Choosing the right investment structure

Choosing the right tax structure for your investments is key. In fact, for many investors, getting this one step right can have a far more significant impact on the benefit of investing than whether your shares, property or otherwise generates a 1%, 5% or 10% return! Let me break it down for you. 

We all know that taxes can take a big bite out of any income we make. This is true of investment returns too. If you're not paying attention to tax when you choose your investments, you could be leaving a heap of cash on the table. For example, investing in superannuation can be a tax-effective strategy for long-term savings. Imagine you're investing $10,000 a year for 30 years. 

If your gross (pre-tax) investment annual return is 8.5% and you invest that money in your own name at a 30% tax rate, you'll end up with around $885,000 after 30 years. However, if you invest that same amount in a 15% tax environment such as superannuation, you'll end up with around $1.13 million. That's a difference of $245,000 just because you chose a more tax-effective strategy! 

The rule to remember: get your tax structure right upfront. It can be super costly to make changes down the line. For example, a transfer of ownership of an investment property or shares from you to a spouse would be seen as a sale, and you would need to pay capital gains tax (CGT) on any gains made on the investment at the time of 'sale'. Your spouse would need to pay stamp duty to the relevant state revenue office for the portion of the property they are purchasing. This is why it makes sense to do your homework or seek professional advice upfront to avoid a potentially costly error.

There are several different tax structures available, each with its own pros and cons. Let's take a closer look. 

1. Investing in your own name 

First up, investing in your own name is the simplest option. Any income or capital gains generated from your investments will be taxed at your individual tax rate. This option is ideal if you're just starting out, but if you're a high-income earner, this can result in a significant tax burden. For example, from the 2024-25 tax year onwards, if you earn over $190 000 a year, you'll be subject to the top marginal tax rate of 45%. This means any income or capital gains you generate from your investments will be taxed at this rate. 

2. Investment bonds (or insurance bonds) 

Investment bonds, a lesser-known product but widely used by those in the know, are similar to superannuation in that withdrawals become tax-free after a certain point, usually 10 years, but differ from super in that you don't have to be retired to cash in. This can make investment bonds a great option if you're saving for the long term but don't want to be restricted by the rules of super or you have already maxed out your concessional (pre-tax) contributions to super. 

Investment bonds pay tax on your behalf at a maximum of the company tax rate of 30%. However, some products specifically apply an approach where they can significantly reduce this rate, and this approach alone can make it incredibly attractive for many investors. 

Be aware that because of the tax benefits available, there are also a few rules around how much you can contribute (usually only 125% of last year's contribution) and the 10-year access point for tax-free withdrawals. 

Some of these products are widely used for saving for children's education. There can be additional tax benefits if used specifically for education, and a number of our clients utilise this special structure where appropriate. 

3. Family trusts 

A family trust is a legal structure where assets are held and managed by a trustee for its beneficiaries. This option can be great if you want to invest with your family or distribute income to those in a lower tax bracket. The trust's income is usually distributed to beneficiaries based on their individual tax rates. This means that if you have family members who earn less than you, you may be able to distribute the income generated from your investments to them, thereby reducing your overall tax liability. Note this is a strategy that should only ever be acted upon as a result of good financial advice. 

There are some downsides to using a family trust, however. One of the main ones is the cost of setting it up and maintaining it. You'll need to engage a lawyer or an accountant to set up the trust, and you'll need to pay annual fees to maintain it. And it becomes another entity for which you are responsible when it comes to reporting to the ATO. Additionally, there are some restrictions on the types of investments you can make through a family trust. 

4. Using a company 

Investing through a company is another option to consider. This structure can provide tax benefits, as the company tax rate is generally lower than the individual tax rate. The current company tax rate in Australia is either 25% or 30%, depending on turnover and the percentage of total income for the company that is passive income (significantly lower than the top individual tax rate of 45%). This means that if you invest through a company, any income or capital gains generated from your investments will be taxed at this lower rate. 

However, there are some downsides to using a company. Setting up and running a company can be costly and time-consuming. You'll need to register your company with the Australian Securities and Investments Commission (ASIC), and you'll need to comply with a range of legal and regulatory requirements. A company is also not able to claim what is known as the capital gains tax discount. This 50% discount applies to assets personally owned, but not company owned, whereby you can claim a 50% discount for any asset you sell for a gain, as long as the asset was held for longer than 12 months. 

5. Superannuation 

A lot of people see super as an investment, rather than as a tax structure. Please understand that a tax structure is all it is. You choose your investments within super, but it is not itself an 'investment'. Super is how most of us save for retirement and is one of the most tax-effective ways to stack your funds for the long term. Contributions to super can be made concessionally (pre-tax), helping you to minimise tax on the way in, and investment earnings inside super are also taxed at a lower rate. 

The major limitation of super is accessibility. Generally, you won't be able to access your super until you reach preservation age, which for most readers of this book will be 60, and after you have stopped work. Additionally, there are limits on the amount of money you can contribute to superannuation each year. 

This is an edited extract from Insufficient Funds (Wiley $32.95), republished with permission.