Another Year of Tax Cuts - A Moment of Truth
The headline discussion leading into the budget was personal tax cuts. Most Australians will indeed receive some tax relief, with a $750 saving as the 15% tax bracket is raised to $30,000.
After a number of years of tax cuts in a row, significant changes to superannuation rules, booming asset values (over the medium term) in both property and shares and what is still a relatively low interest rate environment - it is absolutely time to take stock and be sure that wealth is being created at an individual level now.
This latest tax cut, which will flow through to most Australians, is valued at $750 (a 15% tax saving on the $5,000 of income between $25,000 and $30,000). It should be seen as part of the continued favourable economic conditions that we find ourselves in, and a call to arms to take advantage of the favourable personal finance environment to strengthen our financial situation at an individual and family level.
The $750 is not a huge sum of money - however it can either be put to use in creating further wealth, or frittered away as an opportunity lost.
If we don't take the chance to improve our financial situations now, when 'all the ducks are in a row', then it is going to be considerably harder in the future when economic, political and investment environments are not nearly as favourable.
'Senior Australian Tax Offset' - be Careful About Dumping Lump Sums into Superannuation
The Senior Australian Tax Offset (SATO) is an offset that reduces the tax payable for Australians of age pension age.
A couple can now earn up to $43,360 and a single person up to $25,867 before paying any tax because of the Senior Australian Tax Offset. This is a significant amount of income to earn, particularly when most retirement assets are likely to be held in superannuation and be paying a tax free income stream (to people over the age of 60 from the 1st of July this year).
The point is this - SATO means that few people will be paying tax after the age of 65, particularly they have a reasonable portion of their assets in superannuation.
There seems to be a strong movement at the moment of people selling up assets, paying capital gains tax and dumping money into superannuation. There is nothing wrong with superannuation, indeed it is a great investment environment. However you need to be sure that the tax saving you will receive from putting assets into superannuation actually saves tax in the future - otherwise you are paying more tax than you should.
Even if you are a self employed person and have reduced your capital tax liability by making a tax deductible contribution to superannuation, you will pay a 15% contributions tax on that contribution. So there is also a tax liability there.
The message is this - the Senior Australian Tax Offset means that people will be able to have a reasonable level of assets outside of superannuation, easily $400,000 to $500,000, and not pay any tax after the age of 65. Be careful that in selling up assets and putting them into superannuation - and paying either capital gains tax or superannuation contributions tax - that you are actually saving some tax in the future. Otherwise you are paying more tax than you need to!
Here is an example of this that I saw recently - a couple aged 64 with a share portfolio of $200,000 producing gross income of just over $10,000. They are both working part time - earning about $30,000 each. They wanted to retire next year (aged 65) with combined superannuation assets of $500,000. The original cost of the shares was $50,000.
They wanted to sell the shares and put the money into superannuation, for a 'tax free environment'. The would have paid just over $25,000 in capital gains tax (a $150,000 gain, discounted by 50% and then taxed at 31.5%) in selling the share portfolio.
The reality is that they would not have paid any tax on the share portfolio because of the Senior Australian Tax Offset - they were just creating a tax liability (capital gains tax) where one would not have previously existed!
Rethinking of Negative Gearing
Recent budgets have seen:
- The top marginal tax rate decrease to 45% plus 1.5% medicare levy (from 47% plus 1.5% medicare levy)
- The level at which this tax rate 'kicks in' increased to $150,000 - and moving to $180,000.
Negative gearing is the term that is given to borrowing to invest. The interest costs of the borrowing are greater than the investment income, causing an investment loss. This loss can be used to reduce a person's taxable income.
Negative gearing is a favourite wealth creation strategy for Australians. It's genesis would seem to be in our love affair with investment property, which has carried over into borrowing to invest in the sharemarket.
A key input into the value of this strategy is the value of the tax deduction. A $10,000 loss with a marginal tax rate of 48.5% provided a tax saving of $4,850. On a 31.5% tax rate this saving is only $3,150. This is a significant difference.
These tax changes, combined with interest rate rises, mean that borrowing to invest is not as attractive as it has been previously.
The Government Co Contribution - A Reminder
Those Australians lucky enough to receive a Government Co Contribution in the 2005/06 tax year will receive another bonus with a doubling of the Co Contribution received. This means that some people who contributed an extra $1,000 to superannuation will actually receive a $3,000 Government Co Contribution.
It is too late to do anything about this now, however it is a reminder of the most effective wealth creation strategy that there is - the Government Co Contribution. Having $1 increase to $2.50 because the government adds an extra $1.50 provides an immediate return of 150%.
If your income is under $58,000 you need to investigate this possibility.
Keep in mind that you don't have to put in the full amount. If all you have is $50 then put that in, and enjoy the extra $75 the Government puts in for you. Turning $50 into $125 is still a pretty neat investment.
Trading in Forestry Investment Schemes
Trading of holdings in forestry managed investment schemes is currently only allowed in exceptional circumstances. Proposals in the budget provide measures to allow trading of these interests after the initial investment has been held for a minimum of 4 years. This will allow trading of investments commenced on and before 1 July 2003 to be able to be traded as of 1 July 2007. These rule changes apply to past and future forestry MIS products.
The impact is that units in these investments now become a tradable commodity providing greater levels of liquidity for holders of these investments. Rather than waiting for returns to filter through, investors can sell their interests to secondary buyers - which will potentially see the development of a secondary market for forestry investments. This makes this style of investment more attractive for investors as they are not locking their capital away for what could be 15 to 20 years. As such this change possibly establishes a new asset class for the future.
The government has also confirmed its policy to allow up front deductions of investments in forestry MIS from 1 July 2007 provided at least 70% of the expenditure on the underlying scheme is directly related to developing forestry.
While I don't think that there is a great rush to go out and start buying forestry schemes, the potential establishment of a secondary market would start to open this asset class as a one worthy of investment consideration.