InsightsAustralian shares

Why tax matters for income investors

By June 30, 2022July 5th, 2022No Comments
By Dr Don Hamson- Managing Director, Plato Investment Management

Taking into account your own tax situation is very important when investing for income.

Most Australians have to pay tax, so analysing or making decisions from an after-tax perspective is very important. And it’s highlighted in this chart which illustrates the after-tax value of $1 of pre-tax income, plotted for three different tax situations.

First on the left, you see zero tax investors which would be the first $1.7 million in pension phase superannuation, or for charities, or people who have very low income and don’t pay tax. Then you see the same for a 15% tax rate which is the tax rate for accumulation based super, and on the right we’ve looked at it from the highest marginal personal tax rate.

You can see that the after-tax value of income is different for these three different types of investors, and it’s one reason why Plato has a strategy which is targeted for pension phase super because it’s taxed differently to other types of investors.

You can clearly see on this chart the value of franking credits, because $1 of fully franked dividend is actually worth $1.43 because you get a forty-three cent tax credit when you put your tax return in at the end of the year.

So for those investors the only way they can improve their after-tax income is to get more franking credits.

At 15% super the pattern is somewhat similar in that the full franked dividend is still worth the most, but it is not worth as much because you are actually taxed at 15%, so it is only worth $1.21 after-tax. But that’s still substantially more than other forms of income such as rental income, or interest income which has no franking credits, and short term capital gains which are both taxed at 15% and its substantially better even than a long term capital gain because in superannuation you are taxed at 10%. So if you’ve got a $1 long term capital gain its actually only worth 90 cents in $1.

Interesting though if you flip it around and go to the very right hand and you look at the high tax investors, someone paying 45 cents in the dollar plus two cents Medicare, the best way to maximise after-tax income is to receive income as a long term capital gain. And it’s even better to actually forestall realising that gain for as long as possible because you don’t have to pay tax until you actually realise the gain. That’s why many investors argue you should have low turnover strategies because you want to get a lot of capital gains, and long term capital gains.

Strategies for pension phase investors

For pension phase investors, capital gains tax is irrelevant, therfore their dividend income strategies should be managed to maximise after-tax alpha.

That’s why here at Plato we’ve established strategies for the zero tax end of the market because we feel not enough fund managers manage their portfolios for those investors. Yet they’re the investors most reliant on income to make ends meet.

Read next: What are franking credits?




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