$180k a year

Higher earners, such as dual-income couples, need to make smart decisions to maximise wealth and minimise tax

As a certified financial planner I know that every investing decision you make has to stand on its own feet. As a chartered accountant I also know that you should always pay the correct amount of tax but you should never leave a tip. Frankly, our politicians don’t deserve a tip.

For those on higher incomes, such as our theoretical dual-income couple, who earn $140,000 and $40,000, taxes are a real and material expense that need to be considered when making smart investment decisions.

STRATEGY 1 Salary sacrifice to turbocharge your super

Depending on your age, if a couple earn more than $180,000 there are a number of likely expenses they face. Mortgage repayments, living expenses, private school fees and travel/entertainment all normally chew up a significant portion of take-home pay.

Regardless of age, my most financially successful clients allocate a portion of their income to top up their superannuation. Many seek to retire early and they know they will need to fund 25 to 30 years of their dream retirement. So every little bit helps.

For someone earning $140,000, potentially 37¢ in the dollar goes in income tax, 2¢ in Medicare and NDIS levy and 1.5¢ in medical levy surcharge (if you’re a couple with combined income of $180,000 with no private health insurance). So you could end up with as little as 59.5¢ after tax from every extra dollar you earn.

By comparison, if you salary sacrifice pre-tax income into super the tax is capped at 15%. So a salary sacrifice of $25,000 (the limit from July 1, 2017) will save 25.5¢ in every dollar in tax. Instead of you having 59.5¢ in the dollar, your super receives 85c in the dollar. Of course, you can’t access it until you’re 60 and retired, but that money will also grow quicker in the concessionally taxed environment of super. You win on tax both ways!

The tax benefit for a partner earning $40,000 is not as large. Half of their income is tax free (up to the threshold of $18,201) and above that their income up to $37,000 is taxed at 19% (potentially 21.5% if you add Medicare levy and surcharge). So the advantage between having income taxed at 19% (or 21.5%) and a contribution taxed at 15% in super is not as beneficial. So if cash flow is an issue, most of your family’s tax benefit will come from the higher-income earner salary sacrificing to their super.

Another way to look at this is the way my retired clients do: “I’ve never regretted putting more money into my super.” So my advice is that, yes, governments will never stop tinkering with super and the rules will definitely change over time. When you come to retirement, super may not be as good as it is today but it will always be better than having your money in the normal taxed environment.

So turbocharge your salary sacrifice contributions today to help fund your dream retirement tomorrow.

STRATEGY 2 Use good debt to build your wealth

“Bad” debt finances things that don’t add to your wealth or will typically lose value over time. In this category I’d classify credit card debt, store card debt, car loans and personal loans. Before you even consider good debt, ensure you pay off all your bad debts.

By contrast, good debt builds your wealth. I classify investment loans, business loans, equipment loans, mortgages and education loans as good debt. Some of these are tax deductible.

For those who earn over $180,000, a dependable wealth strategy in recent decades involves a tax-effective investment loan to fund an investment property or an investment portfolio.

Don’t get emotional about any investment

Run the numbers and let them speak for themselves. For a new property, estimate your total purchase price (including stamp duty, legals, etc) and speak to agents to estimate a realistic gross rental. Deduct an estimate of running costs (insurance, management fees, maintenance, etc) to get your expected net rental yield. Divide your net rental yield in dollars by your total purchase price in dollars to get your net yield. Ideally that should be above 3%, or you’re earning less than cash rates but taking more risk.

For an investment in a portfolio of diversified shares or exchange traded funds (ETF), estimate the dividend the portfolio will throw off to calculate the net yield.

You are likely to also be expecting capital gains over time but you need to be mindful of the increasing fears of market corrections. An investment property or

Pay the tax you are legally obliged to pay but don’t leave a tip for the treasurer

portfolio may or may not go up in value but you must at least ensure the income return on the investment gives you an adequate return.

Apply the tax kicker

Only if the investment stands on its own two feet before debt and tax benefits are factored in should you consider taking more risk with leverage. If it doesn’t, debt has the potential to make a bad investment even worse.

If the investment does stack up, using leverage to positively gear (your net rental income exceeds your interest cost), neutrally gear (they are equal) or negatively gear (your interest cost exceeds your net rental income) your investment property can increase returns.

Alternatively, you may wish to focus on an ETF portfolio that favours shares that offer higher franking credits, which typically include the big banks, consumer services and industrial stocks. Leveraging such a portfolio will add more risk but can also increase the tax benefits.

As an investor, you receive a benefit for the tax the company you invest in has paid. Say the firm earns $100 and pays tax on that of $30 (30% corporate tax rate) and pays the rest to you as a $70 dividend. You record $100 as assessable income but you are also entitled to a $30 franking credit. So for someone earning more than $180,000, assuming a marginal tax rate of 47% (45% plus 2% Medicare and NDIS levy), you would only pay tax at 47% less the 30% you get a credit for, or 17%. In my book that’s a win from a tax perspective!

Here I’ve focused on the tax implications of income returns on investments. For those on more than $180,000 it’s even more important to ensure you hold onto assets for more than 12 months to attract the capital gains tax discount or you can double your tax bill.

STRATEGY 3 Health insurance to avoid surcharge

The Medicare and NDIS levy for all taxpayers (apart from low-income earners and seniors) is 2% of taxable income. On top of this, higher income earners may also have to pay an extra 1.5% under the Medicare levy surcharge.

If you’re single and earn more than $90,000, or a couple and earn more than $180,000 combined, and you don’t have an appropriate level of private health insurance, then you will pay the additional 1.5% of your salary as the surcharge. This is similar to leaving a tax tip for the treasurer – and, frankly I don’t think you should. For a couple earning a combined $200,000, 1.5% is $3000 in additional tax.

On the flipside, the cost of private health insurance goes up materially each year. In February, the federal government announces how much it will allow private health insurers to increase fees in April. In 2017 the allowed hike was 4.8%, three times the rate of inflation.

So a family on the top level of cover paid $200 more, with fees jumping from $4200 to $4400 a year. An individual saw a $100 hike from $1150 to $1250pa. These are significant rises, increasing pressure on already stretched household budgets.

To make smart financial decisions, ensure your investing decisions stand on their own two feet and that tax, which is a real and material cost, is factored into your decision making. You should always pay that tax you are legally obliged to pay but by making smart financial decisions you can ensure you never, ever leave a tip.

Claire Mackay is director of Quantum Financial. She is a qualified chartered accountant, SMSF expert and lawyer.