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With many ‘safe’ investments such as term deposits offering very low interest rates, more people are turning to the share market in pursuit of higher returns. For new share investors, this means understanding not only the risk profile of share investments but also the different ways in which the returns on shares are taxed.
Jane is one such investor. Looking for a combination of steady income and the potential for capital growth, she recently purchased a portfolio of shares in major companies with a good history of paying regular dividends. Soon she’ll begin to enjoy receiving dividends, and she’s already following the performance of her shares via daily finance reports. But how will her investment income be taxed?
Understanding Dividends
Each time Jane receives a dividend statement from a company (usually twice a year), she’ll see that the cash amount of her dividend is made up of a franked amount and an unfranked amount. There will also be a franking credit (imputation credit) that represents tax already paid by the company. In her annual tax return, Jane must declare the cash dividend plus the franking credit. This total amount is then taxed at her marginal rate, but reduced by the value of the franking credit.
For example: BigBank Ltd (BBL) pays Jane a fully franked dividend of $70. The imputation credit is $30, and the unfranked amount is nil. Jane declares the full $100 on her annual tax return, and at her marginal rate of 39% (including Medicare Levy) this creates a tax bill of $39. However, this is reduced by the franking credit – the tax already paid by BBL – so she only pays an additional $9 in tax.
Realizing Capital Gains
A capital gain will be realized if Jane sells any shares for more than she paid for them. If the shares have been held for less than 12 months, Jane will need to declare the full profit in her annual tax return, and it will be taxed at her marginal rate plus Medicare levy.
If the shares have been held for more than 12 months, a 50% discount applies to capital gains tax, so Jane only needs to declare half of her profit.
If Jane sells any shares for a loss, it can be offset against current capital gains or carried forward indefinitely and offset against future gains.
Exploring Alternative Investment Vehicles
In the example above, Jane has invested in her own name, and her portfolio will feel the full drag of being taxed at her marginal rate. More tax means less money available to generate a return.
Jane could therefore consider investing via superannuation. Super funds in the accumulation phase have a tax rate of just 15%, and the discounted tax rate on capital gains on assets owned for more than 12 months is 10%. Of course, Jane would need to be happy to have her nest egg locked up in super until she meets a condition of release, potentially decades away.
The Importance of Diversification
Unusual economic conditions are seeing more people invest in assets that they may be unfamiliar with. Success means understanding how these investments work, their specific risks, and the tax implications. Diversification is a key strategy to manage risk. By spreading investments across different asset classes, sectors, and geographies, Jane can reduce the impact of poor performance in any single investment.
Seeking Professional Guidance
Navigating the complexities of the share market and tax implications can be challenging. A licensed financial planner can help Jane identify her needs and design a plan of action to help her make the most of her investment dollars. They can provide personalized advice on asset allocation, tax strategies, and long-term financial planning.
Investing in the share market requires continuous learning and staying informed about market trends, economic indicators, and changes in tax laws. Jane should regularly review her investment strategy and make adjustments as needed to align with her financial goals and risk tolerance.
Share Investing
Share Investing is not just about buying and selling shares; it involves a comprehensive understanding of the market, the companies you invest in, and the economic factors that influence share prices. Jane needs to be aware of the different types of shares, such as common shares and preferred shares, and how each type can impact her investment returns.
The Benefits of Share Investing
Share Investing offers several benefits, including the potential for high returns, dividend income, and capital growth. By investing in shares of well-established companies, Jane can benefit from their profitability and growth. Additionally, shares are relatively liquid, meaning they can be bought and sold easily compared to other types of investments.
Risks Associated with Share Investing
While Share Investing can be rewarding, it also comes with risks. Market volatility can lead to fluctuations in share prices, and economic downturns can negatively impact the value of shares. Jane must be prepared for these risks and have a strategy in place to manage them. Diversification, as mentioned earlier, is a key risk management strategy in Share Investing.
Tax Implications of Share Investing
Understanding the tax implications of Share Investing is crucial for maximizing returns. As discussed, dividends and capital gains are subject to taxation, and the way these are taxed can significantly impact Jane’s net returns. By being aware of the tax rules and seeking professional advice, Jane can optimize her tax position and enhance her investment outcomes.
Investing in the share market offers the potential for higher returns, but it also comes with risks and tax implications that must be understood. By educating herself, diversifying her investments, and seeking professional advice, Jane can navigate the share market with confidence and work towards achieving her financial goals.
Remember, successful Share Investing is not just about picking the right stocks but also about understanding the broader financial landscape and making informed decisions. With careful planning and a proactive approach, Jane can maximize her returns and enjoy the benefits of her investments.
Read this great article on share investing for beginners by the Commonwealth Bank.
