A pay rise is usually good news. You have more money coming in, more room to invest and, ideally, a little more breathing space in the budget.
But there’s another side to earning more that investors can overlook: your tax bill can change, too.
That matters if you have a growing portfolio of ETFs, shares or other investments generating taxable income. The investments themselves haven’t suddenly become less attractive, but the amount of tax you pay on the income they produce can increase as your marginal tax rate rises.
For 2026-27, resident tax rates are 30% between $45,001 and $135,000, 37% between $135,001 and $190,000 and 45% above $190,000. The 2% Medicare levy generally sits on top, meaning your marginal rate can effectively rise from 32% to 39% and then 47%.
So what does that mean for your portfolio?
The hidden cost of a high-yield portfolio
This is where tax drag comes in. Tax drag is simply the difference between what your investments earn before tax and what you actually get to keep.
For ETF investors, there are two main ways this happens:
- Distributions: ETFs pass income such as dividends, interest and realised capital gains on to investors, who generally pay tax on those amounts in the year they receive them.
- Capital gains: If you sell an investment for more than you paid for it, the gain may be taxable. (And the way capital gains are taxed is changing at the start of the next financial year.)
There’s an important difference between the two. You generally can’t choose when an ETF makes a distribution. It happens, it lands in your tax return and you pay tax on it. A capital gain, on the other hand, can often sit unrealised for years. You decide when to sell your investments, giving you more control over when the tax bill arrives. That distinction becomes increasingly relevant as your income rises.
What does that look like in practice?
Consider a simplified hypothetical example.
Say you have $100,000 invested in a high-yield Australian equity ETF paying a 4% distribution, or $4,000 a year. Assume the distribution is fully franked at the 30% company tax rate.
The $4,000 cash distribution comes with around $1,714 in franking credits, meaning about $5,714 is included in your assessable income. The franking credit then offsets some of the tax you owe.
At a 32% marginal rate, the tax on that amount would be about $1,829. After the $1,714 franking credit, you’d owe roughly $115. But at a 47% marginal rate, the tax would be about $2,686. After the same credit, you’d owe roughly $972. That’s a sizeable difference for exactly the same investment.
Franking credits can help, but they don’t make Australian dividends tax-free for higher-income earners. Once your marginal rate is above the 30% company tax rate, you’re generally paying the difference as “top-up” tax.
Does that mean you should ditch Australian dividend ETFs?
Not necessarily. Australian dividend-paying companies can still have a useful place in a portfolio. Franking credits can make their after-tax income attractive, and regular distributions may be exactly what an investor wants.
But if your income has climbed into the 37% or 45% bracket, it can be worth looking at how much of your portfolio’s return is arriving as taxable income each year. That’s particularly relevant when you’re still accumulating wealth and don’t actually need the income.
Income today vs growth later
A portfolio tilted towards traditional Australian dividend payers – including the banks, miners, telcos and other established companies – can generate relatively high cash yields, often with a substantial franked component.
The trade-off is that you’re generally receiving more taxable income every year. If you’re paying tax at 47%, some of that income is going straight to the ATO rather than being reinvested. Over decades of compounding, the difference can add up.
By contrast, broad international ETFs often have lower distribution yields. Many of the companies they hold reinvest more of their profits rather than paying them out as dividends. More of the return can therefore show up as capital growth rather than annual income.
That can offer several potential advantages for a high-income investor:
- Less taxable income each year: A lower distribution means less income is taxed annually.
- More control over timing: Capital gains generally aren’t taxed until you sell.
- Potentially better diversification: International ETFs can provide exposure to markets and sectors that aren’t as heavily represented in Australia.
Of course, there’s no free lunch. International investments come with currency exposure, different market and regulatory risks and different sector concentrations. And a lower yield doesn’t automatically make an investment better.
The point isn’t to choose investments based on tax alone, but to understand how the way your portfolio generates returns interacts with your tax rate.
Super can become more valuable as your income rises
If your salary has jumped, your taxable investment income isn’t the only thing worth revisiting.
Superannuation can become particularly valuable for higher-income earners because it can provide a lower-tax environment for long-term investing.
For instance, concessional contributions – including employer super guarantee contributions and eligible personal deductible or salary-sacrificed contributions – are generally taxed at 15% within the fund. Compare that with a 39% or 47% marginal tax rate outside super and the attraction is obvious. Salary sacrificing can redirect some of your income into super before it’s taxed at your higher marginal rate.
There are, however, a few catches. For one, the concessional contributions cap is currently $32,500 a year, including employer contributions. In some circumstances, unused portions of previous years’ caps can be carried forward if your total super balance is below $500,000.
And if your income plus concessional contributions exceeds $250,000, Division 293 tax can apply, adding another 15% tax to some or all of those contributions. That can bring the effective tax rate to 30% – still below a 47% marginal rate, but with a smaller advantage.
The bigger consideration is access. Super is designed for retirement. Money generally can’t be accessed until you meet a condition of release, so it isn’t necessarily the right place for money you’re saving for a house, school fees or another short-term goal.
For many investors, the answer isn’t “super or ETFs”. It’s both: super for long-term, tax-effective wealth building and investments outside super for flexibility.
Your portfolio doesn’t exist in a vacuum
As your income and wealth grow, your finances can become harder to think about as one simple portfolio. You might have ETFs in your own name, a joint portfolio with a partner, super, cash savings and investments earmarked for different goals – and the tax treatment can be different for each. That’s why it can be useful to look at your investments as a whole rather than asking whether any individual ETF is “tax efficient”.
The better question is: Where should each investment sit to give you the right balance of tax efficiency, diversification and flexibility?
It’s also worth reviewing your portfolio when your circumstances change. A pay rise, a move into a higher tax bracket, a change in your investment goals or a decision to start drawing an income from your portfolio can all change the balance that makes sense for you.
The big takeaway: a pay rise can be a good time to revisit your portfolio
Moving into a higher tax bracket doesn’t mean your existing investments are suddenly wrong. Instead, it means the trade-offs may have changed.
If your income has increased significantly, it’s worth asking:
- How much of my portfolio’s return is arriving as taxable income? A higher-yielding portfolio can create a larger annual tax bill, particularly once you move into the higher marginal tax brackets.
- Am I making the most of franking credits? They can significantly reduce the tax payable on Australian dividends, but higher-income investors may still have a top-up tax bill.
- Could I benefit from holding more growth assets in a lower-distribution portfolio? Lower annual distributions can mean less tax along the way and potentially more control over when capital gains are realised.
- Am I using super effectively? Concessional contributions can be taxed at a lower rate than your marginal rate, although contribution caps, Division 293 and the restrictions on accessing super all need to be considered.
And perhaps most importantly: Am I choosing investments because they’re right for my goals, or simply because they produce the most income?
Tax is only one part of the equation. Diversification, fees, risk, time horizon and your need for income all matter. But as your salary climbs, tax can become a much bigger part of your investment returns.
A useful habit is to review your setup whenever your income changes materially – and ideally before 30 June, when you may still have opportunities to adjust contributions or the timing of investment sales.
Disclaimer: This article is general in nature and has been prepared without taking into account your individual objectives, financial situation or needs. It does not constitute financial, tax or superannuation advice, and nothing in it should be relied upon as a recommendation to buy, hold or sell any financial product or to change your investment or superannuation strategy. Tax outcomes can vary depending on your individual circumstances. Before making decisions about your investments, tax or superannuation, consider whether the information is appropriate for you and seek professional advice from a qualified financial adviser or registered tax agent if needed.
