Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 266

Golden rules for considering tax in investing

Fairfax newspapers have been running a series of articles (see here and here) on the collapse of Great Southern and the hardships it has caused, a timely reminder of the perils of mixing debt, investment and tax breaks. Almost every case consists of investors borrowing to invest on the advice of a trusted professional, usually in search of a tax break. When the investment went bad, the investors were left with huge debts that many are still struggling to pay off. From the Fairfax articles:

"Great Southern’s plunge into administration and infamy laid bare toxic conflicts within the accounting and financial advice professions, led to a series of explosive parliamentary hearings and, eventually, added to momentum for the royal commission now underway. The commission has shone a spotlight on aggressive, unethical and potentially illegal behaviour by financial institutions in Australia but will not consider Great Southern ... 

A Fairfax Media investigation has examined the stories of dozens of such investors, who say they were misinformed about the risks of investing in Great Southern by financial advisors who incorrectly told them the loans were non-recourse, which means if debt was called in, Great Southern was on the hook, not the investors."

It’s a timely reminder for anyone with property in an SMSF. My prediction is that we are two to three years away from replaying similar stories on properties in SMSFs that were bought from spruikers at free seminars and leveraged as much as possible.

These rules are designed to minimise the chasing of tax breaks and people becoming another statistic:

Rule 1: Choose your investment first without regard for tax

Forget about tax. Work out whether the investment is good or bad before you even think about tax. If you can’t justify an investment without incorporating some sort of tax benefit then you probably shouldn’t be investing. You might like an investment on pre-tax returns and then reject it after considering the post-tax returns, but you should never do the opposite.

Rule 2: Get your structure right

It is sensible to invest using a tax-efficient structure, but you need to consider not only the financial cost but the time cost and the potential for additional liabilities or responsibilities.

Choosing between investing in your own name, a company, a trust or an SMSF is sensible. But, if you need to create a special structure to save yourself a few dollars in tax then consider:

  • How much will you pay in accountancy or legal fees? I’m not saying don’t listen to your accountant, but you should do the numbers yourself. If the structure results in a $3,000 tax saving but a $2,500 accountancy bill, then your accountant will probably think it’s a good idea. You need to work out if $500 will be worth the extra time and the potential liabilities.
  • How much extra work every year will you need to do? If you hate doing one tax return then why are you signing up to add company or SMSF tax returns to your annual list of chores?
  • If the tax rules change, how much will you be out of pocket? For example, spending $5,000 upfront on a fancy structure to save $2,000 per year might leave you considerably out of pocket if the rules change.
  • Are you taking on additional liabilities and responsibilities? For example, becoming a director has additional legal ramifications. Your structure might affect how you will be treated legally if things go badly.

Rule 3. Debt is dangerous

Debt can make a good asset great. But, debt can never make a bad asset good, and it can make an average asset bad.

If your investment loses money, debt will never make the situation better. An asset that only returned say 2% might be disappointing if you invested in it without debt, but the investment is not disastrous. An asset that returned 2% funded by debt costing 10% might be disastrous.

I am wary of using debt to invest in any volatile asset. Never use debt to get yourself a tax break. If you are taking out a margin loan then make sure you can meet the margin calls if the stock market falls.

A common example might be borrowing against an investment asset (usually tax deductible) and using that money to say reduce your home loan (not tax deductible). First, this is playing with fire from a tax perspective (it may fall foul of Part IVa of the tax code) and second, check the interest rates. In many cases, higher interest rates mean that the benefit is negligible. And definitely don’t increase the amount you invest to access a bigger tax break. Often the equation is:

  • investment goes well, save a few hundred dollars or so in tax
  • investment goes badly, financial ruin
  • plus potential to fall on the wrong side of the ATO.

Rule 4. Never invest in an asset where the sales pitch has a major focus on tax breaks

Go back to rule number one.

Rule 5. Don't let tax affect your decision when to sell

There are timing benefits in when you might take a capital gain or a capital loss. But I’m much more comfortable selling an asset earlier than holding onto a poor investment hoping that it doesn’t fall further while I wait for some tax advantage. That is, don’t hold onto a poor investment that might get worse just because you are hoping there will be a tax benefit.

 

Damien Klassen is the Head of Investments for Nucleus Wealth. This article is general information and does not consider the circumstances of any individual.

 

RELATED ARTICLES

Admin fees on large super funds vs SMSFs

7 golden rules for SMSF investors

Property excitement, a Saturday auction and an SMSF

banner

Most viewed in recent weeks

Where Baby Boomer wealth will end up

By 2028, all Baby Boomers will be eligible for retirement and the Baby Boomer bubble will have all but deflated. Where will this generation's money end up, and what are the implications for the wealth management industry?

Are term deposits attractive right now?

If you’re like me, you may have put money into term deposits over the past year and it’s time to decide whether to roll them over or look elsewhere. Here are the pros and cons of cash versus other assets right now.

Uncomfortable truths: The real cost of living in retirement

How useful are the retirement savings and spending targets put out by various groups such as ASFA? Not very, and it's reducing the ability of ordinary retirees to fully understand their retirement income options.

How retiree spending plummets as we age

There's been little debate on how spending changes as people progress through retirement. Yet, it's a critical issue as it can have a significant impact on the level of savings required at the point of retirement.

Meg on SMSFs: $3 million super tax coming whether we’re ready or not

A Senate Committee reported back last week with a majority recommendation to pass the $3 million super tax unaltered. It seems that the tax is coming, and this is what those affected should be doing now to prepare for it.

20 US stocks to buy and hold forever

Recently, I compiled a list of ASX stocks that you could buy and hold forever. Here’s a follow-up list of US stocks that you could own indefinitely, including well-known names like Microsoft, as well as lesser-known gems.

Latest Updates

Retirement

How much do you need to retire comfortably?

Two commonly asked questions are: 'How much do I need to retire' and 'How much can I afford to spend in retirement'? This is a guide to help you come up with your own numbers to suit your goals and needs.

Investment strategies

Protecting retirement income from inflation shocks

As we continue to navigate a volatile market and geopolitical landscape, retirees need a portfolio with protection from inflation risks so that they don’t experience another cost-of-living crisis when inflation has another upturn.

Investment strategies

Where to find value in a multi-asset portfolio

Bonds have had a dreadful few years and their positive correlation to equities of late means they may not be the diversifier in portfolios that they once were. What are the alternatives to bonds, and where might there be value?

Superannuation

How the $3 million super tax impacts unfunded pension schemes

Unfunded defined benefit plans mostly cover current and former Commonwealth and State public servants. These schemes are different from funded ones, yet the new $3 million super tax will treat them similarly.

Exchange traded products

Two overlooked tax advantages of investing in ETFs

We're nearing the financial year-end and it's a good time to think about your tax strategies. Here are two tax advantages to having ETF investments, plus a bonus perk if you’re in a fund hedged to the Aussie dollar.

Property

Why healthcare is a compelling property niche

Healthcare has been a bright spot in an otherwise challenging environment for commercial property. With an ageing population, the sector's future remains bright, and here's a look at the best ways to play it.

Strategy

The maths of friendship

Did you know you're far more likely to share genes with friends than non-friends? Or the number of friends you have is correlated to the size of certain parts of your brain? These are the latest findings of a famed psychologist.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.