Tax free bonaza for investors

Financial planners have reported that the halving of the contribution caps on concessional super contributions is driving many investors into higher-risk investment gearing outside super and within self-managed super funds in their determination to get alternative tax breaks.

And this increasing willingness to gear investments is being further propelled by greater investor confidence as the sharemarket continues, with a degree of volatility, to rebound from the GFC.

But many of the investors turning to higher levels of gearing would, no doubt, overlook a crucial factor: there is a tax-free or near tax-free bonanza available to investors without having to resort to gearing.

Under certain assumptions discussed below, an individual investor could, for instance, earn a dividend income of more than $90,000 a year from a non-super share portfolio without having to pay a cent in extra tax – once franking credits are claimed. And couples can simply double this figure for jointly-owned share portfolios, using the same assumptions.

Graeme Colley, national technical manager for ING Australia, is noticing more investors taking higher risks, both outside superannuation and inside self-managed super funds, by allowing their portfolios to be dominated by a single geared investment. This would occur mostly with high-cost real estate investments that individual investors or self-managed funds could not otherwise buy without gearing.

Colley suspects that many investors overlook the high returns that are possible from non-geared, fully-franked Australian shares held outside super without having to pay any additional after allowing for franking credits.

And super funds holding fully-franked shares will receive large tax refunds for excess dividends – further, all franking credits will be refunded once funds enter the tax-free pension-paying phase.

Colley says it makes sense to hold investments both inside and outside super. Non-super investments provided investors with more flexibility – particularly immediate access to their savings before retirement – and have not been subject to the multiple legislative changes affecting superannuation.

The investment of an inheritance, money received in a marital property settlement or proceeds from the sale of a family business in a tax-efficient portfolio of Australian shares may, for instance, make much sense – depending upon the investors’ personal circumstances including their personal tolerances to risk.

Of course, employment or business income is taxed at your marginal rate before being available to invest in shares outside super. By contrast, concessional super contributions are taxed at just 15% upon entering your fund but are limited by the new much lower contribution caps. (Concessional contributions include salary-sacrificed and personally-deductible contributions by the self-employed.)

Consider the three case studies below showing the size of the incomes that can be received outside super without having to either pay additional tax after allowing for franking credits or having to pay any tax after claiming a series of Government tax offsets.

In the first two case studies I mention below, it is assumed that the investors’ shares are earning fully-franked dividends of 3.5% on their Australian share portfolios – which was a little below the 3.69% average dividend yield of the S&P/ASX200 at the time of writing.

CASE STUDY ONE

Scenario: Single SME owner in his mid-40s has a large fully-franked share portfolio held outside super. His income from the small business has not been included in the calculations for the sake of simplicity.

Tax bonanza: Troy Smith, technical specialist for advice and administration with ING Australia, calculates that this investor could receive $92,474 in dividends (under the assumptions setout above) without having to pay additional tax – after allowing for franking credits.

Of course in practical terms, the market value of a portfolio necessary to receive $92,474 in dividends is substantial – a little more than $2.6 million in fact.

SmartCompany had asked ING to calculate the highest dividend income an investor could earn without paying extra tax apart from using their franking credits. Obviously, investors can work within this parameter given the size of their particular portfolios.

For instance, based on the same assumptions, an investor with, say, a non-superannuation portfolio with a market value of $857,143 could expect $30,000 in dividends with a $6,343 refund of excess franking credits.

CASE STUDY TWO

Scenario: Couple in their forties holds a jointly-owned fully-franked share portfolio outside super. Income from their small business is not included in the calculations for the sake of simplicity.

Tax bonanza: Troy Smith calculates that the couple could receive a joint dividend income of up to $184,950 without having to pay additional tax – after allowing for their franking credits.

CASE STUDY THREE

Scenario: This 65-year-old couple is still working in their small business that is struggling at this time. All of their investments are in superannuation.

Tax bonanza: Troy Smith calculates that the couple could receive a combined employment income of $54,996 from their business without having to pay any tax or Medicare levy. They are eligible for the low income tax offset, the senior Australian tax offset and the mature aged worker tax offset.

Even if the couple also had large superannuation pensions, these are tax exempt and would be non-assessable. This means the superannuation income will not reduce any tax offsets on their non-super income.

Perhaps the best lessons from these case studies are to emphasise the tax bonanza outside super and to highlight the remarkable value of the tax-free treatment of super in the pension phase.