How to turn your $1,080 tax cut into $70,000+

Posted: 18 May 2021 9:05 am
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How you can turn this free money into a massive financial windfall.

Let's be clear: The government has announced new tax cuts because it wants you to spend this money in order to boost the economy.

But if you pretend this tax cut doesn't exist, and instead, you automatically invest this money elsewhere, what kind of return can you get?

Would it be worth giving up the creature comforts that an extra $20.50 per week could give you, in order to prepare for your financial future?

Our team of in-house experts have crunched the numbers, and the news is very positive. By smartly investing this free money that you never expected to get in the first place, you could be up to $70,000 better off.

How much would your $1,080 annual tax cut be worth if you put it…

Woman put Australia bank note in glass for saving money concept

In your savings account?

One of the safest and simplest things you can do to quarantine this money is to pop it in a savings account. This is where compound interest can be your best friend.

To start, we'll assume you get paid monthly. Each month, your pay packet is going to be $90 healthier as a result of these tax cuts. So, you set up an automatic repayment to swipe that $90 out of your account and stash it in a high-interest savings account, like this Virgin Money Grow Saver, with a current interest rate of 0.65%.

That's it, you just set and forget. The trick here is that once the tax cut, which is delivered as part of the Low and Middle Income Tax Offset (LMITO), ends, you need to keep contributing to your savings account. We're due to get a different type of tax cut next year, and while it varies depending on how much you earn, it could see you pocket up to $90 per month in ongoing tax cuts.

If you can commit to direct depositing $90 per month into your savings, largely funded by these tax cuts, and you don't think about this money again for 20 years, you stand to build a nice little nest egg. Using our savings calculator, we can see that the results are pretty positive.

The verdict:

  • In 2 decades time, your account balance will sit at a healthy $23,060.
  • This is assuming you add $90 per month to your account, funded in year one by the LMITO, and in future years funded partly by ongoing tax cuts.
  • If you match the tax cut with another $90 monthly deposit of your own money, your savings jump to $46,120.

In your superannuation fund?

Picture not describedInstead of frittering the money away on coffee, brunch and other incidentals, you could put it into your superannuation account.

Finder's banking and investments editor Alison Banney explains that doing so could deliver big returns down the track.

"You can make a personal contribution to your super fund whenever you want – you're not limited to just what your employer is required to pay you. Regular, small contributions to your super can add up to a lot by the time you retire. This is especially true the younger you are," she says.

As a hypothetical example, you could be 30 years old, you earn $75,000 a year and you've got about $40,000 saved in your super already. According to Industry Super Australia's calculator, if you add your tax return money of $1,080 to your balance next year, you could increase your super at retirement by almost $4,500.

"That's not bad, but the real growth would come from maintaining this habit by adding $90 a month (or $1,080 a year) to your fund every year for the long term," Alison says.

In our savings example, we projected the balance after 20 years. Looking at the same hypothetical person above, you could increase your super balance by more than $59,000 at retirement, if you started to make these regular contributions at age 30 and stopped at age 50.

If you kept up the extra repayments until you retired, your balance would grow by over $70,000.

The verdict:

  • Adding your $1,080 tax cut to your super, then matching this amount each year, could mean your superannuation balance is worth $70,000 more by retirement.
  • If you're younger than 30, it'll be worth even more than this.
  • The extra value comes by making ongoing, small contributions to your super via salary sacrifice.

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In your home loan?

Richard WhittenHome loans senior writer Richard Whitten points out that if you make extra repayments of $90 per month on your home loan, you could wind up owning your home outright sooner, saving you thousands of dollars in mortgage repayments. Richard explains:

"The average Australian owner-occupier loan is $511,612, according to the latest ABS figures. Let's say you had a competitive home loan rate of 2.25% and your loan term was 30 years," he says.

"Now let's say you set up an automatic repayment of $90 per month from your pay packet, straight into your home loan. When you do this, you are already in the third year of your 30-year loan."

In this scenario, your monthly repayments are normally $1,955, but you're nudging them up to $2,045. If you continue adding $90 to your home loan repayment for every month for the remainder of the loan, your 30-year loan would end 1 year and 7 months earlier and you would pay $10,229 less in interest over the entire loan.

In year one, the extra payments will be entirely funded by the LMITO. In future years, it could be largely funded by upcoming tax cuts, but you may have to tip in a small amount of your own money, depending on your income and tax rate.

The verdict:

  • By adding $90 to your home loan over the life of the loan, you'll own your home outright much sooner.
  • You'll also save $10,229 in interest payments.

In the share market?

Kylie PurcellWhy spend money today when it could be worth double its current value in a few years time?

While the stock market can be riskier than other options thanks to market volatility, it's also historically proven to be one of the best long-term investments you can make.

Investing regular small amounts into the stock market can be less risky than investing all at once and can help you to steadily grow your wealth over time.

Finder's resident sharemarket guru and investments editor Kylie Purcell explains how investing your tax cut into the share market could deliver big returns.

"It's impossible to tell what the stock market will do over the next two decades. But if we look at the performance of the Australian stock market over the last century using data collected by Market Index, we can see it has historically returned an average of 11.8% per annum," Kylie says.

"So if you'd invested $1,080 per year (or $90 a month) into an index fund tracking Australia's All Ordinaries Index over 20 years, thanks to compound interest, you could have earned a whopping $55,231 in interest on top of your $21,600 total deposited. That leaves you a tidy $76,831 in savings. That's a lot of meals out."

One of the safest ways to invest in the stock market is through an index fund or ETF tracking a collection of major companies, such as Australia's All Ordinaries index. Instead of buying shares in one company, you're investing in 500 major Australian companies.

The verdict:

  • Investing a regular amount into the stock market can be a great way to build wealth, however there are risks.
  • If you'd invested $1,080 into the Australian share market just before the 2008 market crash, your initial investment would be worth about half the amount a year on.
  • Because of volatility, investing in shares is safer as a long-term investment over many years and even decades.

In summary?

One quick caveat to the above analysis: all of the above calculations have been made based on assumptions and average figures. The actual results you achieve will be different, based on your specific circumstances and financial position.

What is 100% clear though, is that no matter which of the above options you choose, you're going to be better off making a mindful and proactive decision about this tax cut, than you would be if you simply absorb the money and spend it on everyday items.

Small money habits can lead to big financial rewards. Your tax cuts start flowing in from 1 July this year: What will you do with yours?

Compare the latest savings accounts, home loan offers and super funds to make sure you're getting the best deal, and learn more about trading in the sharemarket.

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