Think about it: capital gains tax is the best type of tax to pay, because is not triggered until you dispose of the asset, and, provided you've held that asset for over a year, you get a 50 per cent discount on your normal tax rate. Furthermore, death does not trigger CGT. It simply transfers your liability to the beneficiaries, who will also not pay any CGT until they dispose of the asset.

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The best type of concessionally taxed income is franking credits from dividends from Australian shares. In the bad old days, dividends suffered double taxation. First the companies paid tax on any profits they made, then shareholders were taxed at their marginal rate when they received the tax-paid profits as dividends.

Fortunately, since July 1, 1987, dividends from companies that have paid Australian company tax carry imputation credits. This allows shareholders to receive credit for the tax paid by any company in which they hold shares, so that they pay tax only on the difference between the company tax already paid and their own tax rate. Dividends that carry imputation credits are called "franked dividends".

Suppose a company made $1,000,000 profit, paid tax of $300,000, and distributed the after-tax profit of $700,000 in dividends to its shareholders. The $300,000 of tax paid entitles the shareholders to $300,000 in imputation credits. So if you had $140,000 worth of shares in that company, and it paid it you a dividend of $7000, it would include $3000 of franking credits.

Those credits are as good as cash, which means you have to pay tax on them. Yes, even though you received only $7000, you must declare $10,000 ($7000 + $3000) as taxable income. That's the bad part - now comes the good bit. You also declare $3000 of tax deductions for your franking credits - they offset your tax bill and may reduce it. And if you have more franking credits than you owe in tax, the balance will be refunded to you.

Case study: Jack and Jill are a couple, each earning around $100,000 a year. Because they are in their late 30s they are choosing to save outside the superannuation system, for fear of lack of access and changes in the rules.

They invest $200,000 of their savings into an Australian Index Fund. The All Ordinaries Index has averaged 9 per cent (income and growth combined) for the last 100 years, so for this exercise I will assume that for the next year the fund achieved growth of 5 per cent, and paid income of 4 per cent, fully franked.

Because they understand the importance of putting compound interest to work for them, Jack and Jill reinvest all the income. Therefore, after a year their fund should be worth $218,000, made up of $10,000 in growth and $8,000 in reinvested income. That means at the end of the year the capital value has increased by $18,000.

Now let's think about the tax consequences. They intend to keep adding to this fund over the long term, therefore there is no tax each year on the growth because no assets are being cashed in. The dividend of $8000 will carry franking credits of $3430, which means their taxable income will increase to $11,430, made up of $8000 income plus $3430 in franking credits.

At their marginal rate of 34.5 per cent (including Medicare) the tax on this will be $3943, but because the franking credits can be used to reduce that, the total tax they will pay on that income is just $513.

If we put that all together, we can see that the tax on an investment of $200,000 for two people earning $100,000 each, and which produced a total return of $18,000 for the year, was just $513. How much better can it get?!

Question

I am 58 and plan to work for another five to six years. I have $950,000 in superannuation, and $165,000 worth of shares and managed funds. I wonder why annuities do not seem to be recommended by many advisers. I was considering buying one for $100,000. What are their pros and cons.

Answer

The essence of an annuity is that you hand over a lump sum, in exchange for an income stream, often for life. The transaction once done is hard to reverse. If you choose an indexed annuity, it would be very expensive if you are young, and if you use one with fixed payments you could be in trouble if inflation hits hard.

They are mainly used now for older people who want some certainty of income, or retirees who wish to maximise their pension by taking out particular annuities that get special treatment by Centrelink. You are very well-placed for retirement, and I doubt very much if you will ever get the age pension. I think the best way to start off when you retire is to seek advice about starting an account-based pension from your super fund. You could always revisit the situation when you are older.

Question

I had a fixed rate mortgage with RACQ bank at a low rate. When I paid out the loan, and was surprised to find that I did not get some sort of adjustment on settlement for the fact that I was paying out a low fixed rate, thus enabling the bank to relend the money at a higher rate. I know that there is a penalty charged by banks if you pay out a high-rate fixed loan, at a time when interest rates are low. Any comments would be appreciated.

Answer

RACQ Bank offers the option of a fixed rate home loan to borrowers who want to have fixed repayments for an agreed period while accepting there will be no benefit of any interest rate decrease that may occur during the fixed rate period. Borrowers can make up to $10,000 of additional repayments per year without incurring an extra payment fee. If borrowers want to make more than $10,000 of additional repayments or repay the loan during the fixed rate period, a termination fee or extra repayment fee applies. As you point out there is a fee one way but no refund the other.

Question

I am 72 and my husband is 85. We receive a part pension from Centrelink. Apparently, if I gave up work our pension would be about $740 each per fortnight. My super is only $340,000 and my husband has no super. We have $5000 in the bank - I earn gross $2000 a fortnight. How can I keep working without losing most of our pension? Is there some way we could receive the $740 each per fortnight without my giving up work? At the moment we only receive about $251 each a fortnight as I have to report my income.

Answer

You are income tested which means once you earn more than $8736 a year, you will start to lose $0.50 in pension for each additional dollar earned. Your superannuation will be deemed to be earning $5778 a year which certainly will have a big effect on how much you can earn. There is no simple solution - you need to balance the fulfilment you gain from working, with the reduction in your pension working causes.