When looking to invest, tax is an important consideration. Imagine how much more cash flow you would have without having to pay tax. As a simple illustration, if you could invest $1 per month at 6% return per annum for 20 years, you would have approx $4,600 if no tax was payable, compared to $3,500 if you paid 40 per cent tax.
The question is: “How I can legally not pay tax?”
The only totally risk-free strategy is to eliminate as opposed to reduce. The only way to do this in Australia is via superannuation, where earnings related to super in pension stage is not taxed in super or when paid to the member.
Prior to pension stage, super has very favourable tax rates of 10% on capital profits and 15% on profits from normal income. Even this can be reduced to eliminate or discount the tax prior to pension to a point were negative taxation becomes a reality.
Think of it as the event horizon; a black hole where tax disappears and at its centre the tax man pays you the tax that was paid by others. An inconceivable concept to most (but so is quantum physics).
How much could one generate if tax was not a consideration?
It is in trying to answer this question that many Australians have turned to superannuation, which has concessional tax rates of 10-15% and zero once you are over 60 years of age.
Depending on what you invest in e.g. Australian equities you can even get to negative tax where you are paid by the ATO not the other way around. Tax becomes a cash inflow.
For most Australians super is the lowest tax regime and if you can save 15% tax that is the same as an increase of at least 15% in the return on your investments. This is all but an impossible target to generate when looking at improving the return on the assets choice or mix.
For the older generation, risk is a significant factor in investing. The human spirit would often rather not make money, than to be in a position to lose money. It is the safer option. The other consideration is debt. As you get older and maybe move outside of the workforce, borrowing becomes more problematic.
Your Life Cycle
When looking at different age bands the above considerations take on different significance.
The game of life can be seen as the four quarters of any football match. The first quarter we learn, the second quarter we grow, the third quarter we pay down our debts and the last quarter is for investing.
Which team ever won if they only really played in the last quarter? It can happen, but it’s less frequent than when you follow the traditional four quarters. The same is true for investing. It is never too late. You just need to change the strategy. You would also break it down into different time periods.
For instance if you are between 50-59 years old, you are probably working and so borrowing may still be available to you. You could be at the peak of your discretionary spending life if your home is paid off, children are off your hands and maybe both spouses are working.
At this age you can also contribute into super up to $50,000 per person of concessional contributions (e.g. tax deductible) until June 2012. After that date, your maximum concessional contributions fall to $25,000, unless your super member’s balance is below $500,000.
At age 55 you can enter into a transition to retirement and this can create a tax differentiation, which is “cash” into super.
It works like this…
You salary sacrifice wages into super and get a tax deduction. You can then take a “pension” from super, which is taxed at your tax rate, but you are given a 15% credit on the “pension” as a rebate for the tax the super fund paid when it received your super contribution.
This means that you can take less out of super as a pension and still end up with the same amount after tax income. The difference stays in super for investment. This benefit is not available for savings outside of super. This increased investment power can greatly increase your wealth creation.
Some of our clients are borrowing in super to purchase property. The deposit comes from super and the fund (must be a SMSF) borrows. This means you have more money working for you. While working any negative gearing is tax deductible by making a salary sacrifice super concessional contribution. Therefore, there is no difference in the tax benefits whether the asset is outside of super or inside.
At ages 60-69 the game changes considerably. Any investments into super would be tax-free in super and tax-free when paid to you if in pension stage.
There is a huge difference at age 60. While you are working and contributing you get tax deductions, but in pension stage tax is nil and in fact can be negative depending on assets in super.
At this stage, in super any positive rent would be tax-free and any profit on sale would also be tax-free if in pension stage. Within this age bracket the rules change on how much and how you can contribute into super. After age 65 you can no longer average three years’ worth of after-tax money (non concessional contributions), which has an annual limit of $150,000. Therefore at 64 or below, you could put in say $450,000 in one year being 3 years average. At age 65 you can also now take money out of super as a lump sum.
Any concessional contributions after age 65 requires you to pass a work test i.e. 40 hours work in a 30-day period. You must satisfy this test before you can contribute if you are between 65-75. The definition of work is any paid employment such as babysitting, gardening, part time work or even full time work so it is fairly non-restrictive test.
From age 70 and above, the super rules change again. Contributions to super can no longer be made after age 75. There is however an opportunity to continue making the 9% super guarantee contribution, if you are working under a registered award that allows your age bracket to be employed. For some, particularly in a family business environment, this may be possible.
Given improvements to medicine, people are living longer and so longevity risk becomes an issue. How long must my money last? Will I live to 100? If you indeed live to be 100 years old you have another 30 years after age 70 so investments, wealth and improved returns (even if only due to tax) must be paramount in everyone’s thinking.
We find more and more people choosing super and in particular SMSF as part of their wealth creation strategy due to:
1. Ability to control
2. Concessional tax rates and zero at age 60
3. Super money is protected against bankruptcy if contributed in normal circumstances
4. Ability to borrow so as to increase the size of the assets
5. Its ability to pass on assets and benefits intergenerationally
To be able to maximise the benefits of super Chan & Naylor have developed The Enduring Family Superannuation Fund, which is like a family trust on steroids (legal and healthy ones). Many allowable benefits are built in to the EFSF and so funds/assets within these environments allows a family to build wealth and have it accessed intergenerationally.
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