Over the years, it’s not uncommon to see clients reject legitimate financial strategies because they are afraid (perhaps paranoid) that the Government is going to tinker with the current rules.
These views are not unfounded.
Not only does the Government have a steady history of changing tax policies, they also have a history of making it harder for those that are trying to get ahead.
When you look at how much Government spending occurs, most people believe (and I do too), that over time, taxes will increase and tax concessions will reduce.
This creates uncertainty about what the future investing and tax landscape might look like.
Certainty gives people confidence that the strategies they implement will hold up long-term.
Uncertainty does the opposite. It spooks the market, and stops people from taking action.
The tax system is used to incentivise people to undertake a specific action. If the Government wants more rental accommodation, they provide more incentives to residential property investors.
If the Government wants people to buy more cars, they provide better depreciation incentives.
By allowing the concessions to exist, the Government is trying to encourage people to undertake a specific action which they believe will be better for the country as a whole.
People literally plan their financial lives and investments around tax rules, using them to their advantage to build wealth for the long-term.
To later have the rug pulled out from beneath your feet, is not only disingenuous, but it is actually counter-intuitive, as over time, people build a distrust with their Government, and as a result, are less likely to act on these benefits.
Changes plant a seed of doubt.
This leads to less action, often detrimental to the overall financial wellbeing of the economy.
There is always going to be a risk that changes will occur, and that these changes will be for the worse. For the most part, we can’t control those changes, but we can however control how we react and prepare for those changes.
Oftentimes, failing to act is more detrimental than acting and addressing any future changes.
When faced with uncertainty about future changes, there are past realities that give us confidence for the future.
The typical approach to tax policy change
The ATO has a strong history of ‘grandfathering’ tax changes. This means that those that have adopted a strategy based on current legislation, are often allowed to continue to use these rules, even though different rules may apply from a future date.
Even if you are confident that the rules will change in the future, be confident that a lot of the time, changes are grandfathered and you will likely be able to apply the current rules if you adopt them now.
Secondly, even though proposed changes can appear extremely harsh when announced, oftentimes, they are later watered down. The government will just give you the headline, but over time, they will consult with industry bodies, and they will start to assess the impact. Many times, I feel they start to see the errors in their policy, and tend to adapt it based on feedback received.
However, sometimes, a change will just catch you out and come out of nowhere.
Other times, changes are proposed, but never implemented.
To provide a framework for assessing the risk that future changes may have on your financial plans, consider the following:
First, identify if your concern is legitimate. The more extreme and far ranging your viewpoint, the less likely it is to happen. If you have an extreme opinion, try to rationalise it and work through the practicalities of how any changes may occur. Remember that, the more people impacted by the change, the more difficult it will be to get the changes implemented. The more people that are detrimentally affected, the less votes at election time. And no politician wants that.
Consider how the changes could impact you in the future. Compare this against the cost of doing nothing. If you are of the view that negative gearing will be removed (will anyone try again after Bill Shorten?!), it’s time to anticipate the cost. Say you are making a rental loss of $5,000 a year, and paying tax at 39%, this change will cost you $1,950 a year in extra tax payable. Is that extra tax payable worth not buying an investment property, that may grow in value at 4% a year? Sometimes when you quantify the impact, you may realise it’s not that bad after all.
Consider how you could address the proposed changes. Oftentimes, there are ways to work with the new legislation to achieve your desired outcome. Continuing with the loss of negative gearing as an example, consider what action could be taken to reduce the impact of this hypothetical policy change. The first one for me would be, not settling for making a loss on an investment. I’d be looking at increasing rents, reducing costs, refinancing to a better interest rate. Tax benefits are icing on the top, but they should not be the principle reason for making an investment.
If all else fails and you can’t accept the risk, accept the cost of inaction. If you have considered steps 1-3 and you still can’t accept the risk, at least accept the cost of inaction. Hey, at least you gave it a chance.
While there are many examples of fears clients have regarding potential changes, here’s an example of how a long held belief can be financially detrimental.
A taxpayer is adamant that super is going to be taxed at a higher rate in the future. For the last 10 years, the taxpayer has failed to make any contributions to their superfund, while simultaneously complaining that they pay too much tax.
The individual is a high income earner, and could easily afford to put $25,000 into super every year.
This contribution would have yielded them an overall tax saving of 32% per year, being their tax rate of 47% less the 15% tax paid by his superfund.
Not only would the client have received an $8,000 tax saving per year, totalling $80,000 over ten years, their super earnings would have been taxed at 15%, instead of 47% for a higher income earner investing in their own name. This would have led to more investments, compounding in a lower taxed environment, compounding their wealth over the long-term.
Instead, the individual has paid an extra $80,000 in tax over the last 10 years, their investment returns are being taxed at a higher rate, leaving less investments available for reinvesting. In addition, the client will likely miss out of the concessional tax benefits superannuation offers upon retirement.
Ouch.
I know I'm adding salt to the wound, but here is the final rub....these changes haven’t yet occurred.
Personally I believe that at some stage, super is going to be taxed at a higher rate. The pot is just too big to remain untouched. However, I believe that super will maintain a lower tax environment compared with the rate of tax that high income earners pay.
While I believe super may not be such a tax haven in the future, I don’t let this belief stop me from contributing to super.
Change is constant. It’s a part of life. We can’t control all changes, but we can control how we react.
Don’t let paranoia lead to inaction, because the cost of inaction may just be the greatest cost of all.
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