It’s that time of year when we start thinking about ways to make last minute tax savings. One of the best strategies to save on tax over time and also grow personal wealth, is by investing in assets that offer tax concessions.
First up, let me stress that I’m not referring to tax-based investment schemes involving the likes of tea tree plantations or ostrich farms. These typically promise high returns as well as significant upfront deductions.
They can sound appealing, and while some of these tax-driven investments might actually pay off, generally, their track record is appalling, often resulting in loss of capital. If you are unlucky enough to tip money into a dodgy tax scheme you could still be slugged with a tax bill and even late payment penalties. That doesn’t qualify as a good investment in my books. My advice is avoid.
What I mean by tax-friendly investments are assets like quality shares. If you hold onto shares for more than 12 months you are normally entitled to a 50% discount on the capital gains tax that may apply to any profit you make when the shares are sold.
Similarly, dividends earned on shares can be a tax-friendly return to shareholders. That’s because the tax man allows you to claim franking credits, which recognise the 30% tax paid on company profits. For instance, if your personal marginal tax rate is below 30% you generally won’t pay tax on franked dividends, you may even the excess franking credits refunded to you – an extra after-tax return! Even if your personal marginal tax rate is over 30% you will still pay less tax (due to the franking credits) than you would on the equivalent return on another investment, eg bank account interest.
Investment properties also offer opportunities to save on tax. The same 50% capital gains discount applies if you sell an investment property you have owned for more than 12 months. Landlords can also claim a tax deduction for a wide variety of the costs associated with owning a rental property, including depreciation.
Your super can also be a very tax-friendly investment. Any contributions made out of your pre-tax wage or salary are taxed at a maximum of 15%, which could be less than your personal tax rate. And from age 60, you can access your super savings tax free.
This is all quite different from interest earned on savings held in deposit accounts. Any interest you earn is fully taxable, and if you are a high income earner that could mean handing over up to almost half of any interest you receive to the Tax Office.
The surprising thing is that while many of us actively look for ways to save on our tax through, say, work-related deductions, we continue to hold large chunks of money in savings accounts where the returns are watered down by tax.
If you’re serious about building wealth and quite legitimately, cutting your tax bill, it’s worth considering the tax implications of your investments.
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. Bear in mind though, while tax benefits are appealing, you should never base an investment decision on tax savings alone.