Creating wealth is a long-term process, and in the same way that being a small degree off-course can have a huge impact while navigating a long journey, small effects add up to big outcomes over long-term investing.
As such, tax efficient investing creates better returns for no extra investment risk. For example if you built two identical portfolios in two separate entities, with the only difference being the tax rate applied to the earnings, the result will be better returns for the entity with the lower tax environment.
With that in mind there is a tax structure in Australia you can build assets in, so tax efficient it makes seeking a tax dodging strategy like an offshore bank account in the Isle of Man redundant.
Why risk either being ripped off or going to jail by siphoning your money offshore to avoid tax, when there is a perfectly legal way to reduce your tax right now?
Very few people understand how attractive this tax vehicle is, as it has a very boring and bureaucratic name. Considering the advantages of ending up with more money in your pocket over the long term, it’s strange you never see this tax structure up in lights.
However, for those in the know, it has such unbelievable advantages that the government built restrictions on how much you can put in. They did so to stop those who bother to wade through the technical data from pouring as much money in as possible.
Lucky for you, I’m going to save you the hassle of peeling through hundreds of pages of dry government fact sheets, and instead put all the tax benefits here for you in plain English.
The crazy thing is, you would already have heard of this tax structure before, probably even own one, but found it to be as stimulating as a Top 40 dance track from the 1990’s (Except The Prodigy, they were awesome, and I won’t hear another word about it.) It’s called Superannuation.
The misconception about Superannuation is that it’s an investment. It isn’t. It’s a tax structure. Think of it as a car. Just as you can put almost any kind of person in a car, you can build almost any kind of investment portfolio inside of Superannuation (restrictions exist: here for summary, here for in-depth).
It will save you money right now today, save money every year, and save money in retirement. Put simply, with the choice to build an investment portfolio in your own name, compared to building an identical portfolio in Superannuation, you can ensure a better after-tax result by using a tax-efficient entity while not taking on additional investment risk.
1) SAVE MONEY TODAY
As an ex-tax accountant, I can’t tell you how many people ask this question around tax time: ‘What can I do to reduce my tax?’ Most people hate paying more tax than they must, and will do anything to reduce it. Think Negative Gearing, the purposeful loss in income to pay less tax.
What if there was a way to reduce your income, but rather than losing your money through Negative Gearing, you kept the money instead?
This strategy is called salary sacrifice. It is redirecting a portion of your salary to Superannuation and is taxed at 15% (for incomes <$300k). For example, if your salary is above $180k, you pay close to half your income in taxes and levies. By redirecting a portion of your salary to long-term investments, you immediately save over 30% in tax.
2) SAVE MONEY EVERY YEAR
Investments should earn the investor income every year. If you hold investments in your own name, this income goes on top of your salary. For example, if you earn $80,000 per year from employment, and a further $20,000 per year in investment income, the investment income is taxed at almost 40%.
If instead, you earned the $20,000 investment income inside of a Superannuation tax structure, you would have only paid 15% tax. Saving over 20% tax on your investment returns every year of your wealth creation is going to have a substantial positive effect on your long-term results. Also, as franked dividends are taxed at 30%, and the tax environment for Superannuation is only 15%, you’re able to claw back the other 15% tax from the government. Imagine that! The government paying you tax instead of the other way around!
3) SAVE MONEY IN THE FUTURE
The benefits of the Superannuation tax structure are impossible to beat once you hit the age you are finally going to start using your asset base for the purpose it was designed for: to pay you an income when you no longer work. It is impossible to beat because these three points have a tax rate of 0%. And you can’t beat 0% tax. It’s truly an offshore bank account within our own borders.
3a. SELL ASSETS FOR 0% CAPITAL GAINS TAX (CGT)
When a couple in their sixties is sitting in front of me and about to declare retirement, they often tell me with pride the size of the investment portfolio they have built up over the last forty years in their own names. Properties, shares, managed funds etc.
The pain in their eyes when I tell them the size of their tax bill because of their success has stayed with me. It’s not fun learning you have to pay the government hundreds of thousands of dollars just as you’re about to start surviving on the spoils.
If they had only known about the ability to transfer assets held inside of Superannuation into tax-free environments before selling, they could have avoided every cent of tax payable.
As soon as you ‘flick the switch’ on the Superannuation tax structure from ‘accumulation’ to ‘pension’, every asset immediately becomes tax-free (assuming your super account allows this).
3b. TAX ON EARNINGS DROP TO 0%
For the entire wealth creation journey inside of Superannuation, you only pay 15% tax on all earnings by investments. And it gets even better from there. Once you hit pension phase, the tax then becomes 0%.
From the moment you start receiving income from your assets, your investment portfolio will live in an entirely tax-free environment, never to pay tax on investment earnings again.
3c. INCOME FROM SUPERANNUATION IS TAXED AT 0%
And finally the last benefit of reaching pension phase and having your assets inside of a Superannuation tax structure, is the income you draw down to fund your ideal lifestyle when you no longer work is taxed at 0% also (Only after age 60. From age 55 – 60 the income is taxed Marginal Tax Rates less 15%. This age 55 access is only available to those born before 1 July 1960. Sounds complicated but it isn’t. If you are under age 50 now, you have to wait until you’re 60.)
From the benefits above, you can see the Superannuation tax structure is the best entity for you to build an investment portfolio in the short term as you pay less tax today, the medium term as you pay less tax every year, and the long term when all assets and income become tax-free.
Now consider the only ‘downside’ of using Superannuation to build an investment portfolio: you can’t spend the funds until you reach retirement. But investing is a long term endeavor, so I have no qualms in putting forward the merits of Superannuation.
So how do you get money into your superannuation? Firstly you can use Salary Sacrifice to get pre-tax money in there. This can be helpful to save tax today, but it has low thresholds (found here note this limit includes your mandatory super contributions from your employment).
You can also simply deposit money into super from your bank account as it is after-tax money and the threshold is much higher (found here), however when was the last time you did that?
Raiz again have come to the rescue by bringing this valuable tax entity to the fingertips of the money-smart. All you have to do to start being proactive in using this tax effective vehicle to build your long term asset base is 1) click Settings, 2) click Super Fund and follow the prompts. The simplest way I’ve seen to start using the benefits already afforded to you under law.
Disclaimer: While deep diving into topics and education is great, we have a responsibility to ensure you don’t make any mistakes so please read this statement first:
Superannuation is not an offshore bank account, and the term is used as an entertainment analogy only. Thresholds and super laws are notorious for changing, and the rules change frequently. As such, Clayton Daniel nor Raiz cannot be held responsible for the validity of the information contained in this article, nor the outcome you achieve with this information. This article gives an overview of the tax benefits of superannuation, but it does not reference the returns of the investments within any Superfund. It neither takes into consideration your personal situation or your needs. Therefore the information is general in nature. This article - and indeed any article - is not capable of being used as personal financial advice nor is it intended to be. If this isn’t clear enough, before taking any action with superannuation, get professional advice first. More information can be found here.
Clayton Daniel is a financial commentator best known for reducing decision fatigue through financial automation. He is the author of upcoming book Fund Your Ideal Lifestyle.