Many Australians pay investment tax on top of their income tax and it’s a huge amount – but there’s a way to make sure it’s a lot less.
Tax rules in Australia are complex and constantly changing. Therefore, taking the smartest tax measures is an ongoing battle.
And we pay a lot of taxes: according to 2022 tax data, Australia has one of the highest income tax rates in the world – in fact, we are only fourth behind Denmark, Iceland and Belgium.
But with that comes opportunity, because the more taxes you pay, the more valuable tax deductions become. This means that if you’re smart about how you plan and execute your tax strategy, you can save a lot of money and put yourself in a stronger financial position.
Marginal tax rates
In Australia, we work under a marginal tax rate system, also known as a progressive tax system. The current Australian marginal tax brackets (including Medicare contribution) are shown in the table below.
This shows that as your income increases, the “marginal rate” of tax you pay. One thing that many people find confusing is that the higher marginal tax rates only apply to income earned above each threshold. This means that even if your Income is well into the top marginal tax bracket of $200,000, you still pay no tax on the first $18,200 of your income.
When you get a raise or bonus that raises your total income enough to put it in the next tax bracket, it’s common for people to think that higher tax rate applies to all of your income. This is not the case – the higher marginal tax rate only applies to the amount of income earned in that particular tax bracket.
It should also be noted that there is no point in the Australian tax system where you end up with less money after tax due to earning more income.
You only get one tax rate
Another common area of confusion is how taxes affect your investment income. For all investments that you personally own – such as investment accounts in your name, properties held in your name – all investment income is added to your other taxable income (wages and employment income) and taxed on your marginal tax rate.
This includes interest income from bank accounts and term deposits, rental income from investment properties, capital gains from the purchase and sale of shares, gains, losses and income from cryptocurrency investments, and any other investment income.
For example, if your salary income is $100,000 each year and you earn an additional $5,000 in interest on a savings account, $5,000 in dividend income, and $10,000 in net rental income on a building placement, all of these numbers add up to your “total”. taxable income” of $120,000 and you are taxed accordingly.
You are taxed exactly the same amount as if you earned the $120,000 entirely from employment income or investment income, which means there is no difference between the rate of tax you pay on investment income and employment income.
The value of deductions increases with your income
Notwithstanding the above, the more you earn and the higher your marginal tax rate, the better each dollar of tax deductions will benefit you. This means that the more you earn, the more useful it will be for you to maximize your deductions.
To get the best tax results for your current job, understand what deductions you can claim based on your occupation, be tax smart when investing, and be strategic about how you handle your tax. The less tax you pay, the more you have left to move forward (or maybe just for your next vacation).
Tax rates are different for different entities
As stated above, all income earned in your personal name is taxed at marginal tax rates. But tax rates are different for income earned in different “tax entities” like pensions, trusts and corporations.
When you’re growing your wealth through investing, you typically invest new money each year in your investments, which in turn generate investment income. Each year, you pay tax on that income, then reinvest what’s left to continue to grow your investments and your wealth.
The implication is that the less tax you pay, the more money you have left to reinvest and the faster your investments will grow. This means there is an opportunity to be strategic about where you invest that can make a significant difference in the trajectory of your wealth.
For example, the top tax rate that applies to a business is 30%, which is significantly lower than the top marginal tax rate of 47%. If you are already earning good income that puts you in the top marginal tax bracket, every dollar of investment income you earn will be taxed at 47%.
By comparison, when growing your investments within a corporate structure, investment income would only be taxed at a maximum rate of 30%. The result is that you keep an additional 17% of your investment income which you can then reinvest to grow your investments faster.
With the superannuation, it’s even better – the maximum tax rate that applies to investment income earned through the superannuation is 15%.
It should be noted that both of these options come with risks and drawbacks – the cost of setting up and running an investment company, tying up your money in a superannuation, and the time and expense involved. administration needed to manage a more complicated investment portfolio.
These strategies are not for everyone.
But it does highlight the potential benefits you can get from being strategic with your investment tax strategy, and how being smart here can pay serious dividends. Take the time to educate yourself and get good advice so you can take the smartest steps for you.
We pay a lot of taxes. The tax rules are complex. And that can be overwhelming. But the benefit of getting it right is huge, and something worth taking the time to educate yourself on.
Understand the rules, how they apply to you, and how to use them to your advantage – the result is a faster, easier path to the results you want.
Ben Nash is an expert finance commentator, podcaster, financial advisor and founder of Rotate Wealthand author of Amazon’s bestsellerGet Unstuck: Your guide to creating a life not limited by money‘.
Ben has just launched a series of free online financial education events to help you get ahead financially. You can check out all the details and book your spot here.
Disclaimer: The information in this article is general in nature and does not take into account your personal goals, financial situation or needs. Therefore, you should determine whether the information is appropriate for your situation before acting on it and, if necessary, seek the advice of a financial professional.
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