Tax is most people’s largest lifetime expense! Therefore, it is not difficult to understand how taking proactive steps to minimise your taxes can produce significant financial benefits. Different taxes will impact you at different stages of life depending on the wealth you have accumulated i.e. types of investments, amounts and ownership structures used.
The common mistake that people make is that they are too short-term focused. That is, they focus on reducing taxes immediately, with little regard for the longer-term repercussions. Instead, it is prudent to employ a more balanced approach. There are four main taxes you need to consider.
Income tax
Obviously, whilst you are working, income tax is a significant expense. Therefore, looking for ways to reduce your income tax expense is very important. There are several strategies that we can draw upon such as negative gearing, super contributions, shifting income and deductions between spouses in different tax brackets, tax-effective business income structures and so on.
Future expected changes in employment income also need to be considered.
It is also important to consider what your tax position might be in the future too, particularly in retirement. It might be great for one spouse to own all the investments assets prior to retirement (to enjoy the best negative gearing savings) but that might result in a very uneconomical distribution of taxable income in retirement.
Finally, there is a common theme of income tax brackets flattening around the world with the top rate of tax in both the US and UK being under 40%. Therefore, it doesn’t make sense to be too convoluted with your tax planning/allocations as a small change in rules might eliminate any expected savings.
Capital gains tax (CGT)
You may need to sell investment assets at some point to reduce/repay debt or fund retirement. After all, you can’t take them with you when you die! Assuming you have been an Australian tax resident for the entire time you have owned the investment (and have owned it for more than 12 months), you should be entitled to the 50% CGT discount. This means that your effective CGT tax rate will be a maximum of 23.5% of the total net gain (being 50% of the highest marginal rate of 47%).
If you invest in quality assets and hold them for a long period of time, any capital gain is likely to be considerable (in dollar terms). Therefore, the ability to share such a gain with other taxpayers (e.g. via family trust distributions) would save a reasonable amount of money. Tax payable on a $1 million gross capital gain in one taxpayers name would amount to $235,000. However, if you could share this gain equally across four taxpayers (e.g. you, your spouse and your retired parents), the total tax payable reduces to approximately $145,000 (or 14.5%) resulting in a $90,000 saving.
If your financial plan includes divesting of assets at some point, you need to consider the tax outcomes.
Land tax
Land tax is payable if you own land (other than your home) that exceeds the tax-free threshold, which is different for each state in Australia. It is an insidious tax as it tends to be minimal when you first invest in property and then becomes more expensive at a time when you need to minimise your outgoings… i.e. in retirement.
The tax-free thresholds are per individual so, from a pure land tax perspective, you and your spouse are better off owning one property each – if you own two properties, for example.
Land tax rates between states vary significantly. Also, most states levy a higher rate of tax for property owned by a discretionary (family) trust. To illustrate this, the table below (reproduced from page 148 of my book, Investopoly) illustrates the different land tax liabilities for land valued at $1 million when held in different states and via a trust versus personal name.
| Annual land tax on $1m of land value: Family trust versus personal name | |||
| NSW | VIC | QLD | |
| Personal name | $7,316 | $2,975 | $4,500 |
| Trust | $16,000 | $6,438 | $12,500 |
Superannuation tax
Superannuation is a very tax-effective environment. Whilst you are in accumulation phase (i.e. pre-retirement), investment income is taxed at a flat rate of 15% and capital gains at 10%. When you enter pension phase (i.e. when you are retired and over the age of 60), your super fund’s investment income and capital gain tax rate falls to zero (if your total super balance is less than $1.6 million). You can’t get better than a zero tax rate can you?
Many people are discouraged by the fact that the government is constantly changing the super tax rules. Whilst this is frustrating, the tax advantages of super are just too good to ignore. And it’s a reasonable assumption that it will always be concessionally taxed.
Who do you see? A financial advisor or accountant?
As a financial planner that is also a registered tax agent (and chartered accountant), I appreciate how important it is to consider the tax consequences when developing a financial plan. Too many accountants don’t have enough financial planning knowledge and experience. And too many financial planners don’t understand the tax laws. This is a problem and the best solution is to have a balanced approach between both financial planning and tax planning.
Ultimately, your goal should be to maximise your wealth after all taxes. To achieve this, you must ensure that your wealth strategy is tax-effective and that your tax strategies allow you to maximise your wealth. Many accountants focus on tax without any consideration of its impact on wealth. Therefore, make sure that your wealth and tax advisors are aiming at achieving the same goal i.e. maximising your after-tax wealth. To achieve this, they need to have a close working relationship.
Want to learn more? Join me for a live stream seminar
On 24 July I am hosting a live stream seminar on all things tax. The aim of this presentation is to help investors minimise tax in a way that doesn’t hamper their ability to build wealth. You will be able to watch the live seminar from the comfort of your home (desktop, tablet or phone), interact and ask questions. All attendees will also get a copy of our recently updated eBook, Tax Busting Structures.
Click here to learn more and register now. Numbers are limited.
