Numerous cashed-up investors – who are waiting on the sidelines before striking back into the sharemarket – are potentially throwing away thousands of dollars in unnecessary tax by holding their cash outside the super system.
Driven by the savage bear market, many investors have blindly built-up cash reserves without considering the smartest way to hold the money. Generally, a low-cost, concessionally-taxed super fund is by far the most-effective way to hold that cash, where its earnings will not be wiped out by personal tax rates.
For instance, an investor with a 41.5% marginal tax rate who is fortunate to earning 4% on their cash holdings of, say, $200,000, will pay at least an extra $2120 a year in tax if the money is held in cash, rather than super. However, the tax savings can often be effectively much higher if held in a self-managed fund that is paying a pension to one or more members.
The tax advantage of building up cash inside super is, of course, much higher for most taxpayers if making salary-sacrificed contributions or personally deductible contributions by the self-employed and by eligible non-employed investors.
Many investors are understood to have stopped making even cash contributions to super – apart from compulsory contributions by their employers – and have huge cash reserves in their own names.
You might, for instance, have sold an investment property and be holding a large amount of cash in your own name until you become more confident about the sharemarket outlook.
Once investors are satisfied their cash is held in the most tax-effective and appropriate way for their circumstances, the next step should be to determine how to re-enter the market when they are ready.
No astute market commentator or adviser will say the market has bottomed, but the suggestions are getting stronger that it might be close.
Shane Oliver, head of investment strategy and chief economist of AMP Capital Investor has captured this mood. He says: “While it’s still too early to say for sure that the bear market in shares is over, there is good reason for cautious optimism that we have now embarked on a cyclical recovery in shares.”
Apart from holding your cash in the most tax-effective way, key messages from SmartCompany’s superannuation features have been to invest your money gradually over, say, a year rather than all at once, and don’t try to pick individual stocks but invest broadly across the market. The idea of gradually increasing your exposure to shares, when you are ready, is another powerful motive for ensuring that you get the best tax deal for your money.
Here are seven strategies for cashed-up investors who are waiting patiently for their eventual re-entry into the sharemarket:
ONE. Keep tax on your cash to a minimum
The combination of inflation and tax will wipeout earnings on your cash holdings – no matter what. But for most taxpayers, tax within a super fund is much lower than if held in their names. (See the point below.)
TWO. Hold cash in a low-cost, low-tax super fund
The quickest way to erode the tax advantage of super is to hold your cash in a high-cost super fund. Broadly speaking – there are exceptions to this rule – your cash should be in a low-cost industry fund or in an existing self-managed fund.
As Sydney financial planner Graham Horrocks says, the administration costs of self-managed funds are usually more or less fixed, so depositing large amounts of cash into the fund should make little, if any, difference to its fees.
And some industry funds pass on extremely low investment management fees for cash holdings. First State Super – a large industry fund with membership open to the general public – applies an investment management fee of just 0.05% a year on cash holdings.
Industry funds, for instance, also apply a set-dollar administration fee that doesn’t vary with the size of a member’s balance. First State Super, for instance, has a $52 a year fee. But if you are already the member of an industry fund, you won’t pay this fee again after depositing a large amount of cash into the fund. (First State Super is mentioned only as an example of a very low-cost fund. This is not a recommendation.)
Horrocks points out that if you are hold your cash in a self-managed fund that is already paying pensions to members – it may be a transition-to-retirement pension available to those over 55 or retirement pension – the overall tax rate may be much less than the standard superannuation rate of 15% on earnings and capital gains.
Philip La Greca, technical services director with fund administrator Multiport, says that the use of high-cost retail super funds would cause the tax advantage of holding your cash in super to just disappear. This is a point to really watch.
THREE. Understand that money in super is locked-up
La Greca says that one of the biggest drawbacks for younger people of building up cash in super through new contributions is that the money is locked in the super system until they are permanently retired upon reaching at least age 55 (depending upon your date of birth) and permanently retired. (You can also begin to access some of your super savings before retirement from age 55 through a transition-to-retirement pension.)
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