Understanding Tax-Aware Investments

In developing and managing NGS Super’s investment options, we consider all the factors that contribute to achieving the best possible returns for our members.

A number of different aspects of investment feed into these efforts, including:

  • selecting expert fund managers
  • choosing high quality service providers
  • engaging highly skilled advisers, and
  • managing the tax-effectiveness of our investment portfolio.

This Investment update will look at the last of these points, focusing on the ways that NGS Super works to improve the after-tax returns for your super by maximising the tax- effectiveness of our investment options.

What does ‘tax-aware investing’ mean?

Taxes are the one expense you pay as a super investor that’s able (more than others) to be managed effectively, which can work to improve the returns you make on your super investment. In general superannuation is a concessionally taxed structure for investing.

Tax-aware investing is where investors (and investment managers) take the effect of tax into account when making decisions about specific investments.

As you read this Investment update, keep in mind that there is a trade-off between focusing on tax effectiveness and achieving returns: too great a focus on managing the investment’s tax efficiency may increase the risk of achieving lower returns – both before and after-tax.

Australia’s dividend imputation system

Australian shares offer the lowest effective tax rate of all the asset classes in which you can invest your super. This is due to Australia’s divident imputation system. This system is designed to ensure that tax on company profits is paid only once (as opposed to twice:  firstly by the company issuing the shares and secondly by the shareholder).

Some Australian share funds target companies that provide high franking levels (see below for more information) which can help offset the amount of tax that the fund pays on their dividends.

The dividend imputation system explained

The dividend imputation system in Australia is designed to ensure that tax is paid only once on company profits. This is how it works:

  • when a company listed on the Australian Securities Exchange (ASX) earns profit, part of the profits are distributed to shareholders as dividends
  • before the profits are distributed, the company pays any tax payable, then works out the tax payable against each individual share and records the total amount in what’s called a ‘franking account’
  • when dividends are distributed, a full or part franking credit may be recorded on the dividend statement that the shareholder can claim (based on the size of their shareholding) when they submit their annual tax return
  • the current company tax rate is 30% so this credit is passed onto the investor in the case of fully franked shares.

Keep in mind that not all dividends are franked – they can be fully franked (i.e. the full amount of tax is refundable), partly franked or unfranked.

What are the advantages of this approach?

The amount of tax you pay depends on a number of factors including the type of fund (for example, super fund, unit trust or pension), the type of assets the funds invests in and the fund manager’s investment approach.

By maximising the use of tax-efficient investment techniques, organising the assets in the right types of accounts and using other tax savings, NGS Super aims to help investors to maximise investment returns, giving you more to draw on in retirement.

What do we do to improve the tax effectiveness of our investment options?

NGS Super has undertaken work to improve the structure and management of our Australian shares portfolio. Part of this work involves moving our Australian share investments from pooled investment trusts to discrete accounts which allows our managers to consider the tax position of each stock as part of their investment decision making process.

What strategies will be used to improve after-tax returns?

The following strategies will be used by NGS Super’s equity managers going forward:

  1. Minimising the realisation of ‘short gains’

For superannuation investments, capital gains tax is only payable on two-thirds of the realised capital gains if the shares are held longer than 12 months.

  1. Maximising imputation credits

As already mentioned, investors in Australian shares receive a tax offset of up to the amount of tax paid by the company so selecting shares that offer high franking credit levels offer a valuable tax benefit.

  1. Deferring the realisation of capital gains

Whilst tax accrues for an investment’s unrealised capital gains, the actual tax is not payable until the investment is sold and the gain realised. By deferring the sale of these assets, either into the next financial year or even longer, cash is retained in the Fund for investment and achieving returns for our members.

What is capital gains tax?

The term ‘capital gains’ refers to the amount of positive return received on an investment in a financial year. Capital gains tax, therefore, is the tax payable on this amount.

Whilst tax accrues each year, it’s possible to defer payment of this tax to another financial year by holding off on selling the shares until that time.

What does this mean for NGS Super members?

If you’re thinking about making changes to the tax effectiveness of any of your investments outside of your super with NGS Super, it’s important to seek expert assistance. An appointment with an NGS Super financial planner is just a phone call away on 1300 133 177

Information provided in this blog may have changed since the time of writing. You should confirm the information is current before relying on it.

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