Be tax savvy
Consider the tax implications of any investment. An investment is ‘tax-effective’ if you end up paying less tax than you would have paid on another investment with the same return and risk. While lower tax can help your savings grow faster, you should never base an investment decision on tax benefits alone.
Here’s some guidance about what makes some investments more tax-effective than others.
- Know your marginal tax rate
- Shares and property
- Managing gains and losses
- Investment bonds
- Watch out for ‘tax-driven’ schemes
The first step in understanding how tax affects you is to know what ‘marginal tax bracket’ you are in. This simply means ‘If I earn an extra dollar, how much extra tax will I pay?’ The following table will help you work out how much tax you are paying and what your marginal tax rate is, or you can use our income tax calculator.
Find out your marginal tax rate.
Marginal tax rate for regular income (2018-19 rates)
|Taxable income||Marginal tax on income in this bracket*|
|$18,201-$37,000||19c for each $1 over $18,200|
|$37,001-$90,000||$3,572 plus 32.5c for each $1 over $37,000|
|$90,001-$180,000||$20,797 plus 37c for each $1 over $90,000|
|$180,001 and over||$54,097 plus 45c for each $1 over $180,000|
*These rates do not include the Medicare levy (usually 2%) or the Medicare levy surcharge (1%-1.5% for high income earners). For more information see ATO: Medicare levy. Temporary budget repair levy is included in the top marginal tax rate.
Joe reduces his tax through super
Let’s take Joe for example, who earns $50,000 per year. That means he will pay marginal tax of 32.5c (or 32.5%) for every extra dollar he earns, as his income falls in the $37,001 to $90,000 tax bracket.
If you can invest so the tax you pay on your investment returns is less than your marginal tax rate, then you are ahead. For example, if Joe puts money in superannuation, he pays at most 15% tax on investment earnings. This is less than his marginal tax rate, so super is ‘tax effective’ for him.
Find out what income is taxable.
Income you receive from investing in shares and property (dividends or rent) will generally be taxed at your marginal tax rate.
‘Franked’ dividends are dividends paid by an Australian company out of profits it has already paid tax on. You will get a credit for the 30% company tax already paid, called an ‘imputation credit’ or ‘franking credit’. This means that a $7 franked dividend is worth the same as a $10 unfranked dividend.
Franked dividends are ‘tax effective’ investments because the tax you pay on them is reduced by the amount of tax the company has already paid. If your marginal tax rate is less than 30% you can have the excess franking credits refunded to you. For more about franked dividends, see dividends.
A capital gain is the profit you make when you sell an investment for more than what you paid for it. Capital gains are generally taxed at a lower rate than other personal income, see managing gains and losses for more information.
The Government gives incentives through the tax system to encourage people to save for retirement including:
- Investment earnings in super are taxed at a maximum of 15% (10% for capital gains)
- Super contributions, both employer and salary sacrificed contributions (up to the contribution caps) are only taxed at 15%
- If you are self-employed, you can claim tax deductions for super contributions (up to certain limits)
- Most people over 60 pay no tax on the money they take out of super
- When you start a super pension, investment earnings are tax-free
See tax and super for more information.
When you make a profit from selling your investments you are likely to have to pay capital gains tax. The Australian Taxation Office has useful information to help you work out your capital gains.
A capital gain is added to your income in the year you sell the investment and taxed at your marginal rate. If you held the investment for more than a year you are only taxed on half the capital gain. So if your marginal tax rate is 37%, your capital gains are effectively only taxed at 18.5%.
Keep a record of any losses you make as they can be used to offset any gains. Capital losses can be carried forward for use in later years. All you need to do is make a record of them in your tax return. When you make a capital gain in future years, you can deduct your loss from the gain.
Case study: Tom makes use of a capital loss
Tom made a capital loss when he sold his shares in a big mining company. He bought $1000 worth when they were $40 per share and sold them for $30 per share. So he made a loss of $250.
Tom also made a profit of $400 from selling some shares he held in a phone company. Tom can deduct the $250 he lost from the $400 he gained. This leaves him with a total profit of $150. As Tom had held the shares for more than 12 months, he will only pay tax on half the profit. A capital gain of $75 will be added to Tom’s taxable income.
Investment bonds (also known as insurance bonds) are investments offered by insurance companies and friendly socieities that can be a tax effective way to invest for the long-term if certain rules are followed.
All earnings in an investment bond are taxed at the corporate tax rate of 30%. If no withdrawals are made in the first 10 years of holding the bond, no further tax is payable, so they can be tax effective for investors with a marginal tax rate higher than 30%.
Contributions can also be made to investment bonds, however there are limits on the amount you can contribute and still receive beneficial tax treatment.
See investment and insurance bonds for more information.
Watch out for ‘tax-driven’ schemes
Tax schemes generally let you postpone your tax, but you’ll still have to pay tax in the end. They offer tax deductions now for investing in assets that may produce an income in the future.
A worthwhile strategy needs to be a sound investment first. Any tax benefit should be secondary.
Agricultural schemes, for example, can take up to 20 years to earn any income. Look for a clear ruling from the ATO on the tax deductions available for individual schemes.
If you are being advised to invest in a tax scheme, check it’s not because your adviser will be earning substantially more commission than if they recommended another investment such as a managed fund. Many schemes designed to minimise tax are high-risk investments. The investment should fit within your investment plan and risk profile.
For more details see the ATO’s Investigate before you invest.
Some types of investments are more tax effective than others. Shares with franked dividends can help you at tax time. Super also has tax advantages. Managing capital gains and losses needs to be a part of your overall investment plan.