Sunday, April 7, 2013

A super taxing question for investors

So, Treasurer Wayne Swan and Minister for Financial Services and Superannuation Bill Shorten finally caved on the 'rule in/rule out' game that they've played with the media and the Australian public for weeks now.

To be fair, it's a no-win situation. If a government – any government – starts to rule things in and out of the federal budget, the whole thing drips out piece by piece until there's nothing left to actually announce on budget night. If they refuse – fairly – to play the yes and no games, then the opposition gets to speculate wildly on plans the government might be making.

That latter scenario, faithfully reported by the media – has finally become too painful and, more importantly electorally damaging, for the government to bear in an election year. As a result, Treasurer Swan and Minister Shorten have had to announce their superannuation changes this morning as a circuit breaker, to allow the government to 'get back on message'.

The result is that concessional taxation arrangements within superannuation will be reduced for high earners, replacing the completely tax-free status of income earned in the pension phase of superannuation.


Someone has to pay the piper

Regardless of your political stripes, it's hard for a fair-minded analysis to argue that superannuation could remain completely tax-free. With more and more assets being funnelled into superannuation, the federal government's (any government, not just the current one) taxation base has a hole in it – especially when the current dividend franking system meant that a fair (and over time, growing) portion of company tax receipts were being recycled into tax refunds for superannuation funds.

The argument of 'hands off our savings' only holds water as much as 'it's our income' does when it comes to income tax. At the end of the day, government spending is funded through taxation of one sort or another, and there's nothing inherently off-limits about super.

Of course, that's not to say that taxing super is the only or best option available – or that the government's changes are the best way to go about it, but that's where the arguments should be had – not in some generic 'it's our money' approach.

The tax system is ludicrously and unnecessarily complex, and it's worthy of debate. Sound bites from our political leaders – from both sides – isn't the way to do it.

When minimising tax can be bad

Where this matters for investors – outside the obvious financial impact for those with large superannuation balances – is the parallel between the super debate and how we choose to invest.

One of the single worst (and potentially most wealth-damaging) approaches you can take to investing is to try to 'minimise tax'?

No, I haven't lost my mind, and I'm a little fond of Kerry Packer's comments:

"Now of course I am minimising my tax and if anybody in this country doesn't minimise their tax they want their heads read because as a government, I can tell you, you're not spending it so well that we should be donating extra."

The problem for investors is that minimising tax often becomes an end in itself. Tax minimisation schemes have, in the past, become the genesis of whole industries, with some plantation timber businesses chief among them. Unsurprisingly, most of them have since gone out of business or had to radically change their business models.

(Legally) minimising tax has become something of a mission for investors, but they should be focussed on something else entirely: maximising after-tax returns.

Doing the sums

Call me old-fashioned, but I'd rather pay a $10,000 tax bill after making a $40,000 profit (on concessionally taxed capital gains, for example) than pay no tax on a $20,000 profit.

Yes, the latter example is a lower tax burden, but the money left in your pocket after tax is the only thing that should matter to investors.

That's logical enough, and we all like to think we'd do the same, but in practice, too many investors take the latter path. They'll choose fully-franked dividends from a low- or no-growth company over partially-franked or unfranked dividends from a company that's growing strongly and/or selling cheap.

Or they'll avoid selling a bad investment because of the tax burden, in the meantime missing out on gains from reinvesting that money somewhere else that might dwarf the tax they're desperately trying not to pay.

Foolish takeaway

As Warren Buffett wrote:

"…maybe you'll run into someone with a terrific investment idea, who won't go forward with it because of the tax he would owe when it succeeds. Send him my way. Let me unburden him."

By all means, don't pay more tax than you need to, but don't miss the forest for the (tax minimising investment) trees.

Foolish, dividend-loving investors and BusinessDay readers alike who are looking for Australian investing ideas can click here to request a Motley Fool free report entitled Secure Your Future with 3 Rock-Solid Dividend Stocks.

Scott Phillips is a Motley Fool investment advisor. You can follow Scott on Twitter. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691).
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