Top three tax saving strategies

In Australia we pay a lot of tax, and it seems to be increasing every year. Cutting your tax bill will give you more money to save, invest, or just spend today – but it’s not easy.

The tax rules are complicated and can be confusing, and most of the time tax is something that seems to be hidden below the surface, not becoming clear until the end of the financial year after you do your tax return.

But if you’re smart with how you plan with tax, and how you use the rules to your advantage, you can get more out of the money you already have today and get ahead faster without just sacrificing more.

There are a lot of options when it comes to saving tax, but some are more effective than others – and there are three key tax saving strategies you need to be across if you don’t want to pay more in tax than you absolutely have to.

Franked dividend investing

Buying shares is a highly effective way to build your investments and wealth, but most people don’t realise that shares can also save you a serious amount of tax.

When you buy a share in a company, you’re effectively buying up a tiny little slice of that firm. Once you own that slice of the company, you’re entitled to a small slice of their profits, which are paid out through dividends.

In Australia, most big companies pay out their dividends after they’ve earned profit and then paid tax on that profit. The result is that when you receive your dividend income, this comes with tax credits (franking credits) attached. These tax credits can reduce the tax on your dividend income, but if you get enough of them they can also reduce the amount of tax you pay on your salary and other income.

Not all companies pay the same dividends or have the same tax credits attached, so before you invest it’s worth doing some research or getting advice to make sure your investments are giving you the biggest bang for buck.

Negative gearing

This is one of Australia’s favourite money strategies, and with good reason. Gearing means borrowing to invest, which is most commonly done through property investments. The “negative” part of negative gearing refers to the cashflow of your investment – the net income less your total expenses.

When you buy an investment property, the income on this investment is the rental income you receive, and the expenses are your mortgage interest costs, strata, insurance, etc. Basically, if the total income is less than the total expenses, your investment has a cashflow cost and is costing you money.

Now, you might be wondering why on earth anyone would choose to buy an investment that costs them money, and it’s a fair question. The answer lies in the fact that the cashflow of an investment is only one side of the equation. The other side is the growth or increase in the value of your investment over time.

In Australia today, the cost of running a $500,000 investment property is about $10,000 – $15,000 per year depending on your tax rate. But based on the long term property growth rate of 6.3 per cent, on average this property would be increasing in value by $31,500 each year. So even if you’re paying $15,000 annually, once you factor in property growth, you’re still ahead by more than $16,000 every single year.

And it gets better, because under Australian tax rules you can claim the cashflow cost of any investment as a tax deduction at your personal marginal tax rate. If you earn income above $45,000 each year, your tax rate is at least 32 per cent, and could be as high as 47 per cent. This means that you get somewhere between a third and up to almost half of every dollar you spend on your investment property back at tax time.

Super contributions

In Australia, the rules are set up to encourage people to save for their retirement, which the government does because they know that if people are wealthy in the future, they will spend more money (generate more tax revenue) and take less government assistance through the welfare system.

This creates an opportunity for some serious tax savings today, because under the current rules anyone can claim tax deductions of up to $30,000 each year just by using their super fund to invest.

If you put money into your super, either through salary sacrifice with your employer or even just directly from your bank account, you can claim every single dollar as a tax deduction – up to an annual limit of $30,000 each year. It’s worth noting this limit includes any money put into your super fund by your employer through compulsory contributions. But for most people, compulsory contributions still leaves a lot of room for some significant contributions (and significant deductions).

And once you get money inside your super fund, the tax inside your super fund on any earnings or growth is capped at a maximum rate of 15 per cent, which is much lower than personal marginal tax rates of up to 47 per cent.

I get that if you’re young and have a long time until you reach retirement, superannuation probably isn’t the first place you think about investing. But given the tax savings on offer, it also shouldn’t be the last.

The wrap

Tax is the silent killer. But only if you let it be. The rules can be complicated, and more than a little bit confusing. But like any skill or knowledge area, being smarter with your tax is a muscle that you can and should build over time.

The three tax saving strategies covered here have the potential to save you a heap of tax, and they can be used in combination to deliver even better outcomes. When you get this right, you’ll keep more of your income and accelerate how quickly you get ahead.

Ben Nash is a finance expert commentator, podcaster, financial adviser and founder of Pivot Wealth. Ben’s new book, Virgin Millionaire is out now.

Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs.

Therefore, you should consider whether the information is appropriate to your circumstances before acting on it, and where appropriate, seek professional advice from a finance professional.