While the taxman is targeting investors hiding assets overseas, there are much less complicated ways to cut your tax bill. Keeping savings in a mortgage offset account can save thousands of dollars of tax you’d otherwise pay on a savings account. And a family trust can shave big dollars off a household tax bill, thanks to distributions going to lower-earning family members including kids over 18.
Taking a careful look at where you’re keeping your assets means you don’t have to put your money into dodgy shelf companies in a Caribbean tax haven to keep more of your income in the family coffers.
These tax-minimising strategies are right under your nose – they’re widely available, legal and can make a significant difference to your overall wealth creation.
By contrast, investors who have parked their assets offshore have had to hide them, but are now being offered a deal by the Australian Taxation Office where if they come clean the maximum they’ll have to pay is tax for the past four years.
One of the simplest everyday strategies is setting up an offset account against a mortgage to harbour any extra cash. Superannuation, too, offers great tax benefits to boost retirement savings, particularly if you are close to finishing work. Once a super fund starts paying a pension, the earnings on the investments within the fund are tax-free, along with any money taken out of the fund.
But there are caps on the amount that can be contributed to super each year and not everyone wants to wait until retirement to access their savings. There are plenty of major expenses to consider along the way.
This is where investment options outside super, including insurance or education bonds and investing in the name of family members on lower tax brackets, can also help reduce the amount of income tax payable.
Other ownership structures that could be considered include trusts or companies.
This week Smart Money looks at six ways to reduce the amount of tax you pay.
MORTGAGE OFFSET ACCOUNT
This is more often viewed as a strategy to cut interest costs and the length of the loan on a mortgage. The other side of the equation is a tax saving on money that would otherwise have been parked in a savings account and earning interest, on which you would be taxed at your marginal tax rate.
Say you’ve accumulated some cash or sold some assets and you’re not sure what to do with the proceeds. If you’ve got a home loan, putting this extra cash into an offset account can not only reduce the amount of interest payable on the loan but it will also stop you paying tax on the interest you would otherwise have earned.
AFTER-TAX SUPER CONTRIBUTIONS
Much of the focus with super is on the tax savings from making pre-tax contributions through salary sacrifice. This is because of the 15 per cent concessional tax rate paid on super contributions up to the age-based caps.
But there are also potential tax savings from non-concessional or after-tax contributions, says Kate McCallum of Multiforte Financial Services.
“The thing to focus on is the environment that your money is invested within,” she explains. “Compared with investing post-tax money into an investment in your own name, investing via super is taxed at a maximum of 15 per cent on earnings and 10 per cent on capital gains; and for those eligible for transition to retirement their money grows in a zero tax environment.”
What’s more, she says, the contribution forms part of your “non-taxable component” within super – which for people starting transition to retirement pensions before age 60 means that this portion of their income is tax-free.
There are also caps on after-tax contributions. This year it is $150,000, increasing with indexation to $180,000 from July 1.
“Where we have clients with significant funds to move into super or a pension, we are doing a $150,000 contribution this year and then using the ‘bring forward’ rule to make a further contribution of up to $540,000 in the next financial year. This means we are able to contribute $690,000 a person into super,” McCallum says.
DISCRETIONARY FAMILY TRUST
An effective way to hold investments, a trust is a separate investment structure where assets are controlled by one or more persons (the trustee/s) on behalf of a group of other persons (the beneficiaries).
A discretionary trust allows the trustee to decide who gets the income and capital the trust owns. These can suit someone on the highest tax bracket with family members listed as beneficiaries who are on lower rates, BFG Financial Services adviser Suzanne Haddan says.
For example, rental income from an investment property owned by the trust could go to members of the trust on lower incomes.
The trust does not pay tax but the beneficiary does, with income and capital gains derived by a trust generally assessed at the tax rates of the beneficiary.
Centric Wealth’s Natasha Panagis says that by using a properly drafted discretionary trust, distributions can be made to the most appropriate members of the trust in terms of their tax status or other criterion.
For example, more income may be distributed to beneficiaries ion lower tax brackets or those with no other income to utilise their $18,200 tax-free threshold, and potentially the low income tax offset (LITO).
Capital gains may be distributed to a beneficiary who has capital losses available or who can make use of the 50 per cent general discount. And franked dividends may be paid to a beneficiary who can use the imputation credits to eliminate or reduce tax on other income, Panagis says.
She says trusts can use the 50 per cent discount on capital gains tax on the sale of an asset if it has been held for a minimum of 12 months.
Panagis says that like company ownership, trusts are more complicated to set up and maintain, so there are higher set-up and compliance costs. Set-up costs will include fees payable to the specialists who advise on setting up the trust, government stamp duty, registration fees and establishing a corporate trustee.
There will be ongoing costs for specialist advice on completing the trust tax return and other records that must be lodged annually.
A trust is a separate entity to the trustee and the requirement is that personal affairs and those of the trust are kept quite separate. As well as a separate bank account and some form of accounting records for the trust, all decisions made by the trustee – for example payments to beneficiaries – must be properly documented.
As far as the distribution of income goes, all taxable income earned during the trust’s financial year should be distributed to beneficiaries and included in the beneficiaries’ taxable income in the same tax year. Any undistributed income is taxed within the trust at the top personal tax rate of 46.5 per cent including the Medicare levy.
Further, trust losses cannot be distributed to beneficiaries. Where a discretionary trust has a nil net income or a net loss, it will not be entitled to a refund of excess imputation credits.
TRANSITION TO RETIREMENT
If you are over 55, the combination of salary sacrificing pre-tax income into super and drawing an income from super benefits can be very tax effective.
Not only does it get more into your super fund but your cash flow remains the same. You first have to start a transition to retirement (TTR) income stream funded from your super fund. A minimum income of 4 per cent and a maximum of 10 per cent must be drawn from the account balance each year.
You then also start a salary sacrifice arrangement with your employer so part of your pre-tax salary is redirected into super. Centric Wealth’s Panagis says replacing salary with superannuation income and redirecting salary to super will “improve net income, reduce taxation and increase the end retirement benefit”.
The income tax reduction comes about thanks to receiving less salary income (and therefore paying less tax) and more concessionally taxed pension income.
On top of that, salary sacrifice super contributions are subject to 15 per cent tax, which means much more goes into super than if you contributed after-tax income.
Once you turn 60, you receive the whole income stream tax-free.
But for those under 60, in typically complicated super rules, the tax treatment depends on the underlying components of the income stream. The money put in after tax which forms part of the income stream is received tax-free. The taxable component is included in assessable income and taxed at marginal tax rates.
Someone over the preservation age (currently 55) and younger than 60 will receive a 15 per cent tax offset on the taxable component.
Another benefit of the TTR strategy is no tax is payable on the investment earnings accruing in the fund while it is supporting the TTR income stream. So a big benefit of transferring your super benefit from the accumulation phase to the pension phase is the tax differential – i.e, there is 15 per cent earnings tax in accumulation phase but no tax in the pension phase.
AN INVESTMENT COMPANY
Setting up a company through which investments are bought is one way of ensuring the tax paid is never more than 30 per cent.
McCallum says an investment company can assist in keeping funds accessible and outside super, or in cases where after-tax super contributions have already been used. But because a company does not have access to the 50 per cent capital gains tax discount, she generally recommends keeping income type assets in a company rather than growth assets. “Gains are taxed at the full 30 per cent,” she says.
It works when a company is established and assets are bought in its name.
This can include any type of investment – managed funds, shares, direct property, cash – depending on your portfolio needs and overall risk profile, McCallum says.
“We tend to keep a client’s company portfolio defensive [bonds, high interest cash, term deposits] and tilt their super/pension portfolio to more growth to match their overall risk profile. In super the capital gains tax is no more than 10 per cent.”
When income is distributed, the person receiving it pays tax at their marginal tax rate less 30 per cent company tax. So it makes sense to try to distribute to someone on a lower tax rate at a given point in time, McCallum says. An example could be someone who has worked only part-time over the year.
McCallum says as well as the 30 per cent tax rate, other advantages of an investment company include the ability to choose the timing of a distribution from the company to a suitable individual to minimise personal tax payable. A company can also be discontinued at any time. On the downside, investors should expect some additional costs with setting up and maintaining a company.