Tax for investors: Four tax efficient ways to save


Jason Prowd  |  09 October 2018  |  10 min read

Key points
  • Tax is a natural result of growing your wealth, but it’s still a cost you’d want to minimise.
  • Super and investment bonds are tax-friendly but your money is tied up for a while – and with super, it’s until retirement.
  • Discretionary family trusts are more flexible, but tax savings need to outweigh set-up and running costs.

Tax is just a consequence of having more money than you did before. If you’re not paying much tax you’re broke or a crook, and you’re probably not comfortable being either. But when you’re still at the stage of saving money, rather than investing it, handing a chunk over to the ATO can seem exceptionally unfair. You deny yourself the instant gratification of retail thrills and great nights out to get your savings going, only to have the tax vultures swoop in and take a share.

To keep more of your hard-won stash, here are three perfectly legitimate ways to squirrel away your dollars and pay less tax. One is better suited to more distant goals like a comfortable retirement, but there are two solutions here to reduce your tax while keeping your savings accessible to spend or invest.

Super all the way

The super thing about super isn’t just about getting a retirement savings boost through your pay packet. It also comes wrapped up in a whole package of tax incentives. For a start, earnings inside super are getting special treatment for income and capital gains tax, compared with the more demanding rates applied to savings and investments outside of super.

But these super tax breaks don’t just stop there. If you’re looking for ways to save and pay less tax, concessional – before-tax – super contributions are hard to beat. Until the next super shake-up hits, you can top-up your super with up to $25k each financial year in pre-tax contributions. This amount includes all the contributions your employer is making through the Super Guarantee and the value of any life insurance you may receive as part of your employment – which is set to rise over the years until 2025.

Assuming you’ve got room to make your own contributions within that $25k cap, you can add to your super balance and work the magic of compound interest on a bigger sum. But the clincher is you’ll owe just 15% tax on these payments. So if your marginal tax rate is more than 15%, you’ve just found a win-win way to save and claw money back from the ATO.

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Investment bonds

The main snag with super is the part where the money is off-limits until you reach retirement age. So if you’ve already maxed out your concessional super contributions, or don’t want to wait until retirement to get at your savings, investment bonds are worth a look.

Working as a sort of managed fund/ insurance hybrid, investment bonds pool your money with funds from others to invest in different assets. The future value of the bond depends on the performance of these assets. As with all investments, you should be aware of the risk/return profile for different options and compare any fees and costs involved.

So far, so normal from an investment perspective. But the difference is that these bonds are a tax-paid investment. Leave your money in there for 10 years and you’ll pay absolutely no tax on the earnings in your notice of assessment, because it’s all taken care of within the bond.

That’s a win for anyone who pays tax, providing they can afford to lock that money away for the full 10 years.

There are a few other rules to be aware of to make the most of your tax savings from investment bonds. And this is where they become even more appealing for taxpayers with higher marginal tax rates and those with extra money to put in over time. Cash in your investment bonds early and you’ll be liable for tax on some or all of the earnings, but still benefit from a 30% tax offset. And you can top up your bond each year with up to 125% of the previous year’s investment, and have it treated as part of the initial investment. So any earnings on these extra contributions will be tax-free within the original 10-year bond term.

Discretionary family trusts

For a more liquid and tax-friendly solution, discretionary family trusts are way more flexible than bonds or super. They can be great for spreading the wealth around a family in a more tax-efficient way.

Investments can be made by the trust and then a nominated trustee (or trustees) decide how earnings are doled out to family members. The trust doesn’t pay tax but the beneficiary does. So family members in lower tax brackets or with a capital loss to offset against a capital gain can spread the overall tax burden in a more efficient way.

Sounds tidy and convenient. But as a separate investment structure, this approach to effective distribution of wealth for tax purposes comes with a price tag. There are costs to set up the trust and plenty of paperwork and reporting to comply with each year. You can expect to spend between $500 and $2,000 dollars to establish a trust, and roughly the same amount annually on accounting fees. So any tax savings you’re counting on should be set against these costs.

So there you have it. Three very different tax-wise ways to save. Some of these work a treat to simply grow your wealth long-term, others will keep more of your money on standby for an equally tax-efficient investment project down the track.

author

Jason Prowd leads Morningstar Next: ready-made investment portfolios.


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