Investing your money can enable you to earn more income or gain assets that increase in value, but it’s important to invest wisely by not paying more tax than you have to.
Some of the ways to facilitate tax minimisation on investments include negative gearing investment property, making superannuation salary sacrifice contributions and claiming deductions relating directly to investment income.
Both the investment structures you use and the strategies you develop should work together to minimise the tax you pay.
Here’s what you need to know, and some tips to help you get started.
Investment structures and investment strategies – what are they?
Structure: An investment’s structure refers to its legal ownership. Examples of this include individual asset ownership, partnerships, trusts (including superannuation funds), and companies.
Different types of legal structures can offer different advantages. For instance, investing in superannuation offers a reduced tax rate, while a family trust allows income splitting between members, and a company incurs a flat tax rate (currently 30%).
Strategy: An investment strategy is really what you do with your investments in order to get the best outcomes. For example, you might choose to invest in property where you are the owner (that’s the structure bit) for the purpose of reducing tax through negative gearing while growing your wealth in the longer term (the strategy part).
How to minimise tax through investment strategies
Here are a few things to consider when deciding on your strategies.
Super can be one of the best options around for tax reduction and effectiveness, as income earned in super usually has a 15% maximum tax rate, while capital gains are taxed at 10%.
How to reduce taxable income through super:
- Salary sacrifice – ‘sacrificing’ a portion of your pre-tax wage reduces your gross income and your tax liability along with it.
- Transition to retirement (TTR) – people over 55 can set up a TTR arrangement where they can withdraw up to 10% of their super balance each year before full retirement. When combined with a salary sacrifice arrangement of the same value, their super balance is replenished and their current gross income remains the same – but with a reduced tax rate. And for people over 60, super withdrawals may become tax free altogether.
- Co-contributions – contributing to super from after-tax income also has advantages. As well as boosting retirement funds, income earned is usually taxed at a lower rate than marginal rates.
- Business owner / retiree contributions – if you are a business owner or retiree you may be able to contribute to a super fund and claim a tax deduction on your contributions.
- Self-managed super fund (SMSF) – a self-managed fund allows you to decide how your money should be invested, rather than entrusting it to a superannuation company.
There are other ways to reduce tax through super as well, including:
Contributions to superannuation funds are capped at certain amounts and it’s important to be aware of these, or you may end up with a tax bill – which would defeat the original purpose of the exercise!
Many of the expenses involved in an investment property are tax deductible, including borrowing expenses, interest, advertising, maintenance and agent fees. Losses on your investment can also be offset against your other income, which reduces your tax bill.
Capital gains tax from selling your property can be reduced if you hold on to your investment for more than 12 months, and if you sell during a financial year when your income is likely to be lower.
Investment or insurance bonds are taxed at the company rate which can often be lower than marginal rates, and also become tax free after 10 years (as long as there are no withdrawals in that time).
Another advantage is that you are taxed internally (within the bond itself), which means you don’t need to include the earnings on your tax return.
You can also continue contributing without breaking the 10-year benefit, as long as your contribution is no more than 125% of last year’s (known as the 125% rule).
Family trust / asset splitting
A discretionary family trust allows for sharing income around family members and the tax burden along with it – which could be especially good for higher income earners.
The same applies with asset splitting – by putting an asset in the name of a household member in a lower tax bracket, your overall tax burden can be reduced.
Company shares / dividends
Companies pay dividends from their after-tax profit. Shareholders’ dividends come with franking or imputation credits for the tax that has already been paid by the company.
This means you could get a refund from the tax office if your top marginal rate is less than the company rate.
You can own shares directly by investing yourself or by using a managed account, where you hire a professional to invest on your behalf.
Three tips for getting started on tax planning
1. Start by knowing what your marginal tax rates are. This can help you work out whether an investment strategy is likely to be tax effective for you or not.
2. Choose the right structure. This will depend on your goals and other factors such as your income and marginal rates. For instance, if you are the highest income earner in your household, income splitting could allow you to save tax by putting an asset in a family member’s name. On the other hand, negative gearing may be pretty ineffective for low-income earners who are already on a low marginal rate. In this case, the asset is probably best put in the name of the highest income earner in the family.
3. Develop the best strategies to maximise your income while minimising your tax. For example, work out how much income you can afford to sacrifice now for a future benefit.
As you can see, there is more than one way to go about investing in a tax effective way! Structures such as property, shares, superannuation and trusts can offer different benefits for investors, while strategies such as salary sacrificing and negative gearing are great methods of tax minimisation.
However, some of the investment tax rules are very complex, which is why it’s a good idea to seek professional advice before making your decisions.