Many Aussies 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, so it’s an ongoing battle to take the smartest tax measures.
And we pay a lot of tax: according to tax data of 2022, Australia has: one of the highest income tax rates in the world – in fact we are in fourth place, only behind Denmark, Iceland and Belgium.
But with this comes an opportunity because the more tax you pay, the more valuable the tax deduction becomes. This means that if you are smart about how you plan and execute your tax strategy, you can save some serious money and put yourself in a stronger financial position.
Marginal Tax Rates
In Australia, we operate under a system of marginal tax rates, also known as a progressive tax system. Current Australian marginal tax brackets (including Medicare levy) are shown in the table below.
This shows that as your income rises, so does 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 any threshold number. This means that even if your income well in the top marginal tax bracket of $200,000, you still don’t pay tax on the first $18,200 of your income.
When you receive a raise or bonus that increases total income enough to put it in the next tax bracket, it is common for people to think so higher tax rate applies to your entire income. This is not the case – the higher marginal tax rate only applies to income earned within that specific tax bracket.
It’s also worth noting that there’s no point in the Australian tax system where you end up with less money after tax as a result of earning more income.
You only get one tax rate
Another common area of confusion concerns how taxes work on your investment income. For all investments you personally own, such as investment accounts in your name, property in your name, all investment income is added to your other taxable income (salary and income from employment) and taxed at your marginal tax rate.
This includes interest income from bank accounts and time deposits, rental income from investment properties, capital gains from buying and selling stocks, and 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 an investment property, then all these numbers add up to your “total taxable income” of $ 120,000 and you will be taxed accordingly.
You will be taxed the exact same amount as if you earned the $120,000 entirely from employment income or investment income, meaning there is no difference between the tax rate you pay on investment income compared to your employment income.
Value of deductible items increases with your income
Notwithstanding the above, the more you earn and the higher your marginal tax rate, the more benefit each dollar of tax deduction will be to you. This means that the more you earn, the more valuable it will be for you to maximize your deductions.
To get the best tax results for your current position, you need to understand what deductions you can claim based on your occupation, get tax smart when you invest, and be strategic about how you manage your taxes. The less tax you pay, the more you have left to get ahead (or maybe just for your next vacation).
Tax rates are different for different entities
As explained above, any income earned in your personal name is taxed at marginal tax rates. But the tax rates are different for income earned in different “tax entities” such as retirement, trusts, and corporations.
When you are in the process of growing your wealth through investing, you generally invest new capital each year in your investments, which in turn generate investment income. You pay tax on this income every year and then reinvest what is left to further grow your investments and 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 with where you invest, and an opportunity that can make a significant difference to your wealth trajectory.
For example, the maximum tax rate applicable to a company is 30 percent — significantly lower than the top marginal tax rate of 47 percent. If you already earn good income that puts you in the top marginal tax bracket, every dollar of investment income you earn is taxed at 47 percent.
In comparison, when you grow your investments under a corporate structure, investment income would only be subject to a tax rate of up to 30 percent. As a result, you keep an additional 17 percent of your investment income, which you can then reinvest to grow your investments faster.
With retirement, things get even better: The maximum tax rate that applies to investment income earned through retirement is 15 percent.
Worth noting with either option is that there are risks and drawbacks: the cost of setting up and managing an investment company, locking up your money in retirement, and the time and administration required to manage a more complicated investment portfolio.
These strategies are not for everyone.
But this highlights the potential benefits you can gain from being strategic with your investment tax strategy, and how smart here can yield some serious dividends. Take the time to educate yourself and get good advice so you can make the smartest moves for you.
We pay a lot of tax. The tax rules are complex. And it can be overwhelming. But the benefit of doing this right is huge, and something worth taking the time to educate yourself about.
Understand the rules, how they apply to you and how you can use them to your advantage – the result is a faster and easier path to the results you want.
Ben Nash is a financial expert commentator, podcaster, financial advisor and founder of Turning wealthand author of the Amazon bestselling book ‘Get Unstuck: Your Guide to Creating a Life Unlimited by Money†
Ben has just launched a series of free online money education events to help you get on the first financial foot. You can view all details here and reserve your place†
Disclaimer: The information in this article is of a general nature and does not take into account your personal goals, financial situation or needs. Therefore, you should consider whether the information is appropriate for your circumstances before acting on it, and seek professional advice from a financial professional if necessary.
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