Pivotal Year for Adjusting to Tax Changes

The current financial year is shaping up as a crucial one for those nearing retirement or already retired with the new tax regime making some common tax strategies obsolete.

With the changes only becoming operational on July 1 next year, that leaves the rest of this financial year as the last chance to start to adjust your personal tax strategies.

However, it is important to stress that there is not necessarily any hurry to act, given that previously purchased assets are partly grandfathered under the old system.

However, having an asset that straddles the two systems like this will add some administrative complexity and any further capital gains will be subject to the new arrangements.

While there has been a lot of focus on CGT rates and the new inflation adjustment mechanism, the change that really brings many of the old strategies unstuck is the minimum CGT rate of 30% which is totally independent of earnings.

This requires a radical rethink on many very popular retirement strategies which rely on using the low or non-existent personal tax rates available in retirement.

Gradual Sell-Down Loses Appeal

Among the strategies disrupted by this change is the gradual and until now often tax-free sell-down of shares in retirement to help fund lifestyle needs and also the sale of an investment property and then contributing the proceeds into superannuation.

While you can still sell down shares over time in retirement, the capital gains on those sales will incur a minimum 30% CGT rate for any gains after the middle of 2027.

Sales will also require the calculation of two different CGT numbers – the gains before the middle of 2027 including the 50% CGT discount and then the inflation indexed gains made after that date.

A Re-Think Required

That requires a bit of a rethink for those pursuing the old strategy.

The two big questions to ask are:

1. Am I happy and can I afford to retain this share indefinitely and leave the eventual tax bill to my descendants.
2. Would I be better served to sell in the current financial year and adjust my retirement strategy entirely.

It may seem absolutely counter-intuitive to a generation raised on investing in shares and property to reduce tax bills, but earning interest in a high interest savings account could well be a more tax effective strategy than retaining shares with hefty built-in capital gains, given that interest earned is only subject to income tax rates that are likely to be much lower than CGT rates.

Recycling shareholdings to produce a bias towards dividend and other income as I discussed here, could also be a good strategy, given that the minimum 30% CGT rate cannot be diminished by other tax deductions.

Worse for Investment Property

The contrast in strategies is even more pronounced when you look at selling an investment property and contributing the proceeds to superannuation.

This used to be a strategy that often produced a tax refund under the old system but under the new system it could well produce a hefty tax bill, depending on the individual circumstances.

The current situation remains that selling off an investment property and contributing the proceeds to super is a sound idea.

Under the catch-up rules, it is possible to make a one-off tax-deductible super contribution of about $140,000 in a single year if a person has not used any of their annual concessional contribution caps in the five years previously.

That means you can get a good chunk of savings into super and often get a tax refund because the concessional super contribution has been taxed at 15% on the way into the fund.

Sharp Tax Bill Increase

Doing the same thing entirely under the new system could perversely lead to a much larger tax bill because the minimum 30% CGT tax cannot be reduced by other tax deductions.

So, the person selling the investment property will be hit by a minimum 30% CGT on assessable gains and can’t use any other tax deductions to offset that bill.

Even for an investment property bought some time ago, the amount of gains captured under the new 30% minimum CGT rule will keep increasing over time and make selling and putting the money into super less desirable.

Inexorably, every year that passes will mean more of the new CGT regime applies and getting deductions on super contributions where a capital gain exists will be progressively more difficult.

For assets bought after the middle of 2027, super tax deductions will be of much less benefit if the taxpayer does not have sufficient income from sources other than capital gains.

‘Get out of Jail Free’ Card

In the case of both progressive share sell downs and selling an investment property to supercharge super and claim a tax deduction there is still one 'get out of jail free' card that might change the strategy yet again.

If you can somehow thread the needle and defer realising a capital gain until you are eligible for the government age pension, then the much-feared minimum 30% CGT tax that is not able to be offset against anything magically disappears and CGT is calculated on regular marginal tax rates.

That may help in specific circumstance in which the stars align and sound assets can be held for a longer time frame but it won’t work for everybody.

For the rest of us, the time has arrived to review all of our investment strategies as they apply to us and make sure they still hold water in the light of the coming CGT regime.