Assess how tax principles and tax costs affect goal-based and whole-of-family financial plans for individuals
The idea
Planning should be done on an after-tax basis because goals are spent in after-tax money. Tax may fall on income, gains, wealth or transfers, and be paid annually, deferred or exempted depending on account and asset. Deferral compounds: with a 6% return taxed at 30% every year, 1 grows to 1.042²⁰ = 2.277 over 20 years; if the whole gain is taxed only at the end it grows to 1.06²⁰ × 0.7 + 0.3 = 2.545. Assessing a plan means checking the tax drag on each sub-portfolio, the timing of realisations, the use of tax-advantaged accounts and residence-driven differences. The trap is comparing strategies on pre-tax returns.
Formulas
Growth with returns taxed every year
FV = [1 + r × (1 − t)]ⁿ
- r
- the pre-tax return
- t
- the tax rate on returns, paid every year
- n
- the number of years
Per 1 invested. Tax drag grows with the horizon: at 6% taxed at 30% for 20 years, 1 grows to 2.277 rather than 3.207.
Growth with tax deferred to the end
FV = (1 + r)ⁿ × (1 − t) + t
- r
- the pre-tax return
- t
- the tax rate on the gain, paid once at the end
- n
- the number of years
Per 1 invested, with a cost basis of 1: the + t gives back the tax that would have fallen on the untaxed basis. At 6% and 30% for 20 years it grows to 2.545, against 2.277 if taxed every year.
In the app: 2 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
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