The average Aussie needs $2.7 million to retire, but there’s an easy way to add $558,000 to your reserve without doing any extra work.
Most people I talk to have pretty big financial goals. It’s not that they want to have heaps of cash to ride, just that living well in Australia doesn’t come cheap.
If you want to have a good home in a nice neighborhood, provide well for your family, loved ones, or your community, and possibly have the option of retiring with a salary close to an average wage, you have to serious work to do.
How much do you need?
I calculated that to have an “average” retirement in Australia today you must have about $2,744,443 in investments. This amount of wealth would buy you a house at the average property value in Australian capitals of $926,107, and also give you an investment portfolio worth $1,818,336, which, assuming a 5% return, you would generate the average Australian income of $90,916.
Creating a wealth of $2.7 million is no small feat, so you need to give yourself every advantage possible.
For individuals, invest tax-wise is one area that can make a big difference in how quickly you move forward. Different types of investments have different tax treatments, so the difference between a great strategy and an OK strategy can mean the difference between achieving your goals and failing.
Hello postage credits
Most publicly listed Australian companies pay some or all of their profits to shareholders each year in the form of dividends. Since corporation tax has already been paid on these trading profits, when investors receive dividend payments, the ATO is kind enough not to double the tax payable on this income, so the majority of dividends in Australia are paid with ‘postage credits‘ attached to them.
This may sound confusing, but it’s actually quite simple. When profits are paid out to shareholders in the form of dividends, the tax that has already been paid out of profits is recorded, then when you submit your tax return and include your dividend income, the tax already paid counts to reduce the amount of tax you owe.
In short, the impact on your taxation is the difference between your tax rate and the tax rate paid by the company that pays you your dividends. It can be a positive or negative difference. For example, you may have to taxor tax may be due to you.
For example, if your current marginal tax rate is 39% (for annual income over $120,000) and the tax on your dividends was paid at the corporate tax rate of 30%, you only have to pay the difference of 9% tax cent. Not bad, but it can still improve.
If your tax rate is 19% (you earn up to $45,000 a year) and the tax was again paid at 30%, you actually receive a tax refund on your dividends of 11 %. This amount is paid as part of your tax refund and is not simply carried forward to future tax years.
What is the real impact of postage credits?
I wanted to illustrate this with an example showing the difference between having your investment Income made up of franked dividends versus unfranked dividends, assuming your goal is to replace the average pre-tax Australian annual salary of $90,916. The tax that would apply on this salary under the current tax rules is $21,863, which means that the net income after tax is $69,053.
If you were looking to replace that level of income with investment income that doesn’t come with franking credits, you’d have to replace the full $90,916 and then pay taxes at marginal rates to end up with $69,053. $ after tax.
But if you were to create fully franked dividend income with tax paid at the 30% corporate tax rate, you would only need to receive dividends of $63,000, with tax credits of 27 $000. The result is that you would end up with the same amount of after-tax income, but you would need less overall income (and therefore wealth) to get there.
For engineers, teachers and other types of analysts, the work on this is shown below:
Franking equity = (dividend amount / (1-corporate tax rate)) – dividend amount.
Postage Credit [$27,000] = (dividend amount [63,000] / (1-company tax rate [30 per cent])) – dividend amount [63,000].
The implication of this, going back to our original 5% investment income assumption, means that you can have less in your investment portfolio to generate the same level of income.
Once retired, to generate an income of $63,000 assuming an income rate of 5%, you would need $1,260,000, compared to the $1,818,336 needed if your investment income does not come with postage credits.
This reflects a difference of $558,336, and means that no matter how much you save, if you invest in companies that pay franked dividends, you will build your target level of wealth sooner.
Beware of your risk
I must point out that the above is a fairly simple example and that there are a number of considerations when it comes to building wealth, including diversification.
While Australian equities are great, the Australian equity market is small compared to the rest of the world. have your investments concentrated in one country is something that carries risks.
All silver option has advantages and disadvantages. The key to taking the smartest steps for you is understanding your risks and which ones are right for you.
If you want to lead a reasonable life in the future, you will have to work for it. Every hack you can use on your wealth-building journey can help you get to where you want to be faster or easier (or both).
Take the time to understand the rules and how to use them to your advantage, the different investments you can include in your portfolio and be tax smart when investing.
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.