The end of financial year is always a time when strategies that will make a difference to taxable incomes are considered. Those who are now going to be affected by the budget repair levy, with personal income levels over $180,000, might be taking an even closer look at strategies this year.
The Federal Budget proposals will impact the cash-flow of many families, and it will be felt particularly by those who have a high level of mortgage debt.
Many may decide that a negative geared property is now the best way to not only ‘beat’ the levy, but also ensure they reduce their taxable income with legitimate measures as the end of financial year approaches.
But high-income earners need to carefully review their situation, says HLB Mann Judd Sydney partner, wealth management, Jonathan Philpot.
“Negatively geared investments will again be considered by those looking to increase tax deductions and decrease their taxable income. Property has always been a favourite for many investors, given the comfort with property ownership and the ease of borrowing to purchase a property, particularly when the bank also has security of your home.
“However the greatest trap with negative gearing is looking at it only from a tax perspective and not as a long-term investment. If the underlying growth in a property is not sufficient to make up for the shortfall of negative income, it is not a good investment option.
“As a general rule of advice, if the mortgage is above 50% of the home value, the focus should remain on repaying the home loan rather than diverting any after tax cash flow into an investment loan.”
The amount of tax that will be raised by the budget repair levy also needs to be put into perspective, Mr Philpot says.
“For those only just earning over $180,000 or who are expecting their level of pay to increase from 1 July by, say $10,000, the levy is only $200 additional tax. There is a risk that households could make financial decisions that cost a lot more than the actual levy.”
The lending environment should also be considered, Mr Philpot says.
“Even in a low interest rate environment, with most variable home loan rates around the 5.5% mark, an investment property would need to generate a total return, of rent and growth, of about 7% to achieve a better after tax result than simply repaying the home loan with those funds.
“Consider also, that interest rates are expected to rise over the coming years which will require the investment property to achieve an even higher return in order to justify the investment.”
There are options that households that are focused on reducing mortgage debt as well as building long-term wealth should consider.
“One of the most effective ways to reduce personal taxable income is to salary sacrifice into superannuation. The good news is the concessional contribution limits will increase from 1 July 2014, to $30,000 for those who are under 50 and to $35,000 for those who are 50 and over,” Mr Philpot says.
“While the Superannuation Guarantee will also increase from 9.25% to 9.5%, many high-income earners will have income that can be salary sacrificed into superannuation up to those concessional contribution limits.
Peter Bembrick, HLB Mann Judd Sydney partner, tax consulting, says the tax benefit of salary sacrificing super contributions is now more significant with the higher individual tax rates.
“For taxable income levels between $180,000 and $273,000, the tax saving will be 34%. For income levels between $273,000 and $300,000 it will be between 34% and 19% and for income levels above $300,000 the saving will be 19%.”
As the end of financial year approaches and the debt levy looms, the way investments are structured may come under the spotlight, Mr Bembrick says.
“The correct structure for the building of investment wealth should be considered. High-income earners with large sums of cash and fixed interest investments in their own name will end up with close to nil return after inflation and tax are taken out. Investing in lower income earning spouses name may be a better option.
“For larger investment sums, the use of family trusts and also non-concessional superannuation contributions will be appropriate for some,” Mr Bembrick says.
The funding cuts that were announced in the Federal Budget, in the areas of health, education and welfare may focus the minds of those very high income earners who are looking for a tax deduction with a philanthropic bent, Mr Bembrick says.
“The not for profit organisations and charities may benefit from the increased focus. For very high-income earners that wish to gift large sums on an annual basis, they may wish to consider establishing their own Private Ancillary Fund (PAF) or family foundation. The contributions into the foundation are tax deductible and a minimum of 5% of the asset value must then be paid to charities on an annual basis.
“From a zero starting point a minimum of $50,000 per annum would be needed to contribute into the PAF, in order to justify the establishment,” Mr Bembrick says.
Additionally, there are tax strategies that should always be considered, regardless of the economic climate, that will serve to protect your financial position, Mr Philpot says.
“Income protection insurance should always be considered for high income earners and premiums are tax deductible. This insurance provides for 75% of future employment income to be paid in the event of illness or injury, usually up to age 65. Given the many millions of dollars of future earnings that is being protected, its after tax cost for many would be similar to insuring their car, highlighting the value of income protection.
“As is always the case when taxes rise, people will move to include anything that acts to bring income forward into the 2014 tax year, or push deductions back into the 2015 year when they will be worth more.
“With the levies being raised, and the end of financial year approaching, seeking good advice should more than pay for itself and it is also another tax deduction,” Mr Philpot concludes.
HLB Mann Judd Sydney is a firm of accountants and business and financial advisers, and a member of the HLB Mann Judd Australasian Association.
For more information please contact:
Jonathan Philpot – Phone: 02 9020 4196
Peter Bembrick – Phone: 02 9020 4223
20 May 2014