This Week's Insight: How Tax Actually Works

There is a mistake I hear regularly from people who are otherwise careful and thoughtful about money.

They turn down a pay rise because it "will push me into a higher tax bracket."

They decline freelance work because they "don't want to pay more tax."

They avoid investment income because they worry the tax will cancel the gain.

Each of these decisions is based on a misunderstanding of how Australian income tax actually works. And that misunderstanding, over years and decades, costs real money.

Marginal Rates, Explained

Australia uses a progressive tax system. Higher rates apply only to income above each threshold — not to your entire income.

The 2025–26 tax rates for Australian residents are:

• $0 – $18,200 — 0% (the tax-free threshold)
• $18,201 – $45,000 — 19% on income above $18,200
• $45,001 – $120,000 — 32.5% on income above $45,000
• $120,001 – $180,000 — 37% on income above $120,000
• $180,001 and above — 45% on income above $180,000

If you earn $90,000, you do not pay 32.5% on all of it.

You pay zero on the first $18,200. You pay 19% on the next $26,800 ($5,092). You pay 32.5% on the remaining $45,000 ($14,625).

Your total tax is approximately $19,717. Your effective tax rate — the percentage of your total income paid in tax — is approximately 21.9%.

Not 32.5%.

The Pay Rise You Should Have Taken

If you earn $44,000 and are offered a $2,000 pay rise, you will not pay 32.5% tax on all $46,000. You will pay 32.5% only on the $1,000 that sits above the $45,000 threshold.

That is $325 in additional tax on a $2,000 pay rise.

You keep $1,675. Saying no to that pay rise because of the tax bracket would have cost you $1,675.

Where Super Changes Everything

Salary sacrificed contributions to superannuation are taxed at 15% — well below the marginal rate most employees face. For someone earning $90,000, that is a tax saving of 17.5 percentage points on every dollar they direct into super rather than taking as salary.

The concessional contributions cap — the maximum you can salary sacrifice plus your employer's 11.5% contribution — is $30,000 per year in 2025–26.

For most Australian earners, this is the most tax-effective strategy available. It is also one of the most underused.

The Low Income Tax Offset

Australians earning under $66,667 also receive the Low Income Tax Offset (LITO) — a reduction of up to $700 in tax payable. This means many people pay less tax than the standard rate table suggests, and some lower-income earners pay no tax at all despite earning above the $18,200 threshold.

What to Do With This

If the marginal rate system is new to you, spend five minutes with the ATO's simple tax calculator at ato.gov.au. Enter your income and see your actual effective rate. You may find it is considerably lower than you assumed.

If you have been avoiding salary sacrifice because you thought the numbers didn't make sense — run them again with the correct marginal rate. The outcome may surprise you.

Next week: The real cost of not reviewing your super fund — and how to know if yours is working for you.

Sources

• Australian Taxation Office (2025). Individual Income Tax Rates 2025–26. ATO.
• Australian Taxation Office (2025). Low Income Tax Offset. ATO.
• MoneySmart (2025). Tax and Super. Australian Securities and Investments Commission.