Canterbury Services Blog

How to reduce tax by paying off your investment debt rather than increase your tax by paying off investment debt (the exact opposite to what most people believe)

As Noel Whittaker says “Business is a game where the winner is the person who holds the most growth assets the longest time”.

In other words, the more assets you own and the longer you own them, the richer you will get.

Some people overlook that a great deal of their wealth can be held within their superannuation. Many people underperform on what they could have achieved by holding only cash in their superannuation funds. Superannuation returns can be multilpied by owning growth assets (shares and property) within your superannuation fund – and then those returns can then be increased exponentially by using leverage (conservative borrowing) i.e. using some of your superannuation cash to enjoy ownership of a much larger asset.

However, there is an overlooked role that your Self Managed Super Fund (SMSF) can serve and that is to play the role as a “sinking fund”. A sinking fund can be thought of as a tax free account to build up a store of wealth to pay off a loan in the future.

Ideally everyone should be growing their wealth both a) personally i.e. in their own name and also b) within superannuation.

Typically people use leverage (loans) to speed up the process of building wealth in their own names (their personal portfolio). However at some stage, they want to pay them off. One way to pay them off is to build separate wealth within your SMSF over time as a sinking fund. This is a very effective way to build wealth for such a purpose because:

  1. You get a tax deduction for putting the money into your SMSF, whereas you don’t get a tax deduction for paying off a loan in your personal name e.g. if you pay say $1000 off a loan in your personal portfolio, it is done in “after tax dollars”. You might have had to earn $1,640 pre-tax, then pay the $640 tax to have $1000 available. In contrast, if you put $1000 into your SMSF, even though you pay 15% contributions tax, you get a [say] 39% tax rebate for it. 
  2. The income and capital gains within the SMSF sinking fund can be tax free and accumulate in a tax free environment. That’s a very powerful advantage for your SMSF assets. 
  3. If you have say $150,000 growing within SMSF in shares for say 20 years at 7% it would become $455,810. That delivers you a lot of wealth to your SMSF (sinking fund) to pay off any remaining personal debts at a later stage. 
  4. Better still, if you use leverage (conservative borrowing) within the SMSF so that the same $150,000 can be used to own a $450,000 property. The same 7% growth will increase the value of the asset to $1,817,432. The SMSF would now hold $1,817, 432 (less any amount possibly remaining on the original loan). If your SMSF sells that asset after you retire there will be no capital gains tax to pay. The powerful advantage to this SMSF sinking fund strategy is now exponentially bigger.  
  5. An even better strategy again is not to take all of the money out of your SMSF all at once when you retire. Just draw enough annually to pay any personal loan payments and enough for your other needs. This will allow the majority of the money to remain within the SMSF to grow for even longer in an environment free of tax. You now have a significant passively managed golden goose – permanently working on your behalf.
Financial situation on retirement day

In many cases, creating a sinking fund like this within your Self-Managed Super Fund (SMSF) will be the most effective way to pay off any overhanging personal debts when you retire – and help you retire in comfort with an ever growing tax free income stream.

As always “Knowledge is power”……and knowledge brings wealth.