In the realm of investment strategy, one often overlooked yet fundamentally critical factor is the impact of taxes. While many investors meticulously analyse market trends, asset allocation, and risk management, the significance of the tax structure on total investment returns cannot be overstated. Taxes wield a substantial influence on the profitability of investments, shaping the bottom line in ways that can either enhance or diminish long-term wealth accumulation. Recognizing the profound implications of taxation is not merely prudent; it’s essential for crafting a resilient and tax-efficient investment portfolio. In this blog, we’ll delve into why understanding the tax landscape is paramount for maximizing investment returns and securing financial success.
The following table illustrates the effective after-tax return on an investment return of 10% based on the 2025 financial year tax rates.
TABLE 1
| Earnings rate before tax | Tax rate plus 2% Medicare | Type of Taxpayer | Earnings rate after tax (ERAT) |
| 10% | 0% | SMSF tax rate (pension mode) and personal tax rate up to $18,200 | 10.0% |
| 10% | 10% | SMSF capital gains tax rate | 9.0% |
| 10% | 15% | SMSF income tax rate (accumulation mode) | 8.5% |
| 10% | 18% | Personal tax rate $18,201 to $45,000 | 8.2% |
| 10% | 25% | Company tax rate (base rate) | 7.5% |
| 10% | 30% | Company tax rate | 7.0% |
| 10% | 32% | Personal tax rate $45,001 to $135,000 | 6.8% |
| 10% | 39% | Personal tax rate $135,001 to $190,000 | 6.1% |
| 10% | 47% | Top marginal tax rate $190,001 and above | 5.3% |
If an investment generating 10% per annum is owned by a tax free SMSF then the after-tax rate of return is 10%. If the same investment is owned by an investor with a marginal tax rate of 45% plus Medicare, then the after-tax rate of return is 5.3% (i.e. 100% minus 47%).
The ERAT of 5.3% for a person on the top marginal tax rate is not much: inflation and tax destroy the return on the investment.
It is important to also bear in mind the power of compound interest and how it then amplifies what might first seem a relatively small difference in return. As the table below illustrates, a difference in earning rate of say 2.2%, i.e. the difference between the ERAT at the top marginal tax rate of 47% (i.e. 5.3%) and the ERAT at the corporate tax base rate of 25% (i.e. 7.5%) compounded over ten, twenty or thirty years becomes very significant, eventually more than $779,000.
TABLE 2
| Individual | Company (base rate) | |
| Input summary | ||
| Investment term | 30 years | 30 years |
| Rate of return | 10% | 10% |
| Initial investment | $100,000 | $100,000 |
| Additional investment p.a. | $10,000 | $10,000 |
| Tax Rate | 47% | 25% |
| Net return after taxes | 5.3% | 7.5% |
| Compound interest return | $402,100 | $1,103,750 |
| Simple interest return | $405,450 | $573,750 |
| Total invested capital | $400,000 | $400,000 |
| Investment final total | $1,207,550 | $1,987,039 |
Source of calculation: bankrate.com/retirement/roi-calculator/
In conclusion, the tax structure plays a pivotal role in determining total investment returns. Ignoring or underestimating the impact of taxes can erode the profitability of investments and hinder long-term financial goals. By prioritizing tax efficiency and understanding the tax implications of different investments, investors can optimize their portfolios for greater after-tax returns and ultimately build a more secure financial future. In the complex landscape of investing, embracing the importance of taxes is not just prudent—it’s paramount.
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