Tax Tip 122: PreTax Equivalent Earnings on the PPOR offset

Discussion in 'Accounting & Tax' started by Terry_w, 16th May, 2016.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Plus Member

    9th Jun, 2006
    Australia wide
    PreTax Equivalent Earnings on the PPOR offset

    Money in your PPOR offset saves you interest. If you earned the same amount of interest elsewhere it would be taxable. So really you are getting a higher return on your deposit than just the interest savings.

    Working out Post tax return

    $1000 in the offset of a loan that charges you 4% interest would mean you are saving $40 per year in interest. If your marginal tax rate is 49% then the equivalent pre-tax return would be $78.43.

    To work this out use the following formula:

    (Interest Savings) / (1- marginal tax rate).

    $40 / (1-49%) = Pre-tax earnings $78.43

    Back check this:

    $78.43 x 49% = $38.43. This would be the tax payable on earning $79.43

    $78.43 - $38.43 = $40 after tax.

    Working it out as a percentage,

    To earn $78.43 from $1,000 invested you would need to earn 7.84%

    The formula for this is:

    Earnings / capital = return

    78.43/1,000 = 7.84%

    What all this means, for this particular situation, is that paying money into your offset account on your PPOR loan or paying your loan down will result in you earning a 7.84% return – and is virtually risk-free.
    Jaik2012 likes this.
  2. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

    18th Jun, 2015
    Virtually risk free ? I think that CBA have a trademark on that expression for their financial planning division.

    One downside is a fixed rate loan cannot be used on the offset loan so the taxpayer remains exposed to potential upside on interest rate if / when they move. That effect operates more like a bond and can represent a significant cost over say 3-5 years.

    I wish someone would offer a credit card offset account.
  3. mcarthur

    mcarthur Well-Known Member

    19th Jun, 2015
    Great Terry - often wondered.

    So if one had $100,000 in the PPOR offset, with the PPOR loan at 4.5%, from your formula:
    $4500pa / (1-37% marginal) = $7,143.

    In making a decision whether to keep in the offset or invest, then that $100,000 invested (whatever the LVR/leverage) would have to earn $7,143pa. just to "break even".

    Taking the easist example, If the investment was neutrally geared, then that approx $7k would need to come from capital gain over time.
    But if you have a simple holding, in ones own name not trust, then there will be CGT payable on that gain (eventually), which has to be taken into account since CGT isn't payable on the PPOR. So we can use a similar formula to determine how much the 50% CGT exemption gives:
    2 * $7142 / (2-37% marginal) = $8,763
    which is the minimum benefit (CG if neutrally geared) needed each year on the investment property.
    If the leverage is 80%, and purchase costs is 4.2%, then the property was bought at about $415,000 with $100,000 being used as $83,000 for deposit and $17,000 for costs.

    $8,763/$415,000 = 2.1
    So a YoY CG of 2.1% or more is needed to offset the loss of that money sitting in the PPOR offset for a neutrally geared property.
    Terry_w likes this.
  4. dean2012ad

    dean2012ad Active Member

    31st Mar, 2016
    Unless you use Bank of Adelaide or Mortgage house which offer an Offset account on fixed rate loans greater than the standard 1 year.

    But yeah a credit card offset account would be great...
  5. wombat777

    wombat777 Well-Known Member Premium Member

    18th Jun, 2015
    On a Capital and Income Growth Safari
    Undoubtedly there would be an unreasonable annual fee.
  6. legallyblonde

    legallyblonde Well-Known Member

    23rd Jun, 2015
    Thank you for the great post! It isn't applicable to me at the moment but it is great food for thought.
    Terry_w likes this.
  7. TwoDogs

    TwoDogs Well-Known Member

    13th Sep, 2005
    There is, just pay the balance in full every month with cash from your home loan offset account. Never yet paid a cent in credit card interest.