Don’t make this expensive tax planning mistake: time travel

Australia’s tax law is said to be the largest piece of legislation on Earth. It’s definitely the silliest.

But, with property prices plunging, Australians need something new to talk about. And since Labor’s tax reforms upended everything, tax planning is picking up the slack handsomely.

Just like the property bubble, most tax planning is a bit of a scam. And for a surprisingly similar reason.

Rising property prices don’t create wealth. They merely redistribute it, because we all have to live somewhere.

Tax planning does not lower tax directly, it shuffles income around to places that face a lower tax rate.

It might shuffle some of your income to your spouse, who pays at a lower marginal rate.

Or it might convert capital gains into dividends.

Or it might defer income to a period in your life when your tax marginal rate will be lower. That time usually being retirement.

It’s the third method I want to focus on today. Because it’s the riskiest.

Time travel is inherently dangerous

The main form of tax planning people use is to defer income to retirement. Super contributions are the obvious example. But you can avoid selling shares until a future date too. Or accumulate assets inside a trust or bucket company until retirement.

At that point, you lose your primary source of income. So, your investment income is paid out at lower tax rates.

But there’s an inherent flaw in this plan of delaying income. In order to get your hands on the money, you eventually have to get it back out, somehow. And that’s when things get interesting.

You don’t know what tax rules and rates will look like in the future. By the time you want your money, the whole strategy might not work anymore.

And, at that point, it’s too late. The money is stuck inside the structure you created for outdated tax law.

Just ask people who face dramatically higher taxes under the new capital gains tax reforms. Or people who face a minimum 30% tax on trust distributions. Their money is now stuck inside a structure that doesn’t work as expected.

It’s not just us, of course. In fact, Australia isn’t a frequent offender for moving the goal posts.

Countless people moving to Thailand for tax reasons discovered how radically tax law can change in recent years too. The country changed how it taxes foreign source income. If you remit it to Thailand, you now have to pay taxes on it there.

Many people currently moving to New Zealand to escape Australia’s tax reforms may discover to their horror that capital gains will be introduced across the Tasman eventually too.

Tax planning is like playing a board game with your younger siblings. The rules change as soon as you’re ahead.

Why must it be like this?

Taxes follow the money

Every tax loophole accumulates a pile of assets. And all governments tax large piles of assets eventually. That’s where the money is…

It happened with trusts.

I suspect franking credits are next.

It’ll happen with Super eventually.

But the point is that governments cannot help themselves. The better your tax arrangements are, the more fragile they are to future tax raids.

Of course, it doesn’t have to be as explicit as the recent Labor changes. There are more insidious ways to catch you out.

Bracket creep is when inflation causes people’s income to rise into higher tax brackets over time.

The Treasury once projected the share of taxpayers in the top two tax brackets to rise from 27% in 2014–15 to 43% in 2024–25, for example. Purely because tax thresholds were not indexed to wages or inflation. That’s about 3 million additional Australians in the top two brackets.

So, if you’re using tax planning methods to defer your income, consider this. By the time you retire, much of the income you deferred might get caught at those same tax rates anyway, thanks to bracket creep!

The point is that long term tax planning must take into account substantial changes to tax laws and rates. But we don’t know how they’ll change.

I suspect you might be better off dealing with the devil you know today than whatever tax policies governments come up with in the future.

It’s the old ‘one bird in the hand is worth two in the Super fund.’

But all this presumes you have gains to tax in the first place.

That’s not easy when large asset bubbles like the housing and AI bubble are bursting around you.

Here’s the opportunity which may interest you…