Interest earned has a nasty sting in its tail: it's considered taxable income. Save some cash in a savings account (or term deposit or similar) and interest earned will be included in your taxable income and taxed at your marginal tax rate.
Don't forget to take out inflation too (which was not inconsiderable at 1.9% for 2016/17).
Here's the simple workup:
- Invest $10k @ 5% p.a to earn $500
- Assuming your income is $87-180k, your income will be taxed at roughly $0.37 per $1 earned. As such, the ATO takes $185 of your $500.
- The cost of inflation, calculated on the principal of $10k @ 1.9% p.a., is a further $190 (in other words, your $10k is now worth $9,810 in real terms).
- Instead of earning $500, you've only earned $125 (or achieved a rate of return of 1.25%)
Current interest rates are already low and a 5% interest rate is probably unrealistic. Most 60-month term deposit rates are earning less than 3%.
If you're saving cash, you'd better have a very generous interest rate or a very low income—or you're probably going backwards. Let’s not get started on the opportunity cost of not putting those savings into a better-performing (and safer) investment.
Given the above example again, if you’re earning 2.5% interest, your actually working at a net negative interest rate of –0.33% at a cost of $32.50. As a bonus exercise for the reader, compound these examples over multiple years.
If you have a mortgage, get an offset account and stash your money in there right now. Either way, get a good accountant who can help you legally maximise your deductions.
I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I’m not selling anything and I do not receive any form of commission or incentive payments for any companies or individuals I endorse. I'm learning too and expect to make many, many mistakes along the way.
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