Fairer treatment of savings remains elusive
This week, let's revisit something that we almost had, one of those dangling promises that governments hold out from time to time but never quite eventuate. I'm talking about a tax break on savings, the most recent of which was unceremoniously dumped in last month's budget as part of the government's cost-cutting.
This week, let's revisit something that we almost had, one of those dangling promises that governments hold out from time to time but never quite eventuate.I'm talking about a tax break on savings, the most recent of which was unceremoniously dumped in last month's budget as part of the government's cost-cutting.This wasn't the first time that the promise of fairer tax treatment on ordinary savings was made and withdrawn before it became reality.Readers with longer memories may recall the Howard government's promised savings rebate, which was announced with great fanfare in 1997 and also shelved before it saw light of day.For all the lip service to encouraging people to save, when push comes to shove, it seems politicians of all persuasions have better things to spend our money on. It is, of course, true that neither Peter Costello's savings rebate nor the more recent Labor savings discount would have had any real impact on our savings behaviour.Both were tokens offering the illusion of fairness rather than serious attempts to address the inequity where the sort of investments favoured by higher earners (shares, negatively geared property, even superannuation if you earn less than $300,000) are taxed much more favourably than the bank accounts and term deposits favoured by lower earners.But recent analysis by research company RateCity emphasises the poor deal many people get from interest-earning investments and the need, in the absence of measures to make the investment playing field a bit more level, to find savings products that don't leave you worse off after tax and inflation.RateCity looked at the real return you get on a $5000 deposit after tax and inflation. While investments such as shares and property have the potential to grow over time (hopefully), and thus compensate investors for the fact that inflation is eroding the value of their dollars, savings accounts don't do this.An investment of $5000 now will still be worth $5000 in 2020. But you won't be able to buy as much with the money then.RateCity found the average taxpayer on the 31.5 per cent marginal rate needs to earn 3.2 per cent on their savings just to break even. If you're earning between $80,000 and $180,000 (on the current tax scales) you'll need 3.6 per cent, and if you're on the top marginal tax rate you'll be losing out unless your savings earn 4.1 per cent.That might not sound a lot but when many savings products are earning less than 5 per cent, losing the first 3 per cent or 4 per cent to inflation and the taxman makes the real return look pretty pathetic.RateCity found, for example, that someone on the 31.5 per cent tax rate who had invested their $5000 in an online savings account earning the average rate of 4.36 per cent would receive just $39 in interest after tax and inflation. That's despite the fact the gross interest payment would have been $218.For someone earning between $80,000 and $180,000 the "real" return would be just $24 and for someone on the top marginal rate a paltry $6. Even lower earners on $6000 to $37,000 a year would lose two-thirds of their interest to tax and inflation, receiving a real return of $72.Chasing the maximum online interest rate of 5.7 per cent would improve the real return but, even then, you'll still be losing more than half your interest to tax and inflation.RateCity found the $285 interest you'd get on your $5000 would be worth just $86 for the average taxpayer, $43 for someone on the top marginal rate and $129 for the low-rate taxpayer.In that sense, as the Henry review into the tax system pointed out, our tax system actively penalises people who save. You get taxed on the part of your interest that represents inflation and the longer you save, the higher the effective tax rate on your future consumption.The review calculated that for someone on the 31.5 per cent tax rate, the effective tax rate on savings income was actually closer to 60 per cent. It proposed a 40 per cent discount on interest income (that would also apply to rental property and capital gains) that would bring the effective rate down to something closer to your marginal rate.The government opted for a 50 per cent discount (applying only to interest-type savings) but with a sting in the tail. It would have only applied to the first $1000 of interest income, whereas the proposal in the Henry review was uncapped.Out of interest, the Howard government's proposed savings rebate had offered a 15 per cent tax rebate on savings and investment income up to $3000 a year. It would have also applied to non-deductible super contributions.Those measures have all now been scrapped. But the underlying unfairness remains.As a nation, we're saving more than ever. Thanks to ongoing global economic problems, we're also putting much of our money into those highly taxed deposit-style products rather than risking it on volatile investment markets.Safety first is understandable. But as the numbers show, that safety comes at a price. Storing money in a low-interest account could actually be costing you after tax and inflation. Checking that your interest rate is competitive is not just about getting the best return on your savings - it could be the difference between earning a real return versus a loss.