3 ways to save thousands in tax each year
Reduce your tax liabilities and improve your investing outcomes.
I’ve been writing a lot about tax lately and there’s a good reason for it. Investors are drawn to tax minimisation because of the noticeable toll it takes on their investment outcomes.
This article explores three ways that you can save thousands on tax. You may already be utilising these strategies, but understanding the scale of the impact on your outcomes may trigger you to double down or adjust these approaches to maximise your outcomes.
1. Salary sacrifice
Salary sacrifice is an easy way to contribute to your retirement savings and save thousands on tax.
Take for example an individual who is single and has an $100,000 salary. He looks at the Moneysmart Superannuation Optimiser tool and sees that the biggest boost he can give to his super is $735 before tax a month, or $169 a week.
Source: Moneysmart
Doing so means that he makes an extra $7,500 in net contributions to his retirement savings annually, and reduces his take home pay by $6,000 a year.
The great thing about super is that the rate of tax on earnings is lower, so you’ll continue to save tax over the years on your investments. When you reach retirement, you’ll be able to access a 0% tax rate on your savings (up to a $2 million limit).
It is pertinent to acknowledge thatthe optimised approach suggested by the tool is forgoing a large percentage of their take home income. The example is illustrative and may not reflect the realities of your cashflow or your cost of living. The tool is still useful to give investors a yardstick about what optimising contributions look like and encourages you to contribute what you can spare.
The tool also shows that investors are able to save thousands of dollars that can make saving for retirement easier. It is particularly attractive for high income earners. The tax savings increase as income increases. Individuals effectively receive a tax discount of their Marginal Tax Rate minus the 15% contributions tax into superannuation.
2. Using the tax-free threshold across couples
I recently wrote about tax structures and whether they can minimise tax liabilities for investors.
Trust structures allow you to distribute passive income from investments and business income to the beneficiaries. Doing so means you have a few options to reduce tax liabilities across the individuals, depending on their tax rates. The issue with trusts is that there’s a lot of rules to follow and establishment and maintenance fees.
A simpler solution for some investors is to have joint ownership of assets. Doing so means that you are able to split the tax burden from income between multiple owners. It is assumed by the ATO that the tax obligations will be split equally. The ATO allows you to deviate from a 50/50 split if you can prove ownership. For example, if I contributed 30% of the initial capital to an investment and my husband contributed 70%, he can pay 70% of the tax obligation which leaves me with 30%.
3. Optimise your rebalancing strategy
If you have a comprehensive investment strategy in place, you will have target allocations for asset classes, based on the goals of your portfolio. During portfolio evaluations (usually yearly, or half-yearly), you would compare your target asset allocation with the current asset allocation of your portfolio. This will form the basis for a decision around rebalancing.
There are two theories around rebalancing. The first is that you pick a set interval. For example, you might choose annual. You look at your portfolio and get it back aligned from an asset allocation perspective.
The second theory is that you instead use tolerances. You may set a 10% tolerance which means that if your goal is to have 60% allocation to equities and it gets to be more than 66% you would rebalance. Another version of this is choosing a range. You may have a goal that stipulates that you have 60-80% allocation to equities. In both these cases you are trying not to do it too often as your portfolio will naturally fluctuate.
The reason that you don’t want to rebalance too often is because rebalancing has a downside. There are transaction costs and there are likely taxes as you sell positiions that have gone up in value. These taxes can be significant, and have a significant drag on your returns, especially over the long-term.
There are a few ways that you are able to save thousands in your process of rebalancing. The first is setting the interval for rebalancing at 12 months. This will ensure that if you do need to rebalance, you will be able to claim the 50% capital gains discount.
The second is utilising a portfolio maintenance reporting tool. I recently wrote an article that ran through how financial advisers can improve portfolio returns by 3%. According to the research, one of the ways that they’re able to do this is through technology and tools. Rebalancing means that you are buying and selling assets relatively frequently. Investing in a tool that’s able to structure those realised gains and losses will likely be able to reduce your tax liabilities.
Morningstar Investor is integrated with Sharesight that provides these reporting capabilities, but there are other reporting tools available on the market. A tax professional would also be able to provide this tax advice for you.
Not sure when you should rebalance? We’ve done a podcast episode on all of the circumstances that could trigger a rebalance of your portfolio, and the consequences of doing so. You can listen to the episode or read the transcript here.
Invest Your Way
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