By Jessie Hinds
Benjamin Franklin famously once quoted that ‘Money makes money. And the money that money makes, makes more money’. In his quote, Franklin is referencing the power of compounding interest – where money earns interest, and that earned interest then earns more interest.
The value of compounding interest is something that can be easily overlooked. That’s because it takes time to reap the rewards of this incredible financial powerhouse.
Time is the friend of compounding interest, so the earlier you start, the better off you’ll be. How about starting this year?
In the recent budget, the Government provided some welcome tax relief. This could give you the savings edge you need to put more money to work, making money.
In a quick snapshot, here’s what the Government has announced for personal taxation.
Forecast to cost $17.8 billion, the government has planned to bring forward its stage 2 tax cuts into the 2020/21 year.
- The threshold at which the 37% tax rate kicks in will be lifted from $90,000 to $120,000
- The threshold under which the 19% tax rate applies will also be lifted from $37,000 to $45,000.
- The low income tax offset will increase from $445 to $700. It will be phased out at 5 cents per dollar for taxable income between $37,500 and $45,000. It will be further withdrawn at a rate of 1.5 cents per dollar between $45,000 and $66,667.
- These changes will mean reduced tax of $1,080 pa for someone earning $85,000 and $2,430 pa for someone with a $120,000 income.
- Additionally, the low and middle income tax offset will be retained for a further year, providing those with incomes of between $48,000 and $90,000 a rebate of up to $1,080.
How can you ensure that you capitalise on these recently announced budget measures and take advantage of compounding returns?
Often it comes down to cashflow. The best thing you can do is save first and spend later. Often when we talk to new clients we discover that they tend to do the opposite. They spend first and save whatever is left in their bank account at the end of the pay cycle. By saving first, and having a reasonable saving target (we don’t want you living on baked beans) you put yourself in a position where you can automatically readjust your spending levels without considerably impacting your lifestyle.
Here are some of the ways you can save first:
- You can salary sacrifice your tax savings into super each year. For someone earning $120,000p.a. salary sacrificing their estimated tax saving under the budget measures of $2,430p.a. can save them an additional $583p.a in tax. That’s a whopping 24% return on your money. This is because contributions into superannuation are taxed at 15% vs marginal tax rates which would be 39%, including Medicare, for someone in this tax bracket. The money invested will then provide compounding returns over time and be taxed in an environment where the maximum tax payable is 15%.
- If locking money into superannuation doesn’t tickle your fancy, you could also look at starting an investment portfolio in your own name. With an assumed earnings rate of 8%, you could be $194 better off in the first year alone.
- If you have debt, you could consider using the tax savings to automatically pay down debt. Compounding interest doesn’t always work in your favour. If you are in high levels of debt with high interest rates, it can become extremely difficult to get out of debt. In this scenario, it would make sense to consider paying down the debt with the highest interest rate first (subject to terms and conditions of the loan).
At Elston we spend a lot of time with our clients. This helps us to understand their current position and their goals for the future. We are then able to use our knowledge of financial strategies to stand them in good stead for the years ahead.
If you would like to discuss how to optimise your family’s situation into the future, please speak to an Elston adviser today. We’re here to help.
If you would like more information please call 1300 ELSTON or contact us to speak to one of our advisers.