Where investors can earn low-tax income

The upside of rising interest rates is that returns on savings accounts have improved. Savers who shop around may be able to earn 3% on their spare cash, though various conditions may apply to earn that sort of rate.

The drawback is that interest income is fully taxable. A high income earner can lose up to half their interest in tax.

By contrast, dividends on shares can be very lightly taxed. That’s because investors receive credit for the 30% tax paid by companies on profits that dividends are paid from. It can make dividends very tax-friendly for high income earners. Investors can even claim a tax refund if the franking credits on dividends outweigh the tax they have to pay.

This explains why shares and exchange traded funds that invest in equities are often popular choices among those who rely on investment income for money to live on.

To see how dividends stack up against other types of returns, investors can use a figure called the ‘dividend yield’. It’s calculated by dividing the dividend per share by the market price of the share, and multiplying the result by 100.  

You don’t have to crunch the numbers yourself. The dividend yield for each listed company can be found on the Australian Securities Exchange (ASX) website. The yield will change as the sale price of a share changes. Indeed, if the share price tanked the yield would soar and vice versa.

As I write, the dividend yield on some of Australia’s best-known shares include 4.0% for the Commonwealth Bank, 4.2% for Telstra and 11.6% for BHP. Clearly, there can be big variations in dividend yields across different companies, which highlights the value of having a diversified portfolio.

More broadly, Reserve Bank research shows dividend yields on Australian shares typically averages around 4.5%, which is high by global standards[1].

What’s really exciting about dividends is that they represent your share of a company’s profits. Over the last 100 years, companies have paid out around 65% of their earnings to shareholders.  That’s great news for investors looking for lightly-taxed income. The added sweetener is that shares have a healthy track record for notching up long term capital growth, which can also be tax-friendly.  

Want to learn more about dividends and income investing? Our InvestSMART Bootcamp is a great place to start for $49. Brush up and gain confidence.

Paul Clitheroe is Chairman of InvestSMART, Chair of the Ecstra Foundation and chief commentator for Money Magazine.