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Beneath the surface
Performance figures can cast an impressive shimmer on investments. But the effects of tax may be shearing your perceived investment gains or your returns may actually be greater than they seem on the surface. The recent Russell/ASX Long-Term Investing Report highlights how significantly – and how differently – tax can impact on various investments. You might think you’re going full steam ahead but discover too late just how large a chunk tax has gouged out of your returns. Or, you could find that your return is actually more substantial than it looked at first. Gross rates can be misleading The graph shows tax hits some investment returns a lot harder than others. Investing in Australian shares in the 20 years to 31 December 2005 would have given you a return of 12.2% p.a. before tax but net of investment costs. After tax you would have got 10.4% p.a. if you were on the top marginal rate but on the lowest marginal rate you’d actually end up ahead of even before-tax returns with 12.4% p.a. This is a result of dividend imputation, where investors get a tax offset on their dividends for the tax a company has already paid on its profits.
Look at the differences between Australian shares and residential investment property. These investments produced almost the same before-tax returns over the 20-year period. If you’d invested $10,000 in 1985 and let the returns compound, you’d be left less than $2,000 ahead by investing in shares over residential investment property. But look at the after-tax results, and the attractiveness of shares is magnified considerably – you’d be $24,000 ahead on the lowest marginal rate and $17,000 ahead on the top marginal rate. It just goes to show that small differences in tax can really mount up over time. Interestingly, although Australian listed property fared better than Australian shares on a gross return basis, it fell behind after tax. The graph also reveals that personal taxation has a greater impact on fixed interest and cash investments than property or shares – particularly for those on the top marginal rate. If you’d invested money in cash and were on the top marginal tax rate, you’d have actually landed high and dry, with returns below inflation. Taxing matters It pays to be aware of taxes as you build and monitor your investment portfolio. Different assets are taxed in different ways. For example, the entire return from a cash investment is taxed at an investor’s marginal rate. This is generally also true of most fixed interest investments. But with growth investments like shares, half the return might come from dividends and half from capital gains. Investors may get tax benefits from dividend imputation and, with capital gains, if the investment is held for more than a year, tax is only payable at marginal rates on half the realised gain. Not only does this capital gains position result in a lower amount of tax, investors can delay paying tax until the gain is realised. A super incentive
Investors can access generous tax advantages by investing in super. The Government added further incentives for investors to jump on in when it announced plans in the recent Federal Budget for even more tax concessions. Under the proposed changes, payment of super benefits as a lump sum or pension would be tax free for people aged 60 or over and with benefits paid from a taxed fund. Benefits paid from an untaxed scheme (mainly public servants) would still be taxed, but at a lower rate than they are now for people aged 60 and over. And the current limits on the maximum amount of super a person can take concessionally-taxed (called Reasonable Benefit Limits) would be removed. The Budget proposals would make taxation of super a lot simpler by removing the current benefits tax. This tax is hard for people to get their heads around. For example, a lump sum may include up to eight different parts which can be taxed in seven different ways. And how investors take their benefits influences how much tax they pay. Superannuation is already one of the most tax-effective long-term investments, especially for higher income earners. Employer contributions – and those made by employees through salary sacrifice – are taxed at just 15%. Earnings on super investments are taxed at 15% or even lower, after allowing for dividend imputation and other concessional treatments of some capital gains. This places super in an even better position than the bars on the graph – the lowest marginal tax rate there is 16.5%, compared with super’s 15%.
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What we see on the surface of investments may only be the tip of the proverbial iceberg. While there are some obvious checks to test what lies beneath the surface, a recent Russell/ASX report reveals an important consideration that may surprise many investors…
