Taxes for Australian early retirees

ATO

I’ve been a keen reader of personal finance and FIRE blogs for over six months now, and I have noticed in that time that there is a huge representation of bloggers from the US and Canada, but far fewer bloggers from little old Australia.

This doesn’t really matter, since the concepts are the same and I firmly believe that we can learn things from anyone anywhere, but the point where it doesn’t really help is with the peculiarities of Australian income taxes, which are similar but still quite different in some key ways to those of other Western countries.

You have probably read Go Curry Cracker’s article never pay taxes again, which gives a good summary of US-based strategies for early retirees, but I thought I would also give an Australian perspective on planning early retirement finances (and by early, I don’t mean 59 years old).

Superannuation is no good for early retirees

If you have read my post on this subject then you will already know my views in relation to superannuation, but if not then I suggest that you have a quick read of that post.

Superannuation is a necessary evil, but unless you are a bit older than I am talking about this article then it may not really help you a lot as an early retiree.

For us, we are just viewing it as a pot of gold at the end of the rainbow. We won’t need it, but once we reach an age (probably late 60s by the time the government changes the rules) then we can access it and splurge if we want to. I really can’t see us splurging, but at least it will be something to hand on to our kids.

Use your tax-free thresholds

Under current tax rules (as at April 2015 when I am writing this post), taxpayers will not pay any tax on their first $18,200 of taxable income, and this threshold is per adult so a couple effectively gets the first $36,400 of income completely tax free.

You then only pay tax on any excess over $18,200 and up to $37,000 at a rate of 19%.

At this stage I am not planning on needing cash (which I will equate to income for this exercise) of more than about $50k in retirement (I’m sure that we will make more, but this is more that enough for both of us). This therefore means that the first $36,400 of income will be completely tax free anyway, and it is therefore only the next $14k that we would have to worry about.

Invest in companies (or managed funds) that pay franked dividends to eliminate your tax bill

In Australia, we have a peculiar franking system where you receive a credit for any tax paid by the company in which you own shares when they pay a dividend to you. This credit then offsets against your own tax bill, and if you earn below $80k in franked dividends and franking credits, then these franking credits should be enough to cover your tax bill entirely, and may very well give you a tax refund.

Our current investments are all in blue chip companies that pay fully franked dividends, so in theory we would have no tax to pay even if we earned cash dividends of $56,000 each. In fact, we would both have tax refunds of nearly $5k in this situation, which would then boost our cash incomes up near $61k.

See below for an example:

Disclaimer: This is an example only. Consult your tax professional for personalised tax advice. See our disclaimer page for more information.

Disclaimer: This is an example only. Consult your tax professional for personalised tax advice. See our disclaimer page for more information.

As you can see from this example, at a modest income of $50k in cash dividends (which is heaps for us to live off), we would actually receive tax refunds of $14k, and therefore boost our cash earnings to $64k.

Harvest capital losses to offset capital gains where possible

If you are forced to take capital gains on any of your investments, then ideally you would do this only after holding a stock for more than 12 months. If you do this, then you only pay tax on half the capital gain.

It is important to note however that before being able to halve your capital gains, you must first offset any capital losses that you have made in the current year or carried forward from previous years.

If you know you are going to make a significant capital gain, it could therefore be worthwhile realising a loss from a stock that has dropped in value to offset some of the gain. You are allowed to sell a stock and buy it back again, but you should be careful about how you do this as if it meets certain criteria then the Australian Taxation Office can disallow the loss.

Other lifestyle choices

All of the taxes dealt with above are income taxes that are levied at a federal level, but there are plenty of other taxes that a typical early retiree can easily avoid/reduce through the right lifestyle choices, including:

  1. Land taxes from having excessive amounts of land: While I once owned four properties at once plus a share in a commercial property and had to pay land taxes, I now prefer investments in the stock market since they don’t attract anything but income tax.
  2. Motor vehicle taxes: Registration taxes, stamp duties on purchase of vehicles, luxury car taxes and fuel tax excise on petrol are all ways that car owners get stung. Tips for avoiding these taxes include having less cars, keeping your car for longer to avoid taxes on changeovers, buying cheaper cars to avoid luxury car taxes, and buying fuel efficient cars (and not driving them far) to reduce exposure to fuel excises. All of these things tie in quite well for aspiring early retirees from our online community.
  3. Alcohol, cigarette and gambling taxes: Many early retirees still enjoy alcohol, but by not buying it out at the pub/bar their exposure to alcohol taxes is reduced. As for the other two (cigarettes and gambling), just have nothing to do with them and you won’t pay any of these taxes.
  4. Stamp duty on the purchase of real estate: Every time you buy real estate you pay stamp duty at ridiculous rates, with a property in New South Wales worth $300k, attracting stamp duty of almost $9k when you buy. By either renting your property or retaining the same property for the longer term you can avoid or reduce your exposure to this tax.
  5. Goods and services tax (sales tax): GST is our sales tax, and the simplest way to avoid it is… don’t buy so much stuff! A typical hyperconsumer is paying a lot of GST because they buy so much stuff. When the tax was introduced a number of costs (like fresh food, education, medical costs) were carved out as exempt, so many of the costs incurred by a frugal early retirer may not even attract the tax in the first place.
  6. Council rates: These are taxes that go to your local government to pay for things like water and rubbish collection. If you rent a property then you don’t pay these taxes at all, and if you own more than one property then you will pay these taxes for each property. Obviously if you own your own home then you can’t really avoid the taxes for that property, but hopefully owning that home brings plenty of other benefits (like not having to pay any rent because you own it debt free) to justify payment of your council rates.

It’s all pretty simple really

As you should be able to see from the above (including the example), the whole issue of income taxes in early retirement in Australia is actually quite simple. Yes, you would have paid tax on earning all of the income in the first place, and I could tell you that there was a silver bullet, but I would be selling you a dream rather than a reality.

Once you have accumulated the assets to fund your early retirement, you can almost be in a position where you then have no further exposure to taxes in any significant way.

I know everyone complains about the tax system and tries to find all sorts of crazy ways to avoid taxes, but if you just live by some pretty basic guidelines to fund your early retirement there’s very little to complain about as far as taxes go.

IA.

7 thoughts on “Taxes for Australian early retirees

  1. Hi IA,

    What a great blog you have written. Keep it up as I want to learn more from you.

    Will you be writing more on accounting career profression?

    I want to break into Big 4 accounting firm with my backgroud being international student, graduate from a private uni ( not the five star uni), now taking 1st CA exam and have six months experience working in a BRW top 100 accounting firm (6 partners).

    Thanks a lot, and I truely enjoy reading your blogs!

    • Hi Tiffany, I’m glad to hear that you found my blog of interest. Yes, I will definitely be writing more about the accounting profession and building a career, so make sure you have a look for future posts. Best of luck in your quest for a big 4 role – they can be very hard work but also worthwhile!

  2. Wow, neat that you can actually get a tax refund on your dividend income under $80K!

    Do companies advertise that their dividends are franked, or are they all franked?

    I also appreciate your advice on gambling and smoking. 🙂

    • Yes, the system has its advantages in generating tax refunds, but only rarely do people put themselves in the position to use the franking credit system in this way.

      Not all dividends are franked, but I would say most larger stocks pay fully franked dividends, and they don’t really need to advertise this.

      You’re welcome for the advice about the gambling and smoking – am I right in guessing that Mr German is a smoker? It was very popular when I travelled through Germany!

  3. Hi IA,

    You have a great site – I’ve read every post now. It’s wonderful to find an Australia-focused site as there’s not much out there. In particular its very useful to find information on taxes for early retirees. I am moving to Australia soon with my Australian wife. We will be transitioning to financial independence at the same time. Australian taxes are new to me but I think i have the ATO website more or less figured out but it would be great if you could validate my understanding.

    We will be invested mostly in a split between Vanguard international equities and international bonds funds. Probably accumulation units so no income. We would be funding our expenditure basically through capital sales. So my question is whether from a hypothetical sale of say $100k of funds in a year, assuming that $20k of this is capital gains and that the original assets were purchased over 12 months ago, then i would calculate the taxable income at $10k. But this would then be under our combined tax free allowance. Also, the taxable amount would be under the minimum income threshold for the medicare levy. So in this situation, (ignoring any franking), the tax payable would be zero.

    How am I doing?

    Thanks for your time,

    Regards,
    Earl

    • Thanks Earl, I’m glad you like the blog. I agree that there really isn’t a lot out there for Australians in this space, which is one fo hte reasons why I started the blog.

      As far as your own situation goes I would make a few points:
      1. Even though you are “accumulating” units (or reinvesting as it’s called in Australia), the amount that you have invested back into more units is still treated as taxable.
      2. For assets held for more than 12 months (e.g. units in a managed fund like Vanguard), the taxable capital gain is halved. So you are correct in your example that only $10k of your $20k capital gain would be taxable.
      3. The tax free allowance (or “tax free threshold” as we call it) is currently $18,200 each, and if you each therefore had $5k each of taxable income (being the $10k taxable gain above split jointly between you and your wife) then you would each be below the tax free threshold. If this was your only income then you wouldn’t have any tax to pay at all. You should still remember that the “distributions” of profit, even if reinvested back into more units in the Vanguard fund, would be taxable income though, and this would count towards your tax free threshold.
      4. The Medicare levy is nil if your income is below $20,896, and phases in if your income is between $20,896 and $26,121. If your income is over $26,121 then you just pay the flat 2% Medicare levy. For couples medicare levy is calculated based on the income of the couple, and if your wife has a lower income than you then you may not be required to pay the medicare levy even if your income is over the $20,896 lower threshold.

      I hope this answers your questions, and congratulations on making the transition to financial independence in the land down under!

      IA

  4. IA,

    Thanks for your reply, that’s very useful to know that reinvested dividends will still be counted as income. I will need to factor this into our calculations but thankfully, we have enough buffer that it won’t derail the plans. The rest of what you say accords with my understanding but still good to get confirmation.

    Regards, Earl

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