applied.
Thirdly, once you enter pension phase there is no tax on earnings.
The icing on the cake is that once you’re over 60, you can withdraw money from your super without paying any tax.
Super is also favourable when it comes to capital gains tax as you only pay 10 per cent tax on any gain.
Other tax-effective investments
Outside super, you may choose to put your money in investment bonds.
Also known as insurance bonds, they can prove tax effective if your marginal tax rate is higher than 30 per cent. That’s because you pay 30 per cent tax on the investment for the first 10 years. If you make no withdrawals during that period no further tax is payable.
Different strokes for different folks
According to a survey by Russell Investments and the ASX, tax also plays a role when deciding whose name to hold investments in and what investment vehicle to use.i
The return on Australian shares in the 10 years to December 2016 was 4.7 per cent in the hands of somebody with the lowest marginal tax rate, 3 per cent for somebody on the highest rate and 4.9 per cent when in super.
It’s a similar story for residential property: a return of 7.2 per cent for the lowest tax rate, 5.8 per cent for the highest and 7.2 per cent in super.
Returns were significantly lower for cash but the same trend emerged.
Tax plays an important role when it comes to maximising returns so why not talk with us to see how we can help you to make the most of your investments.
i 2017 Russell Investments/Long-term Investing Report, ASX.