Budget 2012: Time for a tax strategy rethink

Changes to the tax-free threshold and marginal tax rates have important implications for your portfolio.

PORTFOLIO POINT: This year’s budget provides a good opportunity to make some subtle changes to your tax strategy.

From a personal finance perspective, three items from the 2012/13 budget might cause a rethink of strategies. These are:

  • The changes in tax rates to create a much larger 'tax-free threshold’, which might see couples considering more income-splitting opportunities;
  • Higher 'marginal tax rates’ that might see an increased emphasis on 'salary sacrifice’ and 'negative gearing’ strategies; and
  • A reminder of the decreasing opportunities to get money into superannuation close to retirement, and the need to think about extra contributions earlier.

A larger tax-free threshold

For a number of years Australians have faced a $6,000 'tax-free threshold’, meaning that the first $6,000 of income earned by everyone is tax-free. In what is a significant change, this tax-free threshold has been more than trebled to $18,200.

This might be of particular use as a strategy for couples in which one partner is not earning income for a period of time, perhaps because they retire earlier or are not working for some reason. They can build an investment portfolio in their own name, while generating up to $18,200 of income (a little more if you include the benefits of the 'low-income tax offset’ or 'senior Australian tax offset’) and paying no tax.

It would take a portfolio of more than $300,000 to generate this level of income, so suddenly building an investment outside of superannuation, in the name of a non-income earner, might be more tax effective than building a superannuation investment portfolio, which is taxed at a 15% tax rate during the accumulation phase.

There are other potential benefits of investments held outside of superannuation; for example, it is easier to access the money (no withdrawal rules) and it may be more tax effective to distribute in the case of death.

Higher 'marginal tax rates’

But wait, there’s more: while income earners will benefit from a much higher tax-free threshold, they will be hurt by higher tax rates above this. This is the rate that the last dollar of every person’s income is taxed – known as a 'marginal tax rate’ – which will make those strategies that decrease taxable income slightly more lucrative.

Consider someone earning the average full-time income (as measured by AWOTE) of around $68,000 a year. They were previously taxed at a rate of 30%. This has been increased to 32.5%. This means that if they use a strategy that decreases their taxable income (such as salary sacrificing to superannuation or negative gearing by borrowing to invest), the tax benefit has increased by an extra $2.50 for every $100 taxable income is reduced by.

For example, on an average income, if you salary sacrifice $2,000 to super, your taxable income drops by $2,000 (say from $67,000 to $65,000). The income tax that you save on this ordinarily is $600. Under the new tax rates, the tax saving increases to $650. Sure, this is not the sort of money that will guarantee a retirement of caviar and lobster, however it does increase the incentive for investment strategies that decrease your taxable income.

Tighter superannuation limits

A harsh reality for most people who are currently working is that the 12% compulsory superannuation level is going to come too late to make a big impact on their superannuation situation. For those wanting a self-funded retirement, they are going to have to make extra contributions to superannuation.

The traditional time for making extra superannuation contributions is when people get close to retirement. However, the $25,000 limit on tax deductible superannuation contributions (for most people, compulsory employer contributions and salary sacrifice contributions) means that the ability to make contributions close to retirement is significantly limited.

Superannuation remains a tax-effective environment – earnings are taxed at a maximum of 15% and most withdrawals will be tax-free – and people looking to take advantage of this environment will need to make contributions earlier in their life.

Conclusion

There is the opportunity to make some subtle changes to your personal finance strategy following last night’s budget.

We have been aware for some time that it is going to be harder to get large amounts of money into super close to retirement. However, the budget does provide a couple of interesting strategies to think about. Firstly, a significantly higher tax-free threshold increases the possibility of highly tax-effective investments being held outside of super. Secondly, higher tax rates as income increases make salary sacrificing to super (as well as negative gearing strategies) more tax effective, providing an incentive to start these extra contributions to super earlier.

Scott Francis is an independent financial adviser based in Brisbane.