- Tax effects on investments
- Superannuation
- Equity investments
- Borrowing to invest
- Some important considerations
- Investment review and changes
Tax effects on investment
Do you understand the tax implications of investing?
The key to building wealth is creating the right investment strategy. Consideration should be given to the way your investments will be taxed and how you can achieve maximum returns.
Preparing a financial plan, setting investment goals and assessing risk can be complicated. If you have any doubts you should consider seeking professional financial advice.
Superannuation
Superannuation should be used to build up long-term wealth because of its tax advantages.
Superannuation is the most tax effective investment strategy as it is taxed at 15 per cent rather than your marginal tax rate. However, if you are in a high income bracket you may incur a Superannuation Contributions Tax Surcharge which is an additional tax of up to 15% on 'surchargeable' superannuation contributions when your taxable income exceeds $75,856 (1998/99). Above this amount the tax rate is 0.001 per cent on every $1. Once income reaches $92,111 (1998/99) the maximum tax surcharge rate is 15 per cent. The income assessed includes your 'reportable fringe benefits'.
Equity investments
Investing in shares has tax advantages not offered by other investment classes. Dividend imputation allows shareholders to receive credit for the tax that Australian companies have already effectively paid on the dividends they declare.
Imputation is a complicated issue but, generally speaking, the higher a company's actual tax rate, the less tax you will have to pay on dividends you receive from the company. If your marginal income tax rate is less than the company's tax rate, you will receive a credit which can be used to offset tax on other income.
The other major benefit of holding shares is that if a company's profits rise over time, its shares usually become more attractive to investors and this in turn increases their value. Shares are seen as long-term growth investments.
Borrowing to invest
When you borrow funds for investment purposes you can obtain tax benefits.
So long as that investment produces an income, most of the costs of owning it are tax-deductible, including the interest on the loan.
Many home loans allow you to use the equity in your home as a revolving line of credit facility. You could borrow against this equity to diversify into investments such as shares or managed share funds. The interest charges as well as most of the costs of owning the investment is tax deductible so long as that investment produces an income.
If you borrow enough, the costs exceed the income from your investment and the deductions can reduce your other taxable income. It is this feature of negative gearing that often leads people to think it is a miracle cure-a way of getting the taxman to help you build wealth for your future.
In recent times, however, low interest rates have reduced the tax-effectiveness of gearing strategies.
Some important considerations
The returns you make on investing are taxable. The income you receive from interest, dividends and rent are all subject to income tax. If you sell an investment for more than you paid for it, you may be liable for capital gains tax.
How much tax you will have to pay will depend on your overall income, the types of investments you have chosen and how long you have held them. If your investment income is significant, you may also have to pay provisional tax.
If you are a self-funded retiree you will need to be aware of the tax rules. As these rules are complicated and always changing, you might need professional advice about the tax implications of investing.
Investment review and changes
As an investor, it is important for you to consider the effects of potential interest rate rises (and falls in asset prices) and plan on this basis. That means greater attention to the quality of assets you're buying, and how they fit into your overall portfolio, rather than the tax effects of gearing.
Don't consider an investment purely because it seems to offer a way of reducing your tax. The primary consideration for your investments should be a 'wealth creation' strategy rather than a 'tax-based' strategy. An investment must first be assessed on its underlying merit. Only then should you consider its tax advantages.
