A key way of adding value to your share portfolio is to ensure it is housed in the correct structure. The simplest structure is to simply buy shares in your own name. Married couples can adopt income-splitting strategies by registering investments in joint-names. Then there are the more complex structures which are family trusts, private company and a self-managed super fund (SMSF)
Buying in your own name
Buying shares in your own name is how most people start. Just how efficient it is depends on your stage of life, your level of income from other activities including salary, and the availability and suitability of other means of holding your investments.
If you are a low income earner, whether working or retired, then you might reduce your overall tax by investing in shares which pay dividends on which tax has already been paid at the company tax rate. These franking credits may be offset against tax payable on income from other sources in the year of receipt. If your marginal tax rate is below the company tax rate, then the difference between your marginal rate and excess tax above the company paid on the dividends will offset tax otherwise payable on other income.
There are various ways of reducing the tax effect. One is to favour shares, which pay very low or nil dividends and instead earn their return from capital growth in the share price.
Capital gains tax works in a different way to income tax. Tax is not paid on capital gains until the gains are realised.
A tax efficient strategy is to retain underlying shares to build up a large unrealised gain and sell them in a year in which you have minimal other income.
Ideally this might be a year in which you retire. You could further reduce your tax bill for that year by entering into a gearing strategy for your share portfolio in that year. It is possible to obtain 13 months of interest deductions in any one year. You could achieve this in the following way. Lets say your share portfolio is worth $500,000 of which $200,000 is taxable capital gain. Early in July of the year you retire, gear your portfolio. You might borrow $500,000 against security of the portfolio. Or you might combine it with a home equity loan secured against a property. The set-up costs of the loan are deductible. You arrange to pay interest monthly in arrears, paid for out of your share portfolio. In May of the following calendar year you arrange to make a full year prepaid loan with the June payment. The rules allow you to prepay up to 13 months of interest. Hey presto, you now have 24 months of deductions in the year you need it.
Ideally you knock your assessable income down below zero. The amount of capital gain you dare realise will depend on your starting point. In this way you can use the share portfolio in an “ordinary money” environment as a capital drawdown strategy, normally in conjunction with building up money in super
Income Splitting
Income splitting is a technique of distributing income and gains over two tax payers to reduce the overall tax rate. Each tax payer is allowed to earn a small amount of money each year without a requirement to pay tax. This is called the tax- free threshold.
Family Trusts
Family trusts have traditionally been a most tax effective method of owning shares. They allow income to be distributed among various beneficiaries in a tax-effective manner. They are the potential target of government reforms.
Self managed superannuation
A common misconception is that superannuation is an investment. This is not true. Superannuation is a means of holding investments. It has become the foremost method of holding assets in retirement for the wealthy. There are now over 600,000 self-managed super funds. When I first wrote this article, in the early nineteen-nineties, there were just 64,000! The main appeal is all your investments in super can grow capital gains tax free from age 55 and be partially distributed in a taxable way from 55, and tax free from age 60. Now you can have up to six members instead of just four, which is a sensible amendment.
Personal Charitable Trust
Its possible to set up your own personal charitable trust (donor-assisted) so that you can commence giving money away before you die. Simply donating a lump sum to a charity, such as a church, runs the risk that if you later fall unexpectedly on hard times, you can’t get the money back you’ve donated. While you can only ask the ATO for relief in extreme circumstances, the safety valve does exist and might well provide the incentive to start. You must select eligible charities and you must give away a minimum 0f 4% p.a. from the trust.
