Budget 2012: Time for a tax strategy rethink
PORTFOLIO POINT: This year’s budget provides a good opportunity to make some subtle changes to your tax strategy.
From a personal finance perspective, three items from the 2012/13 budget might cause a rethink of strategies. These are:
- The changes in tax rates to create a much larger 'tax-free threshold’, which might see couples considering more income-splitting opportunities;
- Higher 'marginal tax rates’ that might see an increased emphasis on 'salary sacrifice’ and 'negative gearing’ strategies; and
- A reminder of the decreasing opportunities to get money into superannuation close to retirement, and the need to think about extra contributions earlier.
A larger tax-free threshold
For a number of years Australians have faced a $6,000 'tax-free threshold’, meaning that the first $6,000 of income earned by everyone is tax-free. In what is a significant change, this tax-free threshold has been more than trebled to $18,200.
This might be of particular use as a strategy for couples in which one partner is not earning income for a period of time, perhaps because they retire earlier or are not working for some reason. They can build an investment portfolio in their own name, while generating up to $18,200 of income (a little more if you include the benefits of the 'low-income tax offset’ or 'senior Australian tax offset’) and paying no tax.
It would take a portfolio of more than $300,000 to generate this level of income, so suddenly building an investment outside of superannuation, in the name of a non-income earner, might be more tax effective than building a superannuation investment portfolio, which is taxed at a 15% tax rate during the accumulation phase.
There are other potential benefits of investments held outside of superannuation; for example, it is easier to access the money (no withdrawal rules) and it may be more tax effective to distribute in the case of death.
Higher 'marginal tax rates’
But wait, there’s more: while income earners will benefit from a much higher tax-free threshold, they will be hurt by higher tax rates above this. This is the rate that the last dollar of every person’s income is taxed – known as a 'marginal tax rate’ – which will make those strategies that decrease taxable income slightly more lucrative.
Consider someone earning the average full-time income (as measured by AWOTE) of around $68,000 a year. They were previously taxed at a rate of 30%. This has been increased to 32.5%. This means that if they use a strategy that decreases their taxable income (such as salary sacrificing to superannuation or negative gearing by borrowing to invest), the tax benefit has increased by an extra $2.50 for every $100 taxable income is reduced by.
For example, on an average income, if you salary sacrifice $2,000 to super, your taxable income drops by $2,000 (say from $67,000 to $65,000). The income tax that you save on this ordinarily is $600. Under the new tax rates, the tax saving increases to $650. Sure, this is not the sort of money that will guarantee a retirement of caviar and lobster, however it does increase the incentive for investment strategies that decrease your taxable income.
Tighter superannuation limits
A harsh reality for most people who are currently working is that the 12% compulsory superannuation level is going to come too late to make a big impact on their superannuation situation. For those wanting a self-funded retirement, they are going to have to make extra contributions to superannuation.
The traditional time for making extra superannuation contributions is when people get close to retirement. However, the $25,000 limit on tax deductible superannuation contributions (for most people, compulsory employer contributions and salary sacrifice contributions) means that the ability to make contributions close to retirement is significantly limited.
Superannuation remains a tax-effective environment – earnings are taxed at a maximum of 15% and most withdrawals will be tax-free – and people looking to take advantage of this environment will need to make contributions earlier in their life.
Conclusion
There is the opportunity to make some subtle changes to your personal finance strategy following last night’s budget.
We have been aware for some time that it is going to be harder to get large amounts of money into super close to retirement. However, the budget does provide a couple of interesting strategies to think about. Firstly, a significantly higher tax-free threshold increases the possibility of highly tax-effective investments being held outside of super. Secondly, higher tax rates as income increases make salary sacrificing to super (as well as negative gearing strategies) more tax effective, providing an incentive to start these extra contributions to super earlier.
Scott Francis is an independent financial adviser based in Brisbane.
Frequently Asked Questions about this Article…
The budget trebled the tax-free threshold from $6,000 to $18,200, raised marginal tax rates above that threshold (for example, the average full‑time earner’s top rate moved from 30% to 32.5%), and highlighted tighter opportunities to make large superannuation contributions close to retirement, including a $25,000 cap on tax‑deductible contributions for most people.
With the higher $18,200 tax‑free threshold, a non‑working partner can hold investments in their own name and earn up to around $18,200 a year tax‑free (a little more with low‑income or senior offsets). This makes building an investment portfolio outside super for a non‑earner more attractive for some couples because the income may be tax‑free and funds are easier to access than super.
The article notes it would take a portfolio of more than $300,000 to generate roughly $18,200 a year in income, so investors should compare expected yields and personal circumstances before deciding whether to hold investments outside superannuation.
Investments outside super can be easier to access (no super withdrawal rules) and may be more tax‑effective for some estates on death. Given the larger tax‑free threshold, certain non‑earners might pay little or no tax on investment income held outside super, making it a viable option alongside super planning.
Because marginal tax rates increased above the new tax‑free threshold, every dollar of taxable income you reduce (for example, via salary sacrifice to super or negative gearing) saves a bit more tax. The article gives an example: on an average income, salary sacrificing $2,000 saved $600 under the old rates and $650 under the new rates, increasing the incentive to use these tax‑reducing strategies.
The $25,000 cap on tax‑deductible super contributions (covering employer compulsory contributions and salary sacrifice for most people) limits the ability to make large catch‑up contributions close to retirement. That means relying on late, large contributions may no longer be an effective strategy for building a self‑funded retirement.
Because super is a tax‑effective environment (earnings taxed at up to 15% and most withdrawals are tax‑free) and the $25,000 deductible cap restricts late large deposits, the article recommends making extra contributions earlier in your working life rather than waiting until you’re close to retirement.
Investors should consider subtle changes: assess whether some investments are better held outside super for non‑earners given the $18,200 tax‑free threshold; weigh up increased incentives for salary sacrifice and negative gearing because of higher marginal rates; and plan to make extra super contributions earlier because of limits on late, large contributions.
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