No  Boundaries  

 

Noels' Money Column

 

Money Matters - Noel Whittaker is a joint managing director of Whittaker MacNaught P/L Australian Financial Services Licensee # 246519.  Also author of a number of books including "Making Money Made Simple" and "More Making Money Made Simple" 
This is general advice only and is published with permission. 
Thanks Noel.

 

28 February 2016

There are rumours that transition to retirement pensions (TTRs) may be attacked in the May budget.

They were introduced in 2006 in tandem with the Howard–Costello reform of the superannuation system. 

Many older workers wanted to cut down on their hours and were happy to accept a reduced wage for doing so, but they did not want to give up work completely.  The problem was access to super - employees cannot access their super until preservation age unless they are prepared to sign a statement that they are permanently retired. 

TTRs solved the problem and enabled the 55-and-overs to have their cake and eat it too.  Australians could access their superannuation as an income stream while continuing to work.

What made TTRs particularly attractive was the ability to continue contributing to super while drawing a tax-free income from the fund; it enabled anyone adopting the strategy to take advantage of the difference between the 15% tax on contributions and their marginal tax rate.

Think about Jack, a 60-year-old who earns $105,000 a year, which puts him in the 39% tax bracket. His employer is required to contribute $9975 (9.5%) to super for him, and he is able to contribute a further $25,025 to super as a concessional contribution.

After taking advice, he decides to increase the amount he salary sacrifices to super to $25,025. This will reduce his take-home pay by $15,266 a year. The contribution will incur a 15% entry tax of $3754, but he still enjoys the experience of having his superannuation boosted by a net $21,2713.

He is $6006 better off – it’s a no-brainer!

But he can put even more money in his pocket by starting  a TTR. He would still salary sacrifice at the same level but he would start to draw a pension from a superannuation fund. Immediately that starts, his superannuation fund ceases to pay tax, which means higher after-tax returns. 

It’s possible that a pay cut of $15,266 a year net would leave the family finances a bit short. If that’s the case he could simply use part of the income from the TTR to make up any shortfall – if his budget can cope with his reduced income, he could contribute straight back into superannuation as a non-concessional contribution, on which there is no entry tax.

My advice is to start a TTR as soon as possible if you are eligible – after May it could be too late.

 

22 February 2016

Pensioners face two major challenges. The first is the continual shifting of the goal posts in one direction – to tighten eligibility. The second is the quandary facing pensioners whose assets are at the higher end of the scale when trying to maintain an investment portfolio which they can live with, but which will let them sleep at night. From next January a couple with assets of $750,000 will receive an age pension of less than $5000 a year. Yet that $750,000, if left in the bank, will be flat out returning $19,000 a year.

The paradox is that most people will have to rely on a portfolio that is biased towards shares to get by, yet, as we've seen in recent weeks, shares can be a nerve-racking investment. This is why I have long recommended that people start investing in shares at an early age – giving them time to get used to the vagaries of the market.

The value of your assets does not include your home, while your chattels such as furniture, car and boat are valued at second-hand value, not replacement value. This puts a figure of $5,000 on most people’s furniture. Thus a couple could live in a multi-million dollar home, earn $60,000 a year, have other assets worth $800,000, and still get a small portion of the age pension and all the goodies that go with it. 

You can reduce your assets by gifting money away, but seek advice before you do so. Centrelink rules allow gifts of only $10,000 in a financial year, with a maximum of $30,000 over five years.  Using these rules a would-be pensioner could give away $10,000 before 30 June and $10,000 just after it, and so reduce their assessable assets by $20,000 quite quickly. 

Pensioners who are income tested should note the deeming rules, which determine the income that Centrelink applies to pensioners’ financial assets. The current rates for a couple are 1.75% on the first $80,600 and 3.25 % on the balance. For a single pensioner the first $48,600 is assessed at 1.75%, and the balance at 3.25%. The assets subject to deeming include bank accounts, shares and managed funds, debentures, superannuation when the owner has reached pensionable age, and deprived assets such as excess gifts. There is no penalty if the money is invested to earn a higher rate than the deeming rates.

One strategy to increase your pension is to spend money on renovations, or on travel. While this may be effective in the short term, it assumes there will be no more changes to pension eligibility. Given the deadly combination of budget deficits, and rising life expectancies, that would be a brave assumption indeed.

1 February 2016

Many would-be property investors procrastinate because they simply do not know where to start. As a result they often end up victims of property spruikers who make around 50,000 cold calls every week.   The initial phone call is hard to resist; "Are you interested in saving tax while paying your house off faster?" Of course, the answer is going to be yes, which leads to the next question: "Are you free next week for one of our experts to show you how it works?"

The only purpose of the interview at the victim's home is to make an appointment for them to attend the spruiker's office, where they will be subjected to hours of hard sell.

Here they are given a long spiel about the pressure on government budgets caused by rising life expectancies, and then shown vivid illustrations of the life of poverty that will be faced by those who don’t provide for themselves. They have a great patter:  "Money in the bank earns nothing,  shares are risky, and you can't trust superannuation as the government is always changing the rules".

But then comes the sting – the way to wealth is to negative gear into over priced residential property chosen and sold by the spruiker. 

Until recently it’s been open slather, with ASIC providing no supervision because a property investment is not recognised as a financial instrument.  However, a recent judgement in the Supreme Court of New South Wales has confirmed that ASIC has power to act if the spruiker is involving the victim in setting up a self-managed superannuation fund (SMSF).

On Monday, 30 November 2015, the court declared that the Park Trent Property group had unlawfully carried on an unlicensed financial services business for over five years by providing advice to clients to purchase investment properties through an SMSF. The court issued a permanent injunction against Park Trent, restraining them from providing unlicensed financial product advice regarding SMSFs.

ASIC Commissioner Greg Tanzer said, "This outcome sends a strong message that there are serious consequences for property spruikers who break the law by providing unlicensed financial advice". While this is a welcome development, those spruikers who are recommending people invest in their own name are still acting outside the regulators’ control. 

This means the onus is on property buyers to ignore the spruikers and do their own research to find an undervalued property that is offered for sale by a vendor who is very keen to sell. That may not be an easy task, but it will pay off in the long run.

25 January 2016

One of the sneakiest credit card tricks is forfeiting the interest free period if the account is not paid in full by the due date.  However, one trap is not so well known -  the balance transfer to a low interest rate card. 

Think about Jack who has built up a debt of $7,000 on his credit card.  The rate is 19% and he doesn’t get an interest free period because he never pays the balance in full each month.

He is intrigued when he sees advertisements bank offering to take over his credit card balance with an initial rate of zero percent.  He makes an application and is soon the proud owner of a credit card with a zero interest and 55 days free credit on purchases. 

To celebrate his good fortune he goes on a shopping spree and charges up $3,000 of clothes and electronic gear.  He is due for a bonus and figures he will easily be able to pay the $3,000 when the credit card statement arrives.

Unfortunately the fine print is going to catch him out.  Credit cards do not give you an interest free period if you do not pay out the entire balance in full, so he is not going to be eligible for an interest free period because of the residual debt of $7,000 that was transferred over.

He will be hit with interest of 19% on the $3,000 of goods - and it will be back dated to when he bought them. 

He will also be caught out by the bank’s practice of applying credit card repayments first to the lowest interest component of the debt.  Therefore, the $3,000 he deposited into the account when the statement arrived will be used to reduce the transferred balance. 

Instead of having an interest free period for his purchases, he now finds to his horror that the $7,000 low interest balance has shrunk to just $4,000. The rate on $3,000 of it is already 18%.  All he needs to do is spend another $4,000 on the credit card and his interest free portion is gone.   

The solution to a problem like this is to tackle it from the start.  If your money management skills are in such that you need to transfer your credit card balance to a zero rate card, make sure you lock your new card up and don’t make any purchases on it.  For your day to day expenses check out www.ratecity.com.au  and find a card with a permanent low interest rate so you can switch the balance on the low interest card when the honeymoon interest rate is over.   

18 January 2016

It's been a turbulent start to 2016 with share markets crashing all over the world. It was a major topic of conversation at a dinner party I was recently with one participant summing up the mood of many people there by declaring  “We like to sleep at night – that’s why we don’t have any shares”.

On the face of it, it’s a reasonable attitude given the present parlous state of the markets, but the reaction from some of us was that we couldn’t sleep at night if we didn’t own shares. 

Now it can be a good feeling to have cash in the bank, especially when you can get a safe 2.5% as you can right now, but the problem with cash is that it has no tax benefits, gives you no chance of any capital gain and is eroded by inflation.  A return of $2500 on a deposit of $100,000 may sound risk free, but take off 3.0% for inflation and you are left with a negative return .

This leaves us with the good old faithfuls – property and shares.  It’s important to have an interest in both these camps, but it’s just as important to understand that they behave in very different ways.  It’s highly unlikely that your property will lose 30 % of its value in a downturn, but there are ongoing costs it can be a long drawn out process if you ever try to sell it. 

Shares will give you a much more exciting ride because their values will bounce around, but the big advantage of them is that you can buy and sell in small parcels, they provide tax advantaged income by way of franked dividends and over the long term, have been the best performing asset class of all – an average of 8.3% per annum over the last 15 years even after taking the present slump into account  

Now let’s get back to the “sleeping at night” bit.  Think about a person who is aged 65, who has $800,000 in super and wants to draw $55,000 a year.  If their fund is diversified enough to earn 8% per annum, their money will last to age 90 if inflation averages three percent per annum.  However, if they are scared of shares and opt for a “safe” 2.5% return, their money will be gone at 78.  In an age where many retirees can expect to live to 90, that’s a thought to keep anyone awake at night.

11 January 2016

The Festive Season is behind us - what sort of shape are you in? For too many the answer will be that waistbands and finances seem to be alarmingly tight.

The people who achieve financial security are not always especially lucky. Very often they have simply come to recognise what is basic human nature and taken steps to use it to their advantage.

It is basic human nature to get our pay, meet our financial commitments and then spend the rest. Those who do are broke by next payday when the cycle starts over. They always intend to start investing for their but somehow it never seems to happen.

But there is a way of turning even this to your advantage and it's the classic strategy of paying your home loan fortnightly, and not monthly.  This simple change can save tens of thousands of dollars of interest.

Let's say you are managing to pay $2,000 a month off your mortgage. Change to fortnightly payments of $1000. Chances are you won't notice the difference but your mortgage account certainly will. Because there are 26 fortnights in a year, changing from $2,000 a month to $1000 a fortnight means you will be paying back an extra $2000 a year. Would you be likely to find that money in the old biscuit tin at the end of the year? I doubt it.

It's an easy way to start your investment plan in 2016.  And there are others. They simply involve putting in place techniques that lock you into a routine.

If your home loan is under control talk to a financial adviser about borrowing for share trusts - you don't have to be an expert as professional fund managers make the decisions. The other great benefit is that you can borrow to an extent that fits your comfort level – you are not forced to borrow $400,000 or more as you would be if you invested in property.

Think about a person who borrowed $100,000 in January 2000 to invest in a share trust. The trust's performance  matched the All Ordinaries Accumulation Index (the benchmark measure of professionally managed funds including reinvested dividends) and the investor now has a portfolio worth $333,000. All it cost was a tax deductible $7000 a year for the interest on his borrowings. 

This is what is known as a “set and forget” strategy.  All you do is have the interest debited to your bank account and the dividends re-invested in the trust.

21 December 2015

One of your worst enemies at Christmas is the credit card.  It will seem like your best friend before Christmas, as you madly shop for last-minute gifts, but don't forget that 31 January will be here before you realise it. That’s when the credit card statements arrive, nicely timed to coincide with all the back-to-school expenses. 

The problem is that shopping with a credit card doesn’t feel the same as shopping with cash.  Have you noticed that pulling a $100 note out of your wallet feels very different to booking up $100 on a credit card?  This is why you inevitably get a shock when the credit card statement arrives and you discover that all those tiny amounts have combined to such a large sum.  Where possible, use cash, or at least a debit card – seeing your balance reducing will help you control your spending. 

The banks know that their customers are vulnerable in this silly season, and will try all sorts of tricks to extract more fees and charges out of us.  They start by offering a higher credit card limit so you will have more spending power and won’t feel like Scrooge – now you can buy all that wonderful stuff for your loved ones!  Then they will tell you they only require a minimum repayment, to take the pressure off your budget, but conveniently forget to mention that the entire balance owing, as well as goods charged up but not on the statement, will be hit with interest at almost 20 percent.

So choose your credit card well. There are two basic types: those that offer an interest-free period, and those that don’t. The interest-free period might sound like a great idea, but you are only eligible for it if you pay the entire balance before the due date.  Even if you pay most of it, if you are one dollar short the bank will charge you interest on everything from the day you bought it.  Unless you pay the card off each month, don’t choose a card that offers an interest-free period; choose a card that has a lower interest rate. 

As you do your best to cope with the Christmas madness, remember that the best gifts aren’t always those that cost the most.  I well remember a time when our kids were tiny tots and they had been inundated with presents from many relatives.  In less than an hour they were having the time of their young lives – playing with the wrapping paper.

14 December 2015

Christmas is fast approaching, and with it, the usual challenge of finding gifts that will be really appreciated and not break your budget.  Books have long been my favourite because they’re reasonably inexpensive, and can bring lasting benefits.

The perfect gift for anyone interested in improving their financial education is, of course, my new book 25 Years of Whitt & Wisdom, which explores the financial history of the last quarter century as seen through my columns in this newspaper.  It’s also a great reference book, with segments covering Wealth Health, Tools of Wealth, and Enemies of Wealth.

You’ll see how history has a habit of repeating itself, with booms following busts with monotonous regularity, and the government of the day over-promising and under-delivering.  It’s also a reminder that the rules regarding superannuation, in particular, are in a continual state of flux.

25 Years of Whitt & Wisdom has been welcomed both by younger people wanting to understand what has shaped the Australian economy and financial services; and by older people who are retired or thinking of retiring. It is available though my website.

But all the money in the world is of little use if you’re not happy, which is why my final choice is How Life Works by my good friend Andrew Matthews, whose books have sold more than seven million copies in 42 different languages.  It’s different to the typical self-help book, because it’s very easy to read and profusely illustrated with Andrew’s own cartoons. 

How Life Works is based on the premise that even though your thoughts create your circumstances, what matters most is how you feel. This leads to the hypothesis that good things happen when you feel good, and bad things happen when you feel bad; and then goes on to explain why placebos work and diets don’t.  It’s a fantastic read for teenagers, who are often held back by poor self-esteem, which can be caused by comparing themselves to others.  I only wish I’d read it myself when I was a teenager. 

Happy book shopping!

7 December 2015

For the last six months, the papers have been flagging changes to superannuation.  Recently Treasurer, Scott Morrison tried to clarify the situation in  a speech to the Association of Superannuation Funds conference in Brisbane.

Morrison stated “It’s important to have a conversation about superannuation, and about the principles that will guide further policy…  The objectives of super, when devised by Paul Keating and John Dawkins, can be distilled into three clear aims. 

1. To promote better standards of living in retirement by supplementing or replacing the age pension.

2. To curb the rising cost of the age pension.  In 2013/14, around 70% of people of age pension age were receiving the age pension, and of these, 60% received the full pension. The proportion of full rate pensioners relative to part-rate pensioners is expected to decrease, but the overall proportion of retirees receiving some age pension is not projected to decline.  Superannuation assets now total about $2 trillion, which highlights that the system has grown and matured significantly.

3. To improve the national savings pool.

A super system for the future needs to deliver:

·      greater choice

·      stronger governance

·      better information

·      more targeted incentives.

These are the government’s core superannuation principles that will shape delivery of real outcomes for Australians who are saving for their retirement.

He then turned to tax reform, and introduced it with the following statement.  “Above all else, we must remember superannuation belongs to those who earned it over their working life.  It is not my money, nor the government’s money; it is your money.”

We can all take some comfort in that statement, but he then went on to remind us that the primary objective of superannuation should be “to provide income in retirement to substitute or supplement the age pension”.  To do this, superannuation tax concessions should be “appropriately targeted to secure an adequate retirement income for Australians”.  The problem is defining “adequate”, and he mentioned one way of doing this would be to set a goal for retirement income as being a proportion of pre-retirement earnings.

So there is nothing specific in the pipeline right now.  Keep in mind that next year we have a White Paper on tax, and Retirement Incomes Recommendation Paper both due for publication.  They are obviously interlinked, and will both generate a lot of media attention when they’re published.  The government has promised to take any proposed changes to the next election so I certainly wouldn’t be overly concerned about any negative changes to superannuation in the near future.

30 November 2015

Recently I wrote that a person aged 25, earning $35,000 a year could accumulate $4 million in superannuation at age 65 just by relying on the employer compulsory contribution.

This resulted a flood of emails asking if I had made a mistake in the calculations as the outcome seemed too good to be true.

There was no mistake – it was just compound interest doing its work. To put it simply how much you will have at the end of a given period depends on the time the money is invested, and the rate you can achieve. If the term is short the rate matters little,  but as time lengthens it matters enormously.

To get an estimate of how much a 25-year-old could expect at age 65 we need to make certain assumptions. They are the rate of growth of salary, inflation, and what is a reasonable earning rate. In the example I assumed inflation was 3% per annum, wages growth was 4% per annum, and the rate of return was inflation plus 7%.

Next convert those future dollars to todays dollars. If inflation was 3% per annum, $4 million in in 40 years would have a value of just $1,212,000 in todays dollars. Yes, it still a hefty sum, but doesn't sound nearly as much as $4 million.

The big lesson here is the way the rate and the duration of the investment dramatically affect the end balance. Suppose a person invested $1000 a month toward their retirement. If they started at 25 they would have $6.3 million at age 65 if they could achieve 10% per annum. However, the final sum would be just $2 million if they only achieved 6% per annum. 

If a person waited until they were 45 to start the programme, and still managed to invest $1000 a month they may have $760,000 at 10% and $462,000 at 6%. Because the term is much shorter the lower earning rate does not have such a dramatic effect.

30 November 2015

Recently I wrote that a person aged 25, earning $35,000 a year could accumulate $4 million in superannuation at age 65 just by relying on the employer compulsory contribution.

This resulted a flood of emails asking if I had made a mistake in the calculations as the outcome seemed too good to be true.

There was no mistake – it was just compound interest doing its work. To put it simply how much you will have at the end of a given period depends on the time the money is invested, and the rate you can achieve. If the term is short the rate matters little,  but as time lengthens it matters enormously.

To get an estimate of how much a 25-year-old could expect at age 65 we need to make certain assumptions. They are the rate of growth of salary, inflation, and what is a reasonable earning rate. In the example I assumed inflation was 3% per annum, wages growth was 4% per annum, and the rate of return was inflation plus 7%.

Next convert those future dollars to todays dollars. If inflation was 3% per annum, $4 million in in 40 years would have a value of just $1,212,000 in todays dollars. Yes, it still a hefty sum, but doesn't sound nearly as much as $4 million.

The big lesson here is the way the rate and the duration of the investment dramatically affect the end balance. Suppose a person invested $1000 a month toward their retirement. If they started at 25 they would have $6.3 million at age 65 if they could achieve 10% per annum. However, the final sum would be just $2 million if they only achieved 6% per annum. 

If a person waited until they were 45 to start the programme, and still managed to invest $1000 a month they may have $760,000 at 10% and $462,000 at 6%. Because the term is much shorter the lower earning rate does not have such a dramatic effect.

23 November 2015

Let’s have some straight talk on interest rates.  Granted, the Reserve Bank did not lower rates at its November meeting, but all they did was delay the inevitable.  It’s an odds-on bet that the trend will continue downwards, with more rate cuts in the short to medium term. 

So what do you do if you’ve got a home mortgage now?  The scariest statement I heard this week was from a TV commentator who said, “homeowners are praying for a cut in rates to give them a present for Christmas”.  Get real – if you’re having trouble coping with interest rates at record lows, where do you think you’ll be living when they start rising again? 

The present low rates are the gift that keeps on giving, and borrowers now should be celebrating the fact that they’ve got a once-in-a-lifetime chance to really make a dent in that mortgage.

You need to understand the way numbers work.  At a rate of 5%, a loan of $100,000 would require repayments of $537 a month if the term were 30 years.  However, if rates rose to 8%, the monthly payment for a 30-year term would be $734.  The problem with a 30-year term is that you are maximising the amount of non-deductible interest you are paying – the good news is that at current low rates of interest it doesn’t take a big increase in repayments to save a packet. 

CASE STUDY.  Jack and Jill have a $400,000 mortgage at 5%, which they are repaying at $2148 a month over 30 years.  The interest over the life of the loan would be a staggering $373,000, even at such a low rate.  If rates rose to 8%, they would have to increase their payments to $2936 a month to maintain their 30-year term.  Even if they could manage to do this, they would end up paying $656,000 in interest, which is 50% more than they borrowed.  However, if they were financially savvy, they could pretend interest rates were at 8% now and repay $2936 a month.  If rates stayed at 5%, they would cut the loan to 17 years and save $181,000 in interest.  Not only have they given themselves the potential to save a small fortune, they’ve also given themselves a valuable safety buffer if interest rates start to rise.

16 November 2015

It’s amazing how an idea can find its way into the general conversation, and then take on a life of its own as misinformed and incorrect comments push it into the spotlight.

The latest issue is women and superannuation.  It’s well known that most women retire with less superannuation than most men because they are over represented in lower paid jobs such as cleaners and factory workers, and also take time out of the workforce to have children and raise a family.

The remedies currently being put about border on the ridiculous.  The first is that the problem could be simply solved by allowing joint superannuation accounts.

The proposal does nothing for single women but, in any event, people can now transfer 85% of their concessional contributions to their spouse every year, and non-concessional contributions can be made to either party.  Which partner is the most appropriate would depend on individual circumstances. If maximising Centrelink benefits is the main consideration, the superannuation should be held by the youngest person, as it would not be counted by Centrelink until they reached pensionable age.  If accessibility was more important, contributions could be placed in the name of the older person, as they would gain access sooner than the younger one.

Treasurer Scott Morrison floated the idea of granting women a higher contribution cap, to enable them to make extra contributions after they return to the workforce, to make up  for lost time.

There is nothing new in this – it was the rationale behind Peter Costello’s decision in 2006 to abolish the age-based cap, and replace it with a universal cap of $50,000 for everybody.  As we know, the Rudd government reduced the caps: concessional caps currently stand at $30,000 a year for those under 50, and $35,000 for those over 50.

Most lower-paid women would have enormous difficulty finding the money to meet the current caps, let alone higher ones.  Think about it – $30,000 of pre-tax dollars, or $180,000 of after-tax dollars, is a big slug for anybody, even high income earners. 

The only solution is education.  The overriding factor that determines the amount of money a person will have in superannuation is the rate of return they can achieve on their portfolio.  Let's assume a 30-year-old earned $45,000 a year, and had $20,000 in superannuation. If her income increased by 3% per annum, and employer superannuation contributions kept pace with that, she would have only $477,000 in super at age 65 if her fund earned just 4% per annum. However, if she took an interest in her super and managed to make it earn 8%, she could retire with $1.2 million.

24 October 2015

There have been reports in the press that the Prime Minister Malcolm Turnbull promising to cut income tax to protect us from bracket creep.  Certainly tax cuts are welcome, but achieving them in the context of a worsening budgetary position is going to be a major challenge.

Frankly, I’m not sure bracket creep is as bad as the PM would like us to think.  The term refers to extra earnings that bring a person into a higher tax bracket, which means they pay a higher rate of tax on the extra dollars earned.  For example, you’re earning $80,000 a year and receive a pay increase of $10,000 a year.  The extra $10,000 is taxed at 39% because you’ve crossed over the line where the 34.5% tax rate ends and the 39% tax rate starts.  The bottom line is that you’re paying an extra $450 tax on that extra $10,000 of income, which is not really a huge amount in the scheme of things.

It was a big issue 15 years ago, when the 43% tax rate cut in at $38,000, and the 47% rate cut in at $50,000.  In those days bracket creep was criticised as a huge disincentive, because anybody who wanted to increase their income by working overtime would be losing almost half the increase in tax.

Today it is completely different, as the tax bands are much wider, and the rates lower until you reach the top.  If a worker is earning $55,000 a year, and the best they can look forward to is increases of 4% per annum, it’s going to be a long time before they hit $80,000 where the 39% tax rate cuts in.

Those who are in the two highest tax brackets are the least likely to be hit by bracket creep.  Once you earn $80,000 you can earn another $100,000 a year before changing brackets; and for the high flyers earning more than $180,000 a year bracket creep is not relevant, because every extra dollar they earn is taxed at the top rate anyway. 

If you think you are going to be a victim of bracket creep, you can protect yourself by using tax-effective strategies. The best of these is salary sacrificed contributions to superannuation, which reduce your gross income. Another is to use investment vehicles with an inbuilt tax advantage. These include superannuation earnings within the fund, which are taxed at just 15%, and insurance bonds earnings within the fund, which are taxed at just 30%.

17 October 2015

Family situations are dynamic. Additions to the family, or a new hobby, may mean that you need to upgrade your home.  This begs the question – should you move or renovate?

My suggestion is to renovate if possible.  Selling one home and buying another could well cost you nearly 10% of the price of the new home.  If you sell a home for $600,000 and buy another for $900,000 you would be looking at close to $90,000 in expenses such as agent’s commission, legal fees and stamp duty.

Once your budget is clear, have a building inspection on your property to ensure it is structurally sound and capable of being renovated, and a survey to ensure the boundary pegs are in the right position. 

Check out your intended builder thoroughly, because if you are unfortunate enough to strike an incompetent or insolvent one you could find yourself in a state of despair.  A slow builder means you could be paying both rent and mortgage payments for many months more than you budgeted, but worst of all is a builder who goes broke in the middle of a job. 

A good builder will be happy to give you the names of people for whom he has recently completed jobs.  Take the time to visit some of them to specifically investigate the quality of the work, and also check if the job was done on time and on budget. 

It’s important to get the finance right too.  The first step is to convince yourself that you can afford repayments on the loan you will have when the job is finished.  All you need to do is add the cost of the renovations to the existing loan balance, making sure you make adequate allowance for extras such as landscaping and new furniture.  Then do a budget based on repayments of $7 per thousand per month.  For example, if your total loan will be $200,000 on completion, budget repayments of $1400 a month.  This may be more than the lender will require, but it will give you a buffer to protect you from future interest rate rises.

If you have sufficient equity in your home, I suggest you start with a line of credit loan, which will enable you to draw it down as progress payments come due and will eliminate the hassle of calling for a bank inspection every time a progress payment is due. But experience tells us that line of credit loans should not be used forever, as too many borrowers simply pay the interest and never reduce the debt. 

10 August  2015

Interest rates are dropping, and will almost certainly go down further.  The good news is that home loans are getting cheaper – the bad news is that prices in some areas are going up.  And of course, as happens every few years, there are voices coming from everywhere telling us that young people can’t afford a home any more.

Guess what – nothing has changed that much.  Buying your first home has never been easy, but it is certainly still possible.

First, get rid of the idea that home ownership is restricted to high income earners.  Right now across Australia there are people who are doing it tough and there are people whose finances are in good shape.  Guess what?  Their financial position has got nothing to do with their income – it’s how they manage their money. 

Managing your money gets back to choices.  You can choose to take your lunch to work or buy it; you can choose to buy a new car or make do with your old one; you can choose to spend $35,000 on a wedding or $35,000 on a house deposit.  It iis the choices you make, not your income, that will determine how well off you are financially. 

If you decide to divert some of your income to investment, your net worth will grow.  If you decide to spend it all on consumption, you will be forever battling the debt treadmill. 

The secret is to focus so hard on the goal that everything else becomes immaterial.  Start by looking at homes where you would like to buy, and then hang photos of them on the wall where you will see them every day.  Talk to lenders to find out how much deposit you will need and then make a sub-goal to save that within a specified time. 

If you were a couple each earning $850 a week after tax, you could decide to live on one income and bank the other $850 a week into a savings account.  In just twelve months you would have $45,000, which would be an adequate deposit for most properties. 

As your savings grow the success pattern you are forming will be reinforced.  Mark my words – you’ll be more than adequately rewarded for your persistence.  

27 July 2015

“Those who don't know history are doomed to repeat it.” These words, from statesman Edmund Burke, came to mind when I read all the latest argy-bargy about possible changes to our tax system.

In April 2008 the Rudd government held a national think tank called the Australian 2020 Summit. One of its major recommendations was a total review of our tax system to make it more equitable. The Rudd government took up the challenge and commissioned the Henry Tax Review. The five members of that committee were highly respected and represented a good cross-section of Australian institutions. The terms of reference, however, were farcical, as two major areas of tax policy were off-limits – GST, and tax on superannuation payments for people aged 60 or over.

In late 2010 the committee handed down its report, which the Rudd government quickly consigned to the too-hard basket. Only after intense pressure did they release its contents – just one week prior to the 2010 May budget.

As 2010 was an election year they ducked for cover by specifically ruling out 26 of the most controversial recommendations.

Five years later our tax system is still a mess, and Australia’s finances have deteriorated so badly that we are borrowing $100 million a day just to pay our bills. Now tax reform is back on the agenda with “nothing off the table”.

That’s an easy statement to make, but incredibly difficult to put into practice.

What changes to our tax system would make better sense? Well, some of the recommendations from the Henry Tax Review would make a great start, particularly if they were implemented, as recommended, in the context of a comprehensive overall reform.

Expect a lot of noise in coming months, as vested interests fight to protect their own patch while pointing the finger at everybody else to make sacrifices. If history is a guide we will see much more noise than action.

20 July 2015

For months we have been subjected to attacks on the money we’ve accumulated in superannuation; now Labor, the Greens and even the Reserve Bank have upped the ante by calling for a review of negative gearing. 

Contrary to the spin, Australians who are using negative gearing to increase their wealth are not millionaires flouting the tax system – the majority of them earn less than $80,000 a year and are only buying a single investment property.

Let’s think about a typical couple earning $80,000 a year each.  They are about to turn 50, have just paid their house off, and are well aware there’s unlikely to be much of a pension available to them when they retire. 

The options available to them are cash, property and shares.  Cash is particularly unappealing, with rates at historic lows, they are terrified of shares and are becoming increasingly wary of super.

They decide to bite the bullet and borrow $450,000 at 5% to buy a property for $450,000.  Repayments of $3560 a month will have the property paid off in 15 years. 

In Year One, the net income from the property will be $18,000, and the interest for the first year on their loan will be $22,500.  Hence they are negatively geared to the tune of $4500 and should qualify for a tax refund of around $1250 each when depreciation allowances are taken into account.  The total cost to the taxpayer is just $2500.

Now fast forward to Year Five, when their net rents are likely to have increased to $21,000, while their loan is down to $339,000.  Their interest deduction for the year is just $16,950.

Lo and behold, they are now positively geared. In fact, the surplus rents may well push them into a higher tax bracket.

By the time they get to 65, the debt should be paid off and the property could be worth $670,000, assuming capital growth of 4% per annum; producing rents of $24,000 per annum assuming annual increases of 3%.

Let me stress that this is not the kind of strategy I recommend – I much prefer the flexibility and growth potential of a diversified share portfolio.  However, the couple in question are typical of many Australians in their tax bracket. Instead of being attacked, they should be commended for trying to be self-sufficient, and for the substantial contribution to taxes they will make in the future.

13 July 2015

Where do you start when choosing a financial planner, and what should you expect from them?

First make sure that the planner is properly qualified.

For that, you need a planner who has the CERTIFIED FINANCIAL PLANNER® designation. Planners who have this designation – the highest level available – must meet ongoing competency, ethics and practice standards, meeting higher professional and ethical standards than those required by law. Look for the letters CFP® after their name.

Next set up an introductory meeting, and use it to make sure that you feel comfortable with your planner. 

The relationship between you and your planner will be a very personal one. For it to work you’re going to need to talk to them not just about money, but about your goals, dreams and your family situation. It’s a bit like choosing a doctor.

Alarm bells should start ringing if your planner:

·        - fails to take time to learn about your individual circumstances, needs and goals

·        - is more interested in selling you a product than developing a strategy for you

·        - promises you the world (i.e. high returns and low risk) and tells you not to worry

·        - avoids questions or withholds information

·        - is not clear about fees and charges, or their fees appear excessive.

Ask: “How will you help me reach my goals?’ The answer will quickly show you whether your planner is a good match. They should understand your goals and lifestyle, create a plan specifically suited to you, then clearly explain the plan before putting it into action.

It is your financial planner’s responsibility to make clear recommendations and ensure that you fully understand their recommendations as well as the possible risks. If something isn’t clear or you don’t understand, ask.

Once you’ve agreed on your plan, you’ll be given a statement of advice. This tells you who is covered by the advice (just you? your partner? children?) and includes the products and services suggested, with a clear explanation of why these were chosen and how they will benefit you. 

Don’t be intimidated to ask questions or take along this article, remember your financial planner’s job is to help you achieve a better financial future. Don’t settle for anything less! 

29 June 2015

Accumulating enough money to retire on is one issue – trying to protect it for our beneficiares in another.

In many cases the best option is to include  a testamentary trust clause in your will. Don't let the term scare you, it's worth taking the time to get a grip on it.

Think about a couple who have three children and several grandchildren. The eldest child is a well-paid professional with a high net worth and a stable marriage, the second is in a rocky domestic relationship, and the third is battling along in a business whose profitability is doubtful and which might go belly-up at any time.

The retirees have substantial assets that include three rental properties and a large amount of money in superannuation. Naturally they wish to leave these assets to their children, but they are savvy enough to realise that simply leaving a third of the estate to each child could create a mine field. The eldest child has more than enough income now and any extra would be taxed at 49%,  money inherited by the second one could be up for grabs in a divorce settlement, while creditors could seize any money left to the third child if his business went bankrupt after their death.

The solution is to leave the money to three testamentary trusts – one for each child. Then, when the parent dies, one third of the assets will go to a testamentary trust for each of the three children and will not be held by them personally. This keeps the assets separate in the event of divorce or bankruptcy but also has taxation advantages if everything goes well. 

In short, testamentary trusts are simple in operation, and highly effective in saving tax and protecting your assets. Just make sure you take advice from your solicitor, financial adviser and accountant before you change your will.

22 June 2015

Is a million dollars enough to retire on?  It’s a tricky question, and certainly a topical one, judging by the emails I received after a recent column where I talked about a couple who were living in a $2 million home and receiving the full age pension of $34,000 a year.

The example assumed they had nothing much in the bank due to the cost of maintaining their old home in a superb location, and they eventually moved to a $700,000 unit, freeing up $1.3 million in capital.

I pointed out that the $1.3 million would take them over the limit for the pension asset test, causing them to lose the age pension and the health concessions that go with it. Furthermore, the income from that sum would most likely be less than the money they would have been receiving on the full pension.

In their situation cash deposits may be the only option they are likely to feel comfortable with, which means they will quickly start drawing down on their capital.  At least as their capital reduces they will start to become eligible for a part age pension and accompanying concessions, which should reduce their need for capital withdrawals.

But, for the sake of the exercise, let’s assume that they opted for a balanced portfolio of say, 50 per cent shares and 50 per cent cash.  An index fund would be a perfect investment for them, as it could not go broke, and would pay around 4.5 per cent fully franked.

The income from the shares would be around $39,000 a year after franking credits are refunded, and the remaining $650,000 in the bank could produce $16,000 a year.  It would also have the benefit of potential growth in the share portfolio, which means that the income from the shares would increase over time. 

Senior Australians are facing the perfect storm.  Interest rates are low and likely to go even lower, government finances are tight, access to the age pension is going to be restricted, and it’s highly likely that they’re going to live to at least 90.

8 June 2015

June 30 is rapidly approaching, which means it is time to seek advice about ways to save tax.

If you have deductible expenses, such as repairs and maintenance on investment properties, try to bring them forward so you will enjoy your tax deduction in the current financial year.

Salary sacrifice to superannuation is still a great strategy because such contributions lose just 15 per cent, whereas money taken in hand will probably lose at least 34.5 per cent.  Provided lack of access is not a problem for you, superannuation is the perfect place to invest an end-of-year bonus. 

If you are a higher income earner, or salary sacrificing now, make it a priority to check your level of contributions as soon as possible.  The maximum deductible contributions are $30,000 a year for those under 50, and $35,000 a year for people 50 and over.  These include the employer compulsory 9.5%.

A simple and useful strategy if one spouse will have low earnings is to make a spouse contribution of $3,000 so you can become eligible for the tax offset – it is the best way I know to get a capital-guaranteed 18% on your money.   

The amount of the offset is 18% of the lesser of $3,000 or the amount of the spouse contribution actually made, so a contribution of $3,000 would give you an immediate tax offset of $540, which would reduce your own tax. 

Once a spouse’s income exceeds $10,800 the offset tapers – no offset is payable once spouse income exceeds $13,800. 

For capital gains tax purposes, the relevant date is the date the sales contract is signed.  Defer signing a contract until after June 30, and you will get an extra year’s use of the money you owe the tax man. If you are retiring, it may also mean you pay at a lower rate as you could be be in a lower tax bracket.  

Another strategy is to sell assets that will trigger a capital loss in the same year as you make a capital profit – the losses will reduce the CGT as they can be offset against the gains.   Even if this means selling shares you believe have strong potential, there is nothing to stop you selling them prior to June 30 and then buying other shares when you are ready.

31 May 2015

Superannuation still remains a superb vehicle for saving tax but the price of growing your money in a low tax environment is loss of access to it until you reach “preservation age”. For people aged 32 or more at 1 July 1992 the preservation age is 55, but it is being slowly increased with the aim of having all benefits preserved until age 60 by the year 2025.

 

You can access your superannuation as a lump sum once you reach 55 if you “retire”. Retirement however, is a state of mind, so it is possible for people to retire at 55, draw part of their superannuation and then return to the workforce a few months later because they are sick of doing nothing.

 

You can access your superannuation when you reach 60 if you retire from any job – it needn’t be your main job. At age 65, access is automatic.

In 2006, as part of a total reform of the superannuation system, the access rules were relaxed so that anybody who wanted to continue working after their preservation age was able to take part of their superannuation as an income stream.   This income stream – the transition to retirement pension (TTR) – is similar to a normal account-based pension except non-commutable. That’s a fancy term that means you can’t make lump sum withdrawals from it. 

TTRs have become extremely popular, and most eligible workers are now boosting their retirement nest egg by salary sacrificing a portion of their salary to super and using the transition to retirement pension to fund any shortfall in their living expenses.  TTRs have some limitations until you reach 60 as, prior to that age, withdrawals from the taxable components are taxed at your marginal rate less a 15% rebate. It’s a no-brainer once you reach 60, as the contributions lose just 15% in entry tax, while the withdrawals are tax free.

A knowledge of the access rules is essential for anybody making long term investment plans. Put simply, the younger you are the more you should opt to invest outside of the superannuation system, the older you are the more you should favour it.

18 May 2015

In 1992 when I was doing the research for my book on retirement I discovered the books of Professor Ellen Langer, Professor of Psychology at Harvard, who has done pioneering work on the potential of older people.

It was Professor Langer who conducted an experiment on elderly patients in a nursing home. Half were told they would be given a pot plant if they were prepared to care for it – the other half were told they would be given a plant but the staff would be the ones responsible for it. The group who were required to look after their plant showed significant health improvements.

As a fan for 20 years I was delighted to have the opportunity to spend some time with Professor Langer when I was in Boston last year. We share a passion for human potential and we were soon heavily engaged in conversation about her favourite topic mindfulness.

She related the story of a friend who was having a house built and had an injury while standing on a porcelain toilet at the construction site to adjust a light fitting. The friend exclaimed “ I have learnt my lesson’’.  Dr Langer responded ’what was the lesson you learned – was it not to visit a construction site, was it not to stand on unstable objects, or was it simply to take more care.”

Her point was that the lesson learned depends entirely on a person’s perception.

That rang bells at once. Immediately I thought of the many times I have heard people say they have learnt their lesson about investing in shares and will never do it again..

The question to ask is what lesson they thought they had learned. Was it not to buy shares when the market is booming, or not to buy speculative shares, or not to buy shares when they were so cash-strapped that they would be forced to sell them if the market fell, or simply that they did not have the temperament for volatile investments. Should they avoid shares altogether in future, or would they simply use managed funds where the decisions are made by full time professionals

This week I have some homework for you. For starters do a Google search on Ellen Langer, read some extracts from her blog, and think about buying at least one of her books. At the same time sit down with your best friend or partner and discuss in a frank manner where your attitudes to investment have come from, and whether you have let one bad experience hold you back from diversifying your investments in the future.

4 May 2015

John is one of the first baby boomers.  Born in January 1946, he has just turned 69 and is living a full life in retirement.

Recently we shared a speaking gig and a message he gave on life insurance really hit the mark, The natural reaction is to ask why this topic would be relevant to retirees, because they would be unlikely to need it or to be able to afford it.

“No,” he said, “it’s not for you, it’s for your children”.  In his experience as a financial adviser, John has seen all the problems that can happen when a family has insufficient insurance, and has long insisted that all his children be insured to the hilt.

This includes life insurance, TPD insurance, trauma insurance, and income replacement insurance.

He then told us about his daughter, who had twin babies, and who three years ago was diagnosed with breast cancer.  She has a high paying executive job, and the combination of her income replacement insurance and her trauma insurance meant the family had enough funds available to handle their mortgage payments and all the treatment that her condition required.  She lived in a large provincial town and full oncology treatment was only available 1000 kilometres away in the nearest capital city.

The good news is that the treatment appears to have worked, and she is now in remission.

Then John delivered the clincher.  “Imagine you’re in a comfortable retirement with a substantial nest egg and enjoying the fruits of all your hard work – how are you going to react when one of your children rings to tell you they’ve been diagnosed with a serious illness?  Are you going to tell them it’s up to them, or are you going to dig into your own savings to rescue them?”

Never have truer words been spoken.  Illness is something we all think is going to happen to somebody else and insurance, like making a will, is something that’s easy to put off.  It’s only when the problems start that we realise it’s too late to do anything about it.

John concluded, “A serious illness is bad enough, but if one partner dies, or is permanently incapacitated, the surviving partner may be unable to continue at work and care for the children at the same time.  If that happened, it may be the grandparents who end up taking care of the children.” 

Getting your children to take out sufficient insurance is an important and emotive matter, and one that is never over in a single conversation, which is why it’s important to involve your financial adviser.  Often, premium affordability is a stumbling block but life and TPD premiums can come from their super.  Income protection premiums are tax deductible – only trauma cover premiums have to come from post-tax dollars.

 27April 2015

The prize for the stupidest idea of the week must go to Treasurer Joe Hockey for his suggestion that first home buyers should be allowed to access part of their superannuation for a house deposit.

Not only would it drive up house prices, the plan has two other major faults: it ignores the true cost of home ownership and it subverts the purpose of superannuation.

Certainly, falling interest rates have reduced the gap between owning and renting but owning is still considerably dearer than renting.

Take a $450,000 property that rents at $450 a week: the tenant gets occupancy for a total yearly cost of  $23,400 – in contrast, the repayments on a mortgage of $400,000 at five percent over 25 years will be $2330 a month or $28,000 a year. And the mortgage repayments are not the end of it; add at least $3000 a year for rates and maintenance and total annual expenditure becomes $31,000. 

From a cash flow perspective the tenant is $7600 a year better off than the owner.

Obviously, renters who cannot save could end up with serious financial problems if they are suddenly handed enough money for a home deposit. 

Then there is the concept of superannuation. It has one major goal – to provide people with a retirement income so they won’t be living on the streets in their old age when the government runs out of welfare money. How much you have when you retire depends on three factors: the amount contributed, the rate earned, and the time the money stays invested. Reduce any of these and you reduce the final payout.

Suppose two people invest $3000 a year for 40 years. If one earns five percent per annum and the other earns 10 percent per annum, the end benefits are $400,000 and $1.6 million respectively. Doubling the rate of return quadruples the end benefit. 

Obviously, the primary objective of anybody with money in superannuation is to achieve the highest returns possible – you could

 

13 April 2015

I figure you can’t take it with you  - this is why my wife and I have just been enjoying a boat cruise in the Galapagos.

Most of my fellow passengers were pretty relaxed about investment markets but one woman stopped the conversation with “We like to sleep at night – that’s why we don’t have any shares”.

On the face of it, it’s a reasonable attitude given the present volatility of the markets, but the reaction for most of us was that we couldn’t sleep at night if we didn’t own shares. 

Now it’s a good feeling to have plenty of cash in the bank, even though the best return is going to be around 3%. But the problem with cash is that it has no tax benefits, gives you no chance of any capital gain and is eroded by inflation.  A return of $3,000 on a deposit of $100,000 may sound safe but take off 3.0% for inflation and you are left with a net return of zero  This is why holding cash over the long-term is one of the worst investment strategies of all.

This leaves us with the good old faithfuls – property and shares.  It’s important to have an interest in both these camps, but it’s just as important to understand that they behave in very different ways.  It’s highly unlikely that your property will lose 30 percent of its value in a downturn, but there are ongoing costs such as maintenance, rates and land tax and it can be a long drawn out process if you ever try to sell it.

Shares will give you a much more exciting ride because their values will bounce around, but the big advantage of them is that you can buy and sell in small parcels, they provide tax advantaged income by way of franked dividends and over the long term, have been the best performing asset class of all – an average of 8% per annum over the last 15 years even after taking the GFC into account.

Now let’s get back to the “sleeping at night” bit.  Think about a person who is aged 65, who has $600,000 in super and wants to draw $40,000 a year.  If their fund is diversified enough to earn eight percent per annum, their money will last to age 91 if inflation averages three percent per annum.  However, if they are scared of shares and opt for a “safe” three percent return, their money will be gone at 79.  In an age where most retirees can expect to live to 90, that’s a thought to keep anyone awake at night.

5 April 2015

Tax reform is in the news  again with a range of proposals being bandied about. These giving special tax concessions to money earned as interest.

It’s is hard to fathom the reasoning behind the bank interest concessions.  The Gillard government started the idea with a promise to give a tax discount of 50% on up to $1,000 of interest earned by individuals to bring the tax on this type of income into line with tax on capital gains . 

It is a fundamental financial principle that an investor who seeks a higher return has to accept a greater risk.  The reason capital gains are concessionally taxed is because any investment that has the opportunity to provide capital gain also has the potential to give the investor a capital loss.  A bank deposit should be riskless. 

A major problem is that it ignores what happens in the real world.  Most young people are not savers but, even if they were, are almost certain to be in the 32.5% tax bracket which extends from $37,001 to $80,000 a year.  A 50% discount on $1,000 of interest would be worth just $162 to them – hardly the price of a big night out. 

Those between 25 and 45 are likely to be paying off a mortgage, and have a hefty credit card bill.  Why would they hold $25,000 or more in an interest bearing account when they could earn a much higher effective return by holding it in an offset account or paying it off their credit card? 

Now think about the 45 to 65 group who are still working.  Most likely they will be in the 37% bracket so a 50% discount means they will be taxed at 18.5% on the first $1,000 of their savings.  Surely, a much better strategy would be to keep the money in super where the earnings on the whole lot are taxed at just 15%?

The last group are over 65 and are either working or retired.  If they are working you can bet your life they are salary sacrificing as much as they can into super - if they are not working, they will probably pay no tax thanks to the Senior Australians Pensioners Tax Offset.  Withdrawals from superannuation for the over sixties are tax free and do not add to taxable income.   

When you take all this into account, it is obvious the only people who would benefit from a 50% discount on savings are the wealthy elderly -  there are not a lot of them about.

 

29 March 2015

Sadly, most voters are not prepared to accept the tough medicine that is needed to get the country’s finances back on track.

But, the longer we put off making the changes, the harder it’s going to be when drastic action is forced upon us. 

Today, there are 3.45 million Australians aged 65 and over. By 2034, just 19 years away the number is expected to be 6.1 million – almost 20% of the projected population of 31.6 million.

In a situation where debt has become the norm, and deficits are forecast for years ahead, how is a government going to find the funds to provide the health services and age pension to deal with all those ageing people.

Our current income tax system is unsustainable. The 65’s and over are our fastest growing group, yet 87% of them pay no income tax at all. The Seniors and Pensioners Tax Offset (SAPTO) enables a couple to earn $28.974 each per annum without paying tax,  while anybody over 60 can hold their superannuation in a tax free fund while drawing a tax free income from it.

Raising the taxes on super without cutting back SAPTO won’t work because retirees with less than a million dollars in super would simply exit the system and continue to enjoy a tax free existence. The only realistic option available is to widen the GST so there are no exemptions.

Most senior citizens expect at least a part age pension. Currently, increases are linked to average weekly earnings, but the Coalition is trying to stem the rate the pension goes up. They have proposed the rate of increase be linked to cost of living from September 2017. 

Let’s assume average weekly earnings are 4% per annum,  inflation is 2.5%, and the couple’s full pension now is $30,000 a year. If it remains linked to earnings the pension would rise to $45,000 a year in 10 years and $67,000 a year in 20 years. By linking it to the CPI it becomes $38,000 a year in 10 years and $49,000 in 20.

Surely it is a no-brainer to reduce the increase in the age pension so that it keeps pace with the cost of living.

12 January 2015 

As we move into 2015 with all its hope and uncertainty, remember that there is much more to taking care of your finances than merely watching the markets.  A good metaphor is an injured leg due to a sporting mishap – naturally you would pay particular attention to that leg, but you would be foolish if you became so focussed on it that you neglected all the other aspects of life.

Start by analysing your debts. As you list your loans, enter the interest rate and the monthly payment next to each one, and then separate them into those where the interest is non-tax deductible (for example your home loan and personal loans) and investment loans where the interest is tax deductible.

 

Tax-deductible interest costs much less than non-deductible interest so check that your deductible loans are on an interest-only basis to maximise the funds you can plough into your non-deductible debt.  The optimum payment for your home loan is $12 a month per $1 000 (for example $2 400 a month on a $200 000 loan) which will have it paid off in less than 10 years with minimal interest.

 

If you’re stuck with personal loans and credit card loans, attack these first as they carry a much higher rate of interest.  Use all your spare money to pay off the smallest loan quickly and, when that is out of the way, use the repayments no longer needed for it to speed up repayments on the second smallest non-deductible one.  Do this and you will be amazed how quickly you will start pulling yourself out of debt.

Finally never forget that becoming wealthy is not a matter of how much you earn but how well you use the money you do earn.  Your new year’s resolution should be to make 2015 a year when you structure your finances to make the most out of every dollar you earn.

5 January 2015

Welcome to 2015.  It’s bound to be another challenging year, and one of the big questions on everybody’s mind is where property is moving.

First, keep in mind there is no such animal as a single property market.  There are many property markets that can range from units in Cairns to industrial sheds in Perth, so it’s important to decide what specific market you are interested in when thinking about buying a property.

A major driver of property prices is interest rates, so you will need to form a view as to what direction interest rates are likely to go in the coming year.  My view is that any movements will be small, and if they occur at all, will be downward.  The economy in general is not doing well, and the government has flagged its intention to cut costs while finding ways to increase taxes.  Both of these strategies will tend to stifle economic activity – it’s hard to imagine any reason for the Reserve Bank to increase rates to slow down the economy if this scenario occurs.

The Reserve Bank Governor Glenn Stevens has stated that the bank is keen to see a lower Australian dollar, which is a reason for the bank to lower rates, but he’s also said that rates are about as low as they can go.

But don’t fall into the trap of thinking that rates cannot go up in the future.  The economic cycle will continue and at some stage rates will bottom and start to move up.  This is why anyone buying a property should do their sums on interest rates of around 6.5%.  Repayments based on this assumption will have your loan paid off much faster if rates stay where they are, but will give you a great safety buffer if rates start to move up

As always, the key to success in real estate is to buy an undervalued property, with potential for improvement, in a top location.  These bargains may take time to find, but are well worth the effort.

 

7 December 2014

Welcome to December – potentially the most dangerous and most frustrating month of the year.  You can spend eleven months doing all the right things and making solid progress, and then find all your good work destroyed as the holiday season hits and you get caught up in the inevitable spiral of over spending and over indulging. 

In a flash the end of January comes and you find yourself trying to deal with a maxed out credit card, school fees and clothes that have suddenly shrunk. 

First, be aware that shopping with a credit card has a very different feel to shopping with cash.  Have you noticed that pulling a $50 note out of your wallet feels very different to booking up $50 on a credit card?  This is why you inevitably get a shock when the credit card statement arrives and you discover that all those tiny amounts have combined to such a large sum.  Where possible, use cash, or else a debit card – this will help you control your spending. 

Next, make sure you have a credit card that is appropriate for your own situation.  You can read a comparison of the leading cards at www.ratecity.com.au but just keep in mind that there are two basic types - those that offer an interest free period, and those that don’t.  Now the interest free period might sound fine, but you are only eligible for it if you pay the entire balance before the due date.  Even if you pay most of it, they will still charge you interest on the whole lot if you are even one dollar short.  The solution is obvious – unless you pay the card off each month don’t waste money on cards that offer an interest free period.   

If you are a heavy spender who can pay the balance in full each month, choose the card that gives you the best rewards.  These may include frequent flyer points, free holiday insurance and even a concierge service.  If you are a moderate spender who pays the card in full every month simply choose the one with the lowest annual fee.  After all, if you are only spending $1,000 a month you are not going to get much in reward points. 

 

1 December 2014

Australia is facing challenging times.  Household debt levels are a record high and still rising, and inflation is running at the top of the Reserve Bank’s target range.  Yet, interest rates are at historic lows with no increase in sight.

It’s all a hangover from the Global Financial Crisis.  In a way, the GFC was as much an economic catastrophe as World War II was– the main difference is the building boom that followed the end of hostilities in 1945.  Now, there are no buildings to repair, just balance sheets.

This does highlight the challenges facing our Reserve Bank now, as they try to cool off an overheated property market.  Governor Glenn Stevens has already pointed out that there is no point in making any further rate cuts as rates have become so low that any further reductions are now ineffective as a stimulatory tool.

The Australian housing market is one of the most overvalued in the world, but you can’t put a brake on it by raising rates by a small amount.  Think about it – if you came across an undervalued asset now, even an extra one percent interest wouldn’t stop you buying it.  You could stop the property market dead in its tracks with a large rate rise, but the outcome would be unthinkable.  There would be a string of repossessions as first home buyers lost their homes. 

Even though the Reserve Bank is concerned about the number of low deposit loans written, it is not practicable to insist that property buyers have a larger equity.  It would simply force first home buyers out of the market, leaving the space to investors who would simply increase their equity by mortgaging other investment properties they own.

So our Reserve Bank remains stuck between a rock and a hard place.  They could go back to the old days and restrict the amount of money the banks could lend for housing, but this could be easily circumvented by the use of non bank lenders and offshore borrowings.  At the end of the day, it’s buyer beware - anyone who buys into a boom must have an exit strategy when the music stops.

1 November 2014

Negative gearing is back in the headlines. On one side are the academics who are pushing for its abolition, on the other are the property aficionados warning of a return to the dark days in 1985 when Paul Keating interfered with it.

It was a different world when Keating changed negative gearing in July 1985.  Interest rates were 14 %, inflation was 10%, and the top marginal tax rate was 60%, which cut in when income reached $35,001.

Think about the dilemma facing anybody then who wanted to create wealth.  If you deposited the money in the bank you lost up to 60% in tax, if you worked overtime you lost up to 60% in tax, if you tried to expand your business or invest in shares, you got hit twice.  Up to 60% in personal tax, and 46% in company tax.

In July 1985 Keating placed restrictions on borrowing for investment.  For all properties bought after that date, he disallowed a tax deduction for interest that exceeded the net rents for the year after allowing for outgoings.

Despite the predictable outcry, the proposals weren’t too harsh.  Let’s look at the numbers for a person buying a new property then for $55,000 using an interest only loan at 14%.  We’ll assume gross rents were $90 a week and the deal was apportioned land $20,000 and building $35 000.  If net rents were $3500 a year and interest was $7700, there was a deficiency $2200 that was able to be quarantined to be offset against future profits from that property.  However the building allowance of $1400 (4% of $35,000) meant the taxpayer was going to lose only $800 a year in tax deductions, while having the benefit of the quarantined $2200 to offset against future income. 

The changes were mild but the scare tactics worked.  In October 1987, Keating backed off and restored negative gearing but also reduced the building allowance from 4% to 2.5%. 

The situation today is nothing like it was then.  Marginal tax rates have dropped, shares now enjoy special treatment, capital gains tax is in place and inflation and interest rates are way down and seem certain to stay there.  The tax breaks from negative gearing are mostly illusory as you can now borrow at 5% for a property yielding 4%.  Therefore borrowing the whole purchase price of a $500 000 property is going to save less than $2000 a year in tax.

 

1 July 2014

Welcome to another financial year. It is the perfect time to do some work on improving your financial situation. 

Just remember that becoming financially successful does not take any special skills on your part, but it does require some action - usually the hardest part of that action is starting.

So grab some old bank statements and pay slips and prepare a one page list of income and expenses. Hopefully you will find there is an excess of income – if not, you had better do some serious budgeting as you are living beyond your means, and financial problems are almost certainly around the corner.

If you’re stuck with personal loans and credit card loans, focus on these first as they carry a much higher rate of interest and they are not tax deductible.  List them, and then use all your spare money to pay off the smallest loan quickly. When that is out of the way, use the repayments no longer needed for it to speed up repayments on the second smallest non-deductible one.  Do this and you will be amazed how quickly you will start pulling yourself out of personal debt.

Once you start taking an interest in your finances you will be amazed how ideas start to appear. No longer will you ignore those dollars sitting in an account that pays almost no interest - you will have the money in one of the online accounts earningthree percent, or have it in an offset account where you will be receiving the tax free equivalent of the rate you are being charged on your mortgage.

 

23 June 2014

In 1987 when I wrote Making Money Made Simple I pointed out that Australia's population was ageing, with more and more pressure to be placed on government budgets. I also wrote that financial independence is within the grasp of anybody who learns the fundamentals of investment at a young enough age, and decides to put their mind to becoming wealthy.

Think about those born after January 1966 – they will not be eligible for the age pension until they turn 70. Odds on that most of them will live to over 90.  This means they have to stay at work until 70, and while doing so, accumulate enough money to see them for more than twenty years. 

This is why it is vital to start using strategies now to boost your finances. 

Let me show you how powerful extra superannuation contributions can be. 

A person is 48, earns $80,000 a year, has $120,000 in super all contributed by the employer.  Their partner does not work.  They intend to work for 22 years and then go on the aged pension, if it is still available, at age 70.  They estimate they will need $4,000 a month in today’s dollars when they retire  - this will be $7500 a month at age 70 if inflation is 3% per annum)  To achieve this goal they will need to accumulate $1,300,000 if they live to age 95. 

If their employer superannuation earns 8%, and their income increases by 3% a year, they should have $1,100,000 in their employer fund at age 67 - $200,000 short of their target. If they had stopped work at 65, their super would have only been worth $720,000. 

Notice the mathematics of compounding here.  Almost half of the final balance at age 70 occurs in the five years between age 65 and 70.  Because they are working till age 70, all they have to do to make up the shortfall of $200,000 is salary sacrifice a paltry $300 a month for the next 22 years.

 

16 June 2014

First Home Saver Accounts Scheme (FHSA) were wonderful products for people saving for their first home. Launched with fanfare by the Rudd government on 1 October 2008, the initial expectation was a take-up by over 750,000 first time buyers, with a total cost to the government of  $6.5 billion.

The figures were way out. - only 46,000 accounts were opened in total - and just 800 in the last six months.

Factors that contributed to the lack of enthusiasm for the accounts include the perceived four year lack of access, and general inertia by young people, who are usually far more focussed on the latest release from Apple than on their finances. 

The low take-up rate is further proof that the financial literacy of young Australians leaves much to be desired. The features offered by the accounts were almost too good to be true.

It was a no brainer for first home owners buyers.  The government was prepared to contribute 17% on the first $6000 of funds deposited each year until the balance reached $90,000. This was equivalent to a capital guaranteed tax free return of 17% per annum.

Furthermore the interest on these accounts was taxed at just 15%, the same as superannuation.  If a first home saver deposited $6000, and received $180 interest for the financial year, tax would take just $27, leaving them with $153 in addition to their $1020 from the government.  This is a total after tax return of 19.6%. 

Well, as the old saying goes "what you don't use you lose" - the scheme was terminated in last week's budget. Any new accounts opened from 7:30pm on Thursday May 2014 will not receive any concessions or government contribution.

The news is all good for existing account holders.  Even though for them, the government contribution will cease from 1 July 2014, all restrictions on withdrawals will be removed from 1 July 2015. From that date the accounts will be treated like any other savings account and savers can withdraw their money when they like, for whatever purpose they choose.

 

9 June 2014

Have you ever thought about putting money away for a newborn baby?  Can you believe that investing just $2.83 a day ($1000 a year) could grow to a small fortune?  Yes it can! 

Suppose your child had been born in October 1981 and you invested $2.83 a day for him into an investment that matched the All Industrial Accumulation Index.  On his first birthday the portfolio would have been worth just $1004 - at that stage you may have become bored with the project and stopped. 

However, if you’d kept going, the sum would have been $12 000 on his fifth birthday, $25 000 on his 10th birthday, $53 000 on his 15th birthday and a whopping $107 000 on his 21st birthday. 

Today the investment would have grown to $276,000.

What is so good about investing in the All Ordinaries Accumulation Fund is that anybody can do. No special skills are required and you don’t have to be a wizard at stock picking. All you have to do is to talk your adviser and choose a fund that is appropriate for your own situation, and then invest all  the dividends. By definition the index cannot go broke and historically has returned an average of 9% a year,

Check the calculations for yourself on my website. Just go to Stock Exchange Calculators – Dollar Cost Averaging – and pick a starting and finishing date and a hypothetical sum to invest.

Why did I pick October 1981? Because that’s the year my eldest son Mark was born.

Here’s the bad news -  like most parents, I “never got around” to doing it.  Believe me, when the grandchildren come, I’ll start it immediately.

 

2 June 2014

The Commonwealth Seniors Health Card (CSHC) has been a useful tool for retirees who do not qualify for the age pension and the concession card that goes with it. However, big changes in last month's budget mean some current  holders will be losing it.

To qualify, you must be of age pension age but not be in receipt of an age pension. Also  you must have an adjusted taxable income of less than $50,000 for singles or $80,000 for couples (combined). Adjusted taxable income is a person’s taxable income, reportable fringe benefits, salary sacrificed superannuation contributions and net investment losses.

It is valid for one year only and must be applied for each year.

Anybody who starts an account based pension or annuity after December 2014 will find that the income stream will be assessed under the deeming rules with the deemed income being added to their adjusted taxable income. Existing pensions that commence before January 2015 will be exempt.

You would need to be wealthy to be adversely affected. For example, if a  couple had $1.2 million in superannuation and were drawing an account-based pension that started after 31 December the deemed income would be about $41,000 a year. This is way short of the $80,000 cut-off figure, but  of course other income like franked dividends could push them over the cut off point.

It’s a reminder that the recent budget changes have changed the landscape for many Australians. As we approach June 30 good advice is becoming more important than ever.

26 May 2014

There was a scary segment on ABC’s 7.30 program last week about retirement villages. It told of a woman who bought a strata title unit about eight years ago, and died two years ago. Because she owned the unit outright, the only way for the family to get the money is to sell the unit but there are 19 for sale in a complex of 35 units and NO BUYERS. The poor family are stuck with paying all the costs of the unit until they find a buyer. This could happen to the family of anybody who owns a strata title unit – the outgoings are always the responsibility of the unit owner.

It’s a bit of a catch 22. The group that run the units claim that it is essential for them to charge these fees because, if they did not charge them to vacant units, they would be forced to reduce services, or increase fees to all the old people who are living in the other units.

As Rachel Lane and I point out in our book Aged Care Who Cares, there is no easy choice. If you opt for a lease or licence arrangement, you accept the buyback price that is written into the contract when you purchase the unit in the first place. If you opt for strata title, you or your estate is stuck with trying to sell it.

It’s a warning to anyone moving into a retirement village to really take advice on the implications of the contract you sign. Unfortunately, I have seen these contracts and they’re nearly as thick as a phone book. 

I don’t know any area which is as complex as aged care. This is why taking advice is essential.

19 May 2014

A common question is “how much do I need to retire?”  Unfortunately, it’s impossible to give a simple answer because the amount of money needed depends on a wide range of variables that include how long you will live, the state of your health, the rate of inflation, the earnings on the assets you own and how often your children put their hands out for help.

A good rule of thumb is that you need capital of 15 times your planned expenditure.  For example, if you require $40,000 a year when you retire, you should be trying to accumulate $600,000 in financial assets. 

One of the best ways to boost the money you will have in retirement is to work a little longer - because of the way compounding works the benefits  can be dramatic.

Consider a person who is aged 58 and who has $300,000 in superannuation.  If they retired immediately they would be lucky if their superannuation lasted to age 66 if they withdrew $40,000 a year from it and it earned 7%.  However, working just two more years full time to age 60 would mean two more years of growth and contributions – by age 60 the balance could be $400,000. Their money may then last till age 72.

That is probably still way short of what they will need, so let’s recalculate the numbers on the assumption they will work to age 65. If they started with $400,000 at age 60, and salary sacrificed the maximum allowable of $35,000 a year  they should have $750,000 at age 65.

This would probably last them for life.

There is a growing consensus that working longer is not just good for your pocket, it’s also good for your health.   

 

12 May 2014

There are three major areas in which you can invest – cash, property and shares. A well constructed portfolio will have a mix of these assets because they have different characteristics, and one may be performing well when another is performing badly.

Keep in mind that every asset class has advantages as well as disadvantages.

If you invest in cash, that's money in the bank, there should be no entry or exit fees, and you won't lose any of your precious capital if the market has a downturn. However, there is no chance of any capital gain, and no tax concessions.

Shares have the greatest potential for high returns but remember the adage – the higher the return the higher the risk. If you make the mistake of investing in a dud you may well lose all your money. The great thing about shares is that they can be bought and sold in small parcels and there are minimal entry and extra costs.

Residential real estate is a solid investment because you will never lose all your money, unless you borrow too much and are forced to dump your property on a bad market.

The trick is to find an under valued property and add value either by renovating it or changing its use by rezoning.  This is the origin of “buy the worst house in the best street”.  Of course you can’t go on adding value to the same property year after year or you’ll risk over capitalising. Another fundamental is timing – knowing when to consider taking profits and moving on to the next deal. 

 

5 May 2014

"What kind of superannuation fund should I have?" is a question I am often asked. There is no simple answer because, like choosing a home loan, you need one that is right for your particular situation.

Naturally, fees are an important consideration, but I believe that transparency of fees is often a more important issue than the fees themselves.  Fees do vary between funds, but so do the benefits - if the fees easy to understand you are well on your way to making an informed choice.  Keep in mind too that the biggest fee you face is almost certainly going to be the 15% that the government takes out of every contribution your employer makes on your behalf. 

Next consider the ability to take out life insurance within the fund. Can you take insurance without a medical up to a certain figure?  Is the insurance available for any occupation or just a specified occupation?  Does the cover reduce as you grow older, or are you free to choose a level payout figure as long as you pay a higher premium each year?  Does your fund offer income protection insurance?   If so, is it to age 65 or just for two years?  What proportion of your salary is covered?

Most funds offer a wide range of investment options but keep in mind that the assets you hold inside super are usually only a part of the total family assets.  This is why it is important to agree on an overall asset allocation with your advisor and make sure the choice of funds within super is in line with that asset allocation. 

We have long recommended that retirees, or those nearing retirement, keep at least three years planned expenditure in cash.  At this stage in your life you will be either receiving an account based pension (allocated pension) or considering starting one.  Make sure your fund lets you switch from the accumulation phase to the pension phase without penalty and also check that the choice of assets offered by your fund while you are in the pension phase allows you to hold part of your money solely in a cash account.  If your fund does not offer a cash account you could be forced to drawdown growth assets such as shares when the market is having one of its inevitable down periods.   

28 APRIL 2014

Obviously there is going to be no tax relief in the forthcoming Budget, yet a major issue for many households is that tax takes a growing percentage of their pay packet as they earn extra income.

But think about the proverb “A penny saved is a penny earned” - it may be possible to give yourself an effective pay rise by simply cutting your expenses.

Consider a person earning $800 a week ($41,600 a year).  A pay rise of $30 a week would return them only $20 a week because tax would take the other 32.5%. Thus if they wanted to have an extra $20 to spend every week they would have to get a pay rise of more than $20 – i.e. $30 a week.

But they could give themselves a pay rise of the equivalent of $30 a week by spending around $20 a week less, or by having another member of the family with no taxable income earn an extra $20 a week.  Imagine if they do both - that would be the same as getting a $60 a week rise in their packet!

Every household has different priorities, and I'm not about to suggest what you should cut out.  However I do know that almost every household can find ways to cut expenses if they have to.

The bad news is that Australia is going to suffer tough times for years to come – the good news is that most people have the power to make small changes today that will make a massive difference in the future. Resolve to be a have - not a have not.

21APRIL 2014

Today I’ll look at potential superannuation changes.

Treasury has been looking longingly for years at the difference between a superannuation fund in accumulation mode, and one in pension mode. The former pays income tax at 15%  per annum on earnings, and 10% on capital gains - the latter pays no tax whatsoever. This anomaly has enabled thousands of wealthy retirees to hold the bulk of their assets in a tax free environment, while drawing a tax-free income from them.

The Gillard government put a foot in the door by proposing a tax of 15% per annum on the earnings of superannuation funds in excess of $100,000 a year per member. There were howls of outrage from retirees and the Abbott government did not go ahead with the legislation. However, the proposal to levy a higher contributions tax on those earning $300,000 a year did become law, and is now in force.

If  they change the rules to make pension funds pay tax at 15% on earnings every retiree will have to revisit their superannuation strategy. The  changes to account-based pensions from next January have removed one of the main reasons retirees  with relatively small balances stay in super as there is no longer a Centrelink advantage.

If earnings within their pension fund were taxed at 15%, they would probably be better off a withdrawing the whole sum, investing outside the system, and taking advantage of the tax-free threshold  of $18,200 a year.

Wealthier retirees may well move their superannuation back to the accumulation phase, which would remove the requirement that a set amount be drawn each year by way of  a pension. 

It’s a moving target  - watch this space.

 

14 APRIL 2014

Today I’ll look at potential aged pension changes.

Let's start with the proposal to tighten aged pension eligibility by including part of the value of the family home in the assets test..  The present system is certainly inequitable. A couple can live in an expensive home, have up to $238,000 in financial assets and receive the full pension of $33,035 a year – a renting couple with no assets would get exactly the same pension, plus maybe a bit extra for rent assistance.

Think about the practical difficulties of doing it. Every home would have to be regularly valued, and there would have to be weighting given to areas like Sydney where home prices are at record highs. And what sort of consideration would be given to  those who were asset rich and cash poor. If the rules changed, the media would be full of stories of cash strapped widows living in rundown houses in good suburbs, who would be forced out on the street.

Would people have to resort to reverse mortgages to live, or would they spend up big so they could retain the full pension? And who would pay $600 to have their home valued every five years, and then suffer a drop in their pension if a property boom meant that the value of their home had gone up.

Next is the possibility of raising pensionable age to 70.  It might be a worthy goal to keep people at work longer,  and I suspect that most of us who can work longer are already doing it . However the reality is that older people find it harder to obtain work than younger people, and certain occupations such as heavy trade work are not suited to most older people.  But, how does a person aged 60 support themselves if there’s no pension until age 70? 

These proposals are not law, and pressure from stakeholders will mean it may be years before they happen, if at all. What we do know is that the present system is unsustainable – something has got to give.

 

Monday, 7 April 14

I often receive emails from people who have paid off their home, and would like to upgrade to a more expensive one, while keeping the original as a rental. Alternatively, they may be thinking about taking a leisurely trip around Australia, with the aim of retiring to a different home when they return.

In most cases, unless the original home has great potential, there are more disadvantages than advantages in keeping it.

For starters, anybody buying a new home while keeping the old one would be badly structured for tax purposes. They would have a large non-deductible debt on the new home, while paying tax on the rents from the original one.

It is likely that the original home will drop in value when the owners move out.

A major part of getting a good price for your house is presentation. This is enhanced by a nice lawn, and attractive furniture. In most cases (obviously not all) the gardens deteriorate when tenants move in, and the furniture of a tenant may not be as attractive as the furniture of the owner.

Also, it is usually easier to sell your own home than a rental property.  This is because it is harder to arrange inspections when you have to negotiate with tenants for suitable inspection times. 

If you are never going to return, sell it with your stuff in it, and enjoy the capital gains tax exemption. You could always borrow against the new  home for investment – the interest on this loan will be tax deductible.

 

Monday, 31 March 2014

Many investors are attracted by the unique qualities of shares, but don’t know where to start.  They’ve probably heard stories of companies like Babcock & Brown or ABC Learning that went under, and are scared that any money they invest may be lost.

A simple way to start is an index fund – this is a fund that simply mirrors the performance of the particular share market it is designed to track, so will fluctuate in line with the movements of that market.  By definition, it cannot go broke as it is simply an index which reflects stock market performance.  The only way for the index to go broke is for every listed share that is included in the index to become worthless.

When I refer to an index in a column I am usually talking about an index which tracks the top 200 shares in the Australian stock market, but there are many other index funds which enable you to invest in markets in Australia and overseas.

To see for yourself how an index fund has performed, go to my website www.noelwhittaker.com.au, and click on Stock Market Calculators – Stock Market.  You can then enter a notional sum and work out how much you would have now if you had invested in a fund that matched the All Ordinaries Accumulation Index, which includes income and growth.

It’s best to consult an adviser to make sure you choose an index that fits your goals and your risk profile.  You should also ask the adviser to explain actively managed funds - they may or may not perform better than the index.  

Remember – shares offer unique benefits by way of liquidity, tax concessions, and the potential for capital gain.  A major benefit is you can start with just $1000, and add to your investment when appropriate.

 

Monday, 24 March 2014

It’s a tough time right now for conservative investors, with interest rates at historic lows. 

If you are an investor who prefers to stay in cash, you need to understand the term ‘real interest rate’, which is the difference between the current inflation rate and the interest you are receiving.

Suppose you invest $100,000 at 4% when inflation is 3%.  The interest for the year would be $4000, but inflation would reduce the value of your investment by $3000, leaving you with a real rate of just one per cent.

That’s bad enough if you are in a tax free pension fund, but the outcome is much worse if you have to pay tax.  For example, if you were in the 32.5% bracket, tax would take $1300, leaving you with a real after tax return of negative $300.  In other words, you’ve gone backwards. 

It would have been a different matter if that same $100,000 had been invested in a growth asset (such as an equity trust or in property), and it achieved growth of 4% in one year as well as income of 4%.  Because growth assets are subject to capital gains tax, the 50% concession would have been taken off before tax was calculated.  This would have reduced the gain that was subject to tax from $4000 to $2000, and the overall tax would have been much lower.

In any event, no capital gains tax is payable until the asset is disposed of.  This maximises the compounding effect of annual growth because nothing needs to be withdrawn each year to pay tax.  Unfortunately, capital gain can never be guaranteed, so growth assets are not appropriate as short term investments.

 

Monday, 17 March 2014

One of the most asked questions concerns tax deductibility of interest on home loans.  It is common for homeowners to work hard at repaying their mortgage and then decide to move to a more expensive home, keeping the original as a rental.

There is a general belief that, if you borrow against the original property to buy a new one, the interest on that loan will be tax deductible. 

Unfortunately, for anybody contemplating this strategy, the tax laws don’t work like that.  The deductibility of interest depends on the purpose for which the loan is taken out, not the asset mortgaged.

Obviously, the interest on a loan to buy your own residence cannot be tax deductible, as the loan has been taken out for a private purpose.

A much better option for anybody who intends to retain their original home and move to a new one, is to have an offset account attached to their home loan.  Then, instead of reducing the mortgage, any surplus funds can be placed in the offset account.

There is no additional cost, because any interest earned on the offset account is deducted from the housing loan.

In the future, when they decide to buy the new home, the funds in the offset account will be available for the house deposit, leaving a large loan on the original property. The interest on this loan will be tax deductible once it becomes available for rent.

 

10 March 2014

The ongoing volatility in interest rates has generated the predictable hype about  borrowers taking matters into their own hands and switching lenders.

Unfortunately in most cases changing lenders is like swapping spouses – an expensive exercise with no guarantee that the outcome will be an improvement.

The main stumbling block is mortgage insurance, which is compulsory if the loan to valuation ratio (LVR) is more than 80%.

Think about a couple who are considering buying their first home, and who wish to borrow $570,000.  They have been attracted by all the huge newspaper advertisements and decide to go to Lender A because that institution is offering the cheapest rate. 

They have only 5% deposit so the LVR is 95%, -  they have not even given a thought to what the mortgage insurance premium may be.

The lender they choose charges them a premium of 3.9% or $22,230 and they happily sign up. They have no idea that another lender, possibly offering a slightly higher interest rate, may offer them the same loan but with a mortgage insurance premium of  2.41% or $13,737 –a massive $8,493 difference.

Of course, the government gets into the act as well and adds a hefty sum for stamp duty which ranges from 5.37% in Queensland to 11.8% in South Australia.

The mortgage insurance and stamp duty is invariably added to the loan which means they will be paying it off over the life of the loan.

After a couple of years our young couple find that their chosen lender has elected to increase interest rates to a level which is higher than most of its competitors.

Even though their house may have increased slightly in value, their LVR is still going to be 95% because the loan has been increased by the mortgage insurance premium and stamp duty.  To their horror, they discover that the new lender will want fresh mortgage insurance - they will be up for another lot of fees which would be at least $13,737, even if they chose the cheapest premium on offer.   

It would be most unlikely that they could obtain any refund of the original mortgage insurance premium.

 

3 March 2014

From 1 January next year, the treatment of account based pensions (ABP) for age pension eligibility will change.  The new rules will apply to people starting an ABP after that date, and in some cases to ABP’s started before then.

Under the existing rules, ABP’s are exempt from the deeming rules, and the income taken from an ABP receives a discount for the purposes of the Centrelink income test. The discount or deductible amount is calculated using a formula that takes into account the purchase price of the income stream divided by the life expectancy of the pension owner at purchase. 

From 1 January 2015, the ABP is losing its deductible amount, and the entire balance in the superannuation fund that is paying the ABP will be subject to the deeming rates.

The new rules will apply to those people that become eligible and apply for the Age Pension post 1 January 2015. Those currently in receipt of the Age Pension, and who have ABP’s in place, will continue under the existing rules provided they don’t at some point in the future become ineligible for pension assistance.

But be careful – the grandfathering rules will not apply if people change products.  

There are planning opportunities for income tested pensioners who will be entitled to the Age Pension by 1 January 15.  It might be a strategy that maximises their current deductible amount on existing ABP’s or it could be to make contributions to superannuation to commence an ABP prior to 1 January 15.     

It is essential that expert advice be taken – superannuation in accumulation mode is exempt from Centrelink assessment until the member reaches pensionable age.  However, once an account based pension is started, it becomes assessable immediately.

 

Monday, 24 February 2014

Thinking about Investing? Then appreciate that there is an advantage and a disadvantage in every investment decision you make.

For example, if you leave your money in the bank there will be no entry or exit fees, and you won’t lose any of it if the share market falls. However, there is no chance of capital gain and no tax advantages.

If you contribute money to superannuation you are moving it to a low tax area -  the price you pay is loss of access until you reach your preservation age. This is 60 for anybody born after 1964.

Recently a reader wrote to tell me that he was 30 and was paying off a $20,000 car loan at 17.5% interest.

He had just negotiated a pay increase of $30,000 to reach an annual salary of $93,000, and wanted to know if it was better to hold off on salary sacrificing and use the extra income to clear the car loan faster. Having a larger take home pay would also enable him to save a larger deposit to avoid high interest rates on a home loan.

I responded that I would much prefer that he leave any super contributions to his employer, and maximise his take home pay.  On his tax bracket, salary sacrificed contributions lose just 15% while money taken in hand loses 38.5%.  The difference is not sufficient to justify locking up his money in super for at least 30 years.  Also, a higher deposit means less mortgage insurance.

Monday, 17 February 2014

“How can I access my superannuation” is a common question. Access is generally restricted to those who have reached their preservation age which is 55 for those born before 1 July 1960. The preservation age then rises until age 60 which is applicable for people born after 30 June 1964.

However, until you are 65 you cannot simply withdraw your superannuation once you reach your preservation age. If you are between 55 and 60 you must sign a statement that you intend to retire permanently. Of course, retirement is a state of mind and after retiring you could at some stage in the future decide you are tired of doing nothing and return to the workforce without penalty.

If this is your intention keep in mind that there may be tax to pay on money you withdraw before you turn 60. The first $180,000 of the taxable component is tax-free but withdrawals in excess of that suffer a tax of 15% plus Medicare levy.

Once you reach 60 things get a little easier.  Withdrawals become tax free but to access your superannuation you need to retire from a job –it need not be your main job. You could start a casual job working for a while, resign from it, and then cash in your super provided the trustee of your fund is prepared to allow you to do it.

Once you reach 65 you can withdraw at will.

People aged 55 who are still working often ask me if they can access their superannuation to help with mortgage payments. The answer is generally yes – all they need to do is commence a transition to retirement pension which allows them to withdraw an income from the superannuation while they still work. 

As always advice is essential.

 

Monday, 10 February 2014

If you are going to make the best use of your hard earned money, you need to understand the difference between deductible and non-deductible loans. When you have a loan for investment,  you are able to claim the interest off your tax which means the Government effectively pays up to 46.5% of it. In contrast, if the loan is for a private purpose such as buying your own home or buying a car, the interest is non-deductible and so costs much more.

Recently I was talking to clients who had a $150,000 loan for their business on an investment property and a $250 000 loan on their own home. Because they didn’t understand finance, they were paying $2200 a month on the investment loan and $1500 a month on the home loan.  

I suggested they convert the loan on the business to interest only which would reduce the payments to $750 a month and free up $1450 a month to speed up the repayments on the non-deductible housing loan. This reduced the term of the housing loan from 30 years to nine years and saved them a staggering $214 000 of interest.

 

Another client was thinking of withdrawing $40 000 from their savings to buy a car and asked me if it would be better to leave the savings intact and borrow for the car. Bearing in mind the importance of maximising their tax deductions, I suggested they pay cash for the car and then borrow $40 000 to invest in quality share trusts. This enabled them to boost their asset base and also enjoy a tax deduction for the interest

 

Monday, 27 January 2014

June 30 is just five months away - a good time to think about capital gains tax.

It’s the friendliest tax you can pay because it is not triggered until you dispose of the asset, and this may be many years after you acquired it. Furthermore, if you have owned it for over 12 months, the capital gains tax is reduced by 50%.

There is no separate rate of capital gains tax – it is calculated by simply adding the gain to your taxable income in the year the transaction takes place, after adjustment for items such as cost, improvements and the 50% discount. Therefore, it can be a good strategy to defer the triggering a capital gain until a year when you have a low taxable income.

Keep in mind the relevant dates are the contract dates - not the settlement dates. If you sign a sales contract on 28 June 2014 for settlement in July 2014 the gain would be deemed to have occurred in June.

If you would prefer to push the sale into the next financial year it may be worthwhile trying to avoid signing a contract until after June 30. Of course, this strategy opens you to the risk of losing the buyer.

Tax on a capital gain cannot be deferred past June 30, but capital losses can be carried forward indefinitely. This is why it may be appropriate to sell loss-making assets in a year when you have a taxable capital gain, as the capital losses will offset the capital gain.

Next week I’ll discuss how it may be possible to use superannuation to reduce or eliminate a capital gain.

 

Sunday, 12 January 2014

One of the most exciting changes to superannuation happened seven years ago when they introduced superannuation spouse splitting. 

Once a year you can instruct your fund to transfer, to your spouse, your concessional contributions made in that year.  Because the 15% contributions tax on the concessional contributions has to be taken into account the amount of concessional contributions that can be split is limited to 85%.

Think about Jack, aged 52. He earns $125,000 a year and is contributing $25,000 a year to superannuation due to a combination of the compulsory employer superannuation and his own voluntary sacrificed contributions.

He already has over $600,000 in superannuation but his wife Katherine, who does not work, has none. His deductible contribution of $25,000 will still be liable for the 15 per cent contributions tax but he can ask his fund to put $21,250 of it into her superannuation account. If he keeps up this strategy until he is 65 she may end up with over $520,000 in her own superannuation account if her fund earned 9% per annum.

Super splitting doesn’t get Jack out of the 15% contributions tax but it still has advantages. First it enables them to maximise the amount that can be withdrawn tax free if Katherine wants to make withdrawals before age 60 – remember withdrawals are only tax free for those aged 60 or more. Those aged between 55 and 60 can withdraw only the first $180,000 of the taxable component tax free but, for them, the exit tax of 16.5% remains on the balance.

If they decided it was appropriate, he could even work until age 75 and keep up the salary sacrifice/spouse split strategy going.  This would keep him in a lower marginal tax bracket while funding a major part of the household expenses through tax free withdrawals from her super. 

As always, the key to good investment is the flexibility.

6 January 2014

By now, the joy of welcoming the New Year may have been replaced by frustration that all the resolutions made so earnestly just a few days ago are starting to look a little shaky.

The fact that you made a resolution means you know it’s important to make changes in your life - the way to make that happen is to set goals. They work because, once you set a goal and work toward it, the achievement of that goal becomes your dominant thought.

First, look forward 20 years, and imagine your future if you don’t improve your money management skills. Every week will be a growing struggle to pay bills, each interest rate rise a nightmare and you will face years of waiting if you need major surgery. Now imagine the opposite – a house paid off giving you free rent for life, a growing investment portfolio, freedom to travel, and the ability to have the best medical health if it becomes necessary

Gaining financial independence is a matter of putting aside part of your current income and investing it to be used in the future. Obviously to do this you must be spending less than you earn, so the first step is to do a simple budget to find out exactly where you stand. It’s only a matter of listing your income on one side of a piece of paper and your expenditure on the other.

You will probably know what the outcome will be before you do the figures. If you are spending less than you earn you will have no pressure on your finances and should be investing regularly, if you are line ball you are probably just getting by, if you are over spending you will probably be living on credit cards as you won’t be able to pay the balance each month.

The best way to effect change is by small consistent steps. If two people are walking side by side, and one starts to take a different path, they will still be close after an hour or so. However, after five years, they may be a world apart.

My hope for you for the coming year is that you will start on the road less travelled and make the changes that will make a dramatic difference to your financial future.

16 December 2013

It’s been an amazing year – if you cast your mind back to January, America was facing the fiscal cliff and much of their government was at a standstill as the politicians argued over the debt ceiling. You would have been a brave person to forecast then that both our stock market and our property markets would produce above average returns in 2013, and that the year would end with the Dow Jones at a record high.

As my good friend Ashley Owen of Philo Capital Markets points out “Stock market volatility has been incredibly low again this year, on any measure – in Australia and around the world. The annualised standard deviation of daily returns on the global stock market index has averaged an amazingly low 9%, and has been below 10% for 74% of the year. This is almost “dead calm”.

The remarkable thing is how the scare-mongering financial media continue to come with almost daily headlines bemoaning these “volatile times” in this “low return” world – when stock markets continue to post strong, consistently above-average gains with ultra-low volatility.”

The main success story would have to be how Angela Merkel has managed to keep control of Germany and Europe, and how she has continued the careful shift away from hard-line deflationary austerity toward fiscal and banking integration, and allowing more time and money for growth and inflation. What is remarkable is how she has done this in the face of rapid fragmentation into extreme left and right wing political movements across Europe, and through several major setbacks - in particular in Italy, Spain, Greece and Cyprus.

For me, 2013 was the year when I quit most of my residential property and put the proceeds into quality managed funds. That decision is already paying off.

Monday, 9 December 2013

By now you should have received your annual superannuation statement.  You’ve probably taken one look at all the numbers and decided to put it aside until you’ve got more time to think about it.

Think again - ignoring that statement could cost you dearly in the long term, especially if you are young. 

I was horrified when looking at a friend’s daughter’s latest superannuation statement, to find the category that her employer had placed her in had averaged just 2.8 per cent per annum for the last ten years.  That’s a woeful return when you consider that the All Ordinaries Accumulation Index has done better than 8 per cent per annum for that period.

This is for a person who is aged just 28, and who probably has another 70 years of living and investing ahead of her. 

This is why you should look carefully at the returns your superannuation has achieved in the past, and decide whether the asset allocation you have chosen is appropriate for your circumstances.

If your assets are building up, or you are over 40, you should be taking advice on the kind of assets you should hold in super, but for young people it’s a no brainer – just choose the highest growth option that is available.

The next step is to consider what fees are being taken from our account.  You can’t dodge the 15 per cent government tax on employer contributions, but one fund may have a much higher account keeping fee from another.

It is usually tax effective to have your life and TPD insurance within your fund as it enables the premiums to be paid from pre tax dollars.  But, every dollar taken in insurance premiums from your superannuation account means less money in there to grow.

However, the big decisions are whether you need life insurance at all, and if you do, whether what you have in the fund is sufficient.  If you don’t need it, cancel it.  If you need more, increase it.

1 December 2013

Recently I received a notice from the Tax Office telling me that I had made an excess non-concessional superannuation contribution of $150,000 for the year ended 30 June 2012. Such excess contributions are subject to a penalty tax of 46.5 per cent.

The shock of receiving a penalty for $69,750 was coupled with a feeling that it was manifestly unfair.

Think about it – a non concessional contribution is made from after tax dollars. Therefore the only benefit that could be gained by contributing the money to super was moving it from my current tax bracket of 32.5% to the superannuation tax environment of 15%. If we assume that the $150,000 could earn interest at 4%, $6000 a year, the most that could be saved in tax would be a paltry $105 a year.

Yet the legislation allows the Tax Office to levy a penalty of more than 600 times the tax that would be saved. It’s a joke!

Upon investigation, it turned out that I had made a contribution of $150,000 to one fund, and then rolled that balance to another fund. Due to a clerical oversight both funds separately reported to the Tax Office that I had made a contribution of $150,000. This caused the Tax Office computers to believe that two separate contributions had been made when in fact there had just been one.

The incident is a timely reminder that there are limits to the amount that can be contributed to superannuation, and there are heavy penalties for exceeding them.

In the last two years we have experienced a massive increase in the number of people starting their own self managed super funds. Judging by the emails I receive daily from people trying to run their own fund it is obvious that many personal trustees are having great difficulty getting the paperwork right.

The cost of not getting it right is that your fund may become noncomplying and find itself subject to a penalty. That penalty is 46.5% of the taxable assets of the fund at the previous 30 June. For a fund with a balance of $1 million, of which half is taxable, the penalty would be $232,500.

Monday, 25 November 2013

A common question is “how much do I need to retire?”  Unfortunately, it’s impossible to give a simple answer because the amount of money needed depends on a wide range of variables, but a good rule of thumb is that you need capital of 15 times your planned expenditure.  For example, if you require $40,000 a year when you retire, you should be trying to accumulate $600,000 

 

One of the best ways to boost your money is to work a little longer - because of the way compounding works the benefits can be dramatic.

 

Consider a person who is aged 58 and who has $300,000 in superannuation.  If they retired immediately they would be lucky if their superannuation lasted to age 66 if they withdrew $40,000 a year from it and it earned 7%.  However, working just two more years full time to age 60 would mean two more years of growth and contributions – by age 60 the balance could be $400,000. Their money may then last till age 72.

 

Let’s recalculate the numbers on the assumption they will work to age 65. If they started with $400,000 at age 60, and salary sacrificed the maximum allowable of $35,000 a year  they should have $750,000 at age 65.

 

This would probably last them for life.

 

 

There is a growing consensus that working longer is not just good for your pocket, it’s also good for your health

Research suggests retirement increases the likelihood of suffering from clinical depression by 40 per cent and the chance of having at least one diagnosed physical condition by about 60 per cent. The probability of taking medication for such a condition rises by about 60 per cent as well, according to the findings. People who are retired are 40 per cent less likely than others to describe themselves as being in very good or excellent health.

 

There is a wealth of other research that shows that happy retirees have emotional and financial security as well as a broad range of interests.  A person who is confident enough in their future to leave a career with a major corporation at age 50 is more likely to have this than one who hangs on to age 65 because there is nothing else in their life.  In life, and in your investment portfolio, diversification is the key.

Monday, 18 November 2013

This week this week I will continue discussing investment bonds. They are becoming more and more popular now that the marginal tax rate above $37,000 a year has been increased to 32.5%, and because the amount that can be placed in superannuation is now restricted.

As I pointed out last week they are a tax paid investment, with the bond fund paying tax of up to 30% on your behalf. 

They also offer significant capital gains tax advantages.  They can be transferred from one investor to another at any time without capital gains tax, and most investment bond issuers allow a range of options within the bond, and you can switch between them without capital gains tax whenever you feel it is appropriate.;. 

CASE STUDY: Peter and Joan are a high income couple - they invest $200,000 in an investment bond in Peter's name.  Because they believe the share market is at a low point they ask for the entire investment to be placed in the Australian shares option.  Three years later the market has surged and they decide to take some profits.  All they have to do is make a free switch from the share based option to the more conservative cash option.  This will be free of capital gains tax irrespective of how long the bond has been held.  Four years later they have a major change in their circumstances and decide to redeem the bond to renovate their home as Joan had stopped work to have a baby.  Before the bond is cashed in, Peter transfers it to Joan free of CGT – the result is the entire proceeds are tax free as Joan earns no income in that year. 

I am often asked what kind of returns one can expect from an investment bond. It’s no different to asking what returns you can expect from your superannuation. An investment bond is not an asset class of its own like property or shares but merely a structure that lets you hold assets in a tax concessional environment. The performance of your bond will depend entirely on the performance of the assets it holds.

 

Monday, 11 November 2013

Investment bonds are the topic again this week.  And I must confess, when I write about them, I feel like one of those people demonstrating a whiz bang gadget at the shopping mall.  These bonds have such a unique range of features that it is hard to know where to start. 

Just to refresh your memory, they are a tax paid investment, with the bond fund paying tax of up to 30% on your behalf.  All money invested in them comes from after tax dollars, but there is no limit on the amount you can invest and your money is accessible at any time.  Because the earnings accrue within the fund there is no assessable income to declare on your tax return each year, and if you hold them for ten years or more all proceeds can be redeemed tax free.  This makes them ideal for people who want to reduce income for purposes such as maximising the family tax payment, or becoming eligible for the super co-contribution or the Commonwealth Seniors Card.

Investment bonds are especially good for estate planning as they sit outside the will and cannot be challenged. Think about Harry aged 80, a wealthy retiree now happily re-married after a nasty divorce, who wants to leave a range of bequests to children of both marriages. He is aware that there is acrimony between some family members and it is extremely important to him that his assets on death be split in the way he wishes, and not eroded by family legal battles. 

He invests $250,000 in his own name in each of five separate investment bonds, naming one of the five children as the beneficiary of the bond upon his death.  Because an investment bond is technically a life policy the distribution of the proceeds cannot be challenged and he can sleep soundly in the knowledge he has solved the potential litigation problem in advance.   Furthermore, if he dies before ten years have elapsed the proceeds can be redeemed tax free by the beneficiaries.

4 November 2013

Due to interest rates moving down the Centrelink deeming rates have changed again.  The good news is those who are income tested for pension purposes will receive a slight increase to entitlements.  

The rates for a couple will be 2% on the first $77,400 and 3.5% on the balance. For a single pensioner the first $46,600 will assessed at 2%, and the balance at 3.5%. The assets that are subject to deeming include bank accounts, shares, managed funds, insurance bonds, debentures, superannuation when the owner has reached pensionable age, and deprived assets such as excess gifts.

For example, if a single pensioner had financial assets totalling $146,600 the income from these would be deemed by Centrelink to be $4432  year made up of 2% on the first $46,600 ($932) and 3.5% on $100,000 ($3,500).

These rates apply irrespective of the amount actually earned on investments, so pensioners can gain an advantage if they can get safe returns that are higher than the deeming rates. Unfortunately, many pensioners don’t understand this and leave their savings in the “deeming accounts” offered by the major banks.  The problem with these is that all they pay is the rate stated above. This means pensioners are being penalised because banks  and credit unions have accounts with no fees that offer around 4% on the entire balance. 

Cast your minds back to the example above. If the whole $146,600 was placed in an account paying 4% the pensioner would receive $5864 – even though they are only deemed to be earning $4432. That’s a difference of $1400 a year just because they were financially aware. 

For pensioners who are prepared to accept stock-market volatility there are also managed funds available that target high yield stocks. They have the potential to deliver high returns, but also have a higher degree of risk. A good financial adviser should be able to recommend appropriate ones for your situation.

Monday, October 21, 2013

On the face of it, it’s never been a better time to go for a housing loan.  Interest rates are at a record low, and lenders are falling over themselves in an effort to convince us to borrow money from them. It’s a far cry from the 1980’s when money was tightly regulated, and even those with huge deposits and a strong family connection had to fight for a loan.

Now there’s so much money about that lenders will even come to your home to process your application.  The problem is that many of these people are more orientated toward sales, rather than lending. They will probably arrive with a laptop computer full of programs and with a few deft keystrokes tell you how much you can borrow. You may get a shock to find out how large a sum it is.

While I don’t doubt the accuracy of these programs, the danger is that they can lead you into dangerous waters. They don’t take into account individual spending habits. For example, one family may smoke and drink, another may not. One family may have children at university or boarding school, in the other the elder children may work. Unfortunately far too many borrowers think “If the bank says I can borrow that much it must be OK”.

The solution is to take your future into your own hands and do a budget before you think about borrowing. After you have done your budget, and taken into account such items as car replacement, holidays, and home maintenance, you will know how much a week you can spend on a new loan. If you are buying an investment property, don’t overlook the net income from that property.

Then it is only a matter of asking the lender how much you can borrow based on your nominated weekly repayments Once you know this figure you can plan your borrowings with confidence knowing the payments fit your lifestyle, and not just the bank’s computer.

Monday, October 14, 2013

Everyone enjoys spending money, and if you’ve managed your money well there should be plenty to spend in your later years.  So why do some financial institutions make it difficult for those no longer earning taxable income to increase the limits on their credit cards?

I recently received an email from a couple who are enjoying the fruits of a lifetime’s work by spending money enjoying their retirement.  They were recently refused an increase on the credit limit from a card provider of 25 years.  They have around $1m in financial assets which provide adequate income, but apparently not in the eyes of the card provider.

The advice I received from one of the big four banks was that the automated system for assessing your limit, based on taxable income and level of debt, is bound by government legislation on consumer credit and responsible lending.  All well and good.

But a one size fits all model is not ideal when determining a person’s ability to manage their credit card or other debt.  There is no question that legislation is necessary to reduce irresponsible lending, but if you have established a relationship with your bank, you would hope they could treat you as an individual and assess the risk based on your overall financial position.

As the population ages, consumers will have to demand that institutions such as banks keep pace with changing lifestyles.  As with any financial arrangement, if you’re not satisfied with the service being offered by your bank or credit card provider, I suggest you shop around to find a company who can fit in with your needs.  If the question is asked “why are you closing your account?”, make sure you answer honestly. 

If you’re a disciplined money manager, you could consider increasing credit card limits in your peak earning years.  Then, when you do retire, you’ll have the freedom to spend your hard earned cash and plenty of time to spend it.

Monday, 7 October 2013

Today I’m going to tell you about the challenges faced by a client of mine who was relocating to a provincial coastal town because she was retiring.  Until recently she lived in a medium sized country town where house prices were showing no growth.  The area she was moving was a hot spot for retirees with prices booming. 

Her first reaction was to rent out her property until she achieved the price she was seeking.  I pointed out to her that the house would drop in value by at least 20% the moment it was tenanted and she could find herself in a position where she was stuck with a deteriorating house property while being unable to buy in an area where prices were rocketing.  Acting on this advice she dropped her asking price by 30%, which quickly attracted buyers. 

One buyer wanted to rent the house until the sale of their own house occurred.  My friend was tempted by this, but I told her this would give her no security at all.  A better strategy would be to sell the house immediately with interest free vendor finance for six months.  This would ensure the buyer was locked into the deal.

When all the deals are finalised my client will have $50 000 less for retirement than she expected as the short fall between the actual and the expected sale price would have to come out of her superannuation.  However, her aged pension will increase as a result and she will have the security of mind of knowing that she can start a new life without the encumbrance of trying to sell a house in a difficult area. Sometimes it’s better to take short term pain for long term gain

30 September 2013

The generous aged pension income and asset tests mean that most Australians are eligible for a part pension. Even if the age pension is tiny, a major benefit is that a person receiving even a small aged pension is eligible for the precious health card.

However, for those who can’t qualify, there is a Low Income Health Care Card which entitles the holder to cheaper medicines under the Pharmaceutical Benefits Scheme they may also be entitled to concessions on things like energy bills, public transport, and utility costs but these depend on where you live.

There is no asset test for the card, but there is an income test. The qualifying amounts of $497 a week for a single with no children and $862 a week for a couple with no children.

The test is assessed over an eight week period - the figures are $3976 for a single and $6896 per couple. To be eligible for the card your income for the eight weeks prior to your lodging your claim must be less than these figures.

Once you receive the Low Income Health Care Card your income must not exceed the limits. If you do exceed the limits, you are unable to use the card.

This card is particularly useful for self-funded retirees and also those who now are currently hold a Commonwealth seniors health card.

For more info and 'how to claim'  click on:

http://www.humanservices.gov.au/customer/services/centrelink/low-income-health-care-card

16 September 2013

In Victoria recently a facility housing aged people went into administration causing financial loss to the residents.

Unfortunately, this has led to a lot of unnecessary worry from people in the normal kind of aged care facility.

There are many alternatives to residential aged care, and it is not uncommon for people seeking care, companionship and domestic support to enter into living arrangements that are not regarded as formal aged care.

For example, the inability to maintain the family home and the social isolation that can come from the death of a spouse or reduced mobility often leads to a decision to move to an over 55's community or retirement village. In Victoria and South Australia there are also State Governed facilities, known as Supported Residential Services (SRS’s)that people can access on either a temporary or permanent basis.

It was one of these SRS's that went into Administration in Victoria  with debts of $4 million. A number of families are reported to have paid large deposits to the operator, up to $400,000 in one case, of which they are unlikely to get any of it back.

 

Money paid to a retirement village, over 55's community or Supported Residential Service may look a lot like an Accommodation Bond paid to an aged care facility, but only Accommodation Bonds paid to Residential Aged Care Facilities (governed by the Aged Care Act) are guaranteed by the government.

 

Aged care is an increasingly complex area, this is why it is critical that you take advice before making any decisions about the type of accommodation that is most appropriate for you.

9 September 2013

The people have spoken, and we have a new government. This means it’s time to review your investment strategies in the light of possible changes to come.

If you have a home loan I wouldn’t be hurrying to fix your rate. There have certainly been a lot of people holding off buying property until they saw the result of the election, but to the best of my knowledge the economy is still in a fairly poor state. Getting it back to health is not going to happen overnight – it’s a reasonable bet that interest rates are more likely to fall than rise.

Interest rates at their present low levels make it even harder for retirees to achieve the level of income they are probably seeking. This is why I have long recommended that investors become comfortable with shares at an early an age as possible.

The Australian stock market has averaged better than 9% per annum (growth and income combined) for the last 20 years and it’s reasonable to expect it will continue to do so. This is the perfect time to be seeking advice on moving part of your portfolio to good share based investments.

The beauty of shares is that you can start with a couple of thousand dollars and add to it when you feel it is appropriate. Also, you don’t have to pick winners – you can simply buy a low cost index fund ,which by definition cannot go broke, and enjoy a fully franked yield of around 5% per annum. 

Yes, there are exciting times ahead – make sure your investment strategies are designed to make the most of the opportunities that are certain to come along.

 

2 September 2013

Did you know that a cap of $2000 on work related self education deductions is supposed to take effect from 1 July 2014?  

The proposals are far reaching and include course tuition fees, workshops and seminars, computer related costs, as well as travel and accommodation.

To compete on the world stage we need to maintain first class skills and to do this we need continual education. It doesn’t matter whether you are a doctor, engineer, accountant or geologist, you cannot afford to stand still. The rate of change in every field is growing rapidly and those who don’t keep up will be left behind.

Given this undeniable truth it’s hard to imagine that any government would try to introduce a scheme that puts a limit on the money a person can spend to keep their skills up to date. 

To make matters worse there are gaping inconsistencies in what is proposed.

For example, a sole trader who carries on a business which employs staff will be placed in a situation where he or she will be personally subject to the $2000 limit, yet no restriction will be placed on educational costs in relation to that person’s employees. It’s another slug on small business. The psychologist or the hairdresser who work on their own will face a limit of $2000 but big corporations like the banks and mining companies can pay any sum for staff education as long as it is not part of a salary packaging arrangement.

If rorting of travel expenses was the main focus, it could have been simply rectified by putting a cap on the deductible travel component of education costs. 

This week we will be subject to a media blitz by aspiring politicians  I can’t think of a better opportunity to eyeball them and ask them what they intend to do to improve conditions for all of us who live in Australia.  Obvious goals are a more productive economy, less red tape, and better educational opportunities for everybody.  It’s a sad reality that these are being ignored right now.

 

25 August 2013 

As the population ages an increasing topic for discussion is how much you need to retire. However, as this email from a reader shows it can be a difficult calculation.

“In determining how much is required to retire, you often suggest that 12 - 15 times the annual income needed would be appropriate. This would mean that to achieve an income of say $60,000 pa. you might need 15 times this in superannuation i.e. $900,000. However many advisors now suggest that you would need between 21 and 25 times the income you hope to have which would mean a superannuation balance of maybe up to $1.5M when inflation of 3% and a return of say 5% is assumed. Can you please elaborate.”

The email highlights the problems with projected figures. They are certainly useful when planning your retirement strategies but it must be understood that the purpose of projected figures is really to set goals. 

How much you need to retire will depend on a range of variables that includes how long you live, the state of your health, how long your parents live, what care they will need, how much you expect to receive in bequests, and your risk profile.  For example, an extremely conservative investor would need a larger portfolio more than a more adventurous one because in theory, at least, the latter should get higher returns. 

This is why it is critical that anybody retired, or contemplating retirement, have a meeting with their adviser at least annually to make sure they are on track, and to adjust their strategies when necessary.

 

18 August 2013

A recent email from a reader highlights the challenges facing anybody who tries to invest for their retirement. He told me that he and his wife had their super in a balanced fund but then got very nervous when the balance fell because of the Greek crisis.

To protect themselves against further losses he switched the entire balance to cash, on the basis that he would return to more growth orientated assets when the market returned to “normal”.

Of course, we all know what happened – the markets have shown great returns in the last couple of years, while the money he kept in cash is now “stagnating”.

I’ve been in the investment business for more than 50 years and still don’t know what “normal” means. However, I do know that nobody can consistently and accurately forecast the direction of markets. There are always profits of gloom amongst us, but they are wrong more times than they are right.

The way out is to sit down with your adviser and decide on an asset allocation that fits your goals and your risk profile, and then resolve to stick with that regardless of what markets do on a day-to-day basis.  

A person aged 50 now may well have 45 years of living and investing ahead of them – only share based investments have the potential to give them the returns they are going to need. This is why I have always recommended that people get comfortable with shares at an early an age as possible.

It’s also important to meet with your adviser at least once a year, and adjust your strategies to take advantage of the latest investment products available.

 

11 August 2013

The main finding of the Cooper enquiry into superannuation was that 80% of Australians are “disengaged” with their super.  Please read on because I’m about to discuss issues which could cost you hundreds of thousands of dollars if you get them wrong.

Because of the way compound interest works, it takes a big difference in the interest rate to make much of a difference to the outcome if the term is short.

If a person was considering taking out a personal loan of $25,000 to buy a car, and they could pay it back over two years, the repayments would be $1119 a month if the interest rate was 7%, and $1154 a month if the rate was 10%.  Obviously the rate is of little importance – the borrower would be better off to concentrate on any additional fees that may be charged.

It works the same way if you’re investing – if the term is short, the rate matters little; but if the term is long, a change in rate can make a huge difference.

If your superannuation balance was $150,000 now, and your salary of $60,000 a year increased at 3% per annum, the balance at age 65 would be $855,000 if you could achieve a net return of 10% per annum.  However if the best you could do was 8%, the final figure would drop to $670,000 - if all you could achieve was 6% her final balance would be only $526,000. 

The lesson here is that the major factor which will determine the amount you end up with in superannuation is the rate of return, after fees and taxes, that you can achieve on the funds you have invested.

 

4 August  2013

Last week I pointed out the extra opportunities offered by salary sacrifice now that the concessional cap has been increased to $35,000 for people aged 60 and over.

Let’s think about a person aged 60 who still owes $100, 000 money on his home - he would like it to be paid off in five years when he retires at age 65.

Option One is to repay $1933 a month ($23,196 a year) which will have the loan paid off in five years if the rate remains a 6%. The cost to his salary package will be $3143 a month ($37,716 a year) in pre-tax dollars. After five years his home loan would be paid off at a total cost of $188,580 in pre-tax dollars.

Option Two is to leave the loan on an interest only basis and salary sacrificed an additional $25,288 a year to super. After deduction of the entry tax of 15%, he would have an additional $21,495 a year going into super.  If his fund earned 9% per annum, these contributions would put an extra $135,000 in his fund.

The interest only cost would be $6000 a year in after tax dollars or $9756 in pre-tax dollars. 

At the end of the five years, his total contribution in pre-tax dollars would be $175,220 which is a saving of $13,360 over Option One.  Furthermore, after withdrawing $100,000 tax free from his super to pay off his loan, he’d have a bonus of $35,000 left over.  Obviously the second option is much better than the first.

 

22 July 2013

Despite a string of warnings from ASIC, Australians are still forming self-managed super funds (SMSFS) at an alarming rate. Unfortunately, the majority of people who venture into this area have no idea what they are doing – as a result the outcome for many may prove very costly.

For today, let’s just focus on one issue – the trustee. The choice is for the members of the fund to be trustees, or for the fund to appoint a family owned company as trustee.

Even though anybody who is well advised will have a company as trustee, over 80% of SMSFs have individual trustees – the members. Unless the fund is a one member fund, every trustee must be a member of the fund and every member of the fund must be a trustee.

So far so good, but think about what would happen if a member becomes incapacitated. An incapacitated person cannot act as trustee, which means they would be forced to exit the fund if they did become incapacitated and had not given an Enduring Power of Attorney to somebody else who did have the capacity to act for them.

If the fund happened to be a single member fund with a corporate trustee, and the sole member and sole director of the company becomes incapacitated, the fund would have to be wound up  unless an Enduring Power of Attorney had been given to someone else to act on the sole member’s behalf.

Many of the funds that have been formed recently have only chosen the do-it-yourself route because they wanted to borrow for residential real estate. Imagine what would happen if a fund member became incapacitated, and no power of attorney was in place, and the fund had to quickly find the money to pay out the member who had to leave the fund.

 

Monday, 15 July  2013. 

The age pension thresholds and the deeming rates changed on 1 July.

The asset cut-off points for a homeowner couple are now $1,092,000 - for a single pensioner $735,750. The income test cut-off points are $70,553.60 per annum for a couple and $46092.80 for a single.

Financial assets are now deemed to be earning 2.5% for the first $77,400 ($46,600 for singles), and 4% on the balance. For example, if a couple had $300,000 of financial assets their deemed income would be $10,839 a year being 2.5% on $77,400 ($1935) and 4% on $222,600 ($8,904).   These include interest bearing deposits, debentures, shares, share trusts, and friendly society and insurance bonds. However, it does not include property, and money in account-based pensions.

 

The changed rates should mean a pension increase for most part pensioners, and it may mean that people who were previously ineligible may now qualify for a part pension. There is an important message here for holders of the Commonwealth Seniors Health Card – they are the ones most likely to find themselves now qualifying.

Even though the part pension may be small it does entitle you to most of the prized concessions.

 Your superannuation is not counted until you reach pensionable age.  We often encounter situations where the husband may be 65 or more and where the wife less than 60.  Wherever possible we encourage as much superannuation as possible to be held in the wife’s name, as it is not counted by Centrelink, and this enables the husband to maximise his pension.  

 

8 July 2013

Rising life expectancies mean a person now aged 65 may still have 25 years or more of living to do. Consequently, one of the greatest dangers now faced by retirees is living longer than their money.

This is why it is important to treat your financial assets like a garden, and tend them well, with the aim of getting the best returns out of them.

Despite this undeniable fact, more than 50% of Australians with term deposits are so uninterested in their financial affairs that they simply let the bank renew the term deposit on maturity at whatever rate the bank wants to offer. Unfortunately, this is almost invariably less than the rate you could get if you checked out the market and negotiated a better deal. 

The key element in any successful negotiation is knowledge, so start by researching what rates are available by looking at newspaper advertisements, and by strolling down the street looking at the best offers displayed on billboards outside the financial institutions.

Then go to www.ratecity.com.au where the going rates are displayed - there is always, a wide disparity.  At date of writing, you could get 4.15% on a $100,000 12 month term deposit with the best paying institution and just 2.18% with the lowest paying one.

You also need to consider what other investments are available.  There are currently property syndicates offering around 10% per annum, and blue chip shares yielding 5% franked.  Carefully chosen, they could be a good addition to any portfolio.

 

1 July 201

Welcome to a new financial year. There have been quite a few changes in the financial services space, but a significant one is the increase in compulsory superannuation from 9% to 9.25 percent.

While it’s only a small amount anybody who is on a salary sacrifice arrangement should examine their package and make sure the extra .25% is being paid by the employer and not coming out on the package.

For example, you might be on a salary of $80,000 a year and your employer is required to pay 9.25% ($7400) into super. If you could afford it, and you are happy to lose access to the money until your preservation age, you might ask your employer to reduce your salary to $70,000 and make extra contributions of $10,000 a year to superannuation. This is called salary sacrifice.

Unfortunately, there are unscrupulous employers who will do this and then tell you that they are no longer have to put the 9.25% into super as there is already $10,000 going in.

The way around this is to make sure that any arrangements to salary sacrifice are clearly arranged in writing with your employer before the extra contributions start

This is also the perfect time to look at the type of assets you hold inside super and ensure they meet the goals and their risk profile. If you are relatively young, you are unable to access your superannuation until aged 60 at the earliest, and even then rising life expectancies mean you will probably live to 95. If you are in the situation you should be taking advice about having the bulk of your super in growth assets.

 

Monday, 24 June 2013

June 30 is rapidly approaching, which means it is time to look at your affairs to optimise your personal finances.  The best tax saver is superannuation and in the next few weeks we will discuss the various strategies available. 

A simple and useful one is to make a spouse contribution of $3,000 so you can become eligible for the tax offset – it is the best way I know to get a capital guaranteed 18% on your money.   

The amount of the offset is 18% of the lesser of $3,000 or the amount of the spouse contribution actually made, so a contribution of $3,000 would give you an immediate tax offset of $540 which would reduce your own tax. 

Once a spouse’s income exceeds $10,800 the offset tapers - no offset is payable once spouse income exceeds $13,800. 

If the spouse is under 65 their employment status is not relevant but if they are aged between 65 and 70 the spouse must be eligible to pass the work test which involves working 40 hours in 30 consecutive days.  Both the contributor and the spouse must be Australian residents for tax purposes at the time the contribution is made. 

The age of the contributing spouse is not relevant nor do they need to be employed.  However, they cannot claim the contribution as a tax deduction. 

As always, take advice and keep in mind that the contribution must be received by the fund before June 30th to be eligible. 

Monday, 17 June 2013

A huge amount of assets are going to be transferred to the baby boomers over the next 20 years as their parents die. This is why it is important to understand the capital gains tax treatment of assets on death.

Death itself does not trigger capital gains tax – it merely transfers the liability to the beneficiaries who will not be liable for capital gains tax until they, themselves, dispose of the bequeathed assets.

Recently I had a question from the executor of a deceased estate. He asked what were the advantages and disadvantages of distributing the shares in specie or of selling the shares and distributing the cash proceeds.

There is no simple answer because the best strategy depends on the financial position of each of the beneficiaries. For the first three financial years after death the estate is taxed like an individual with the usual personal tax thresholds. If the shares are sold in that time the estate will pay capital gains tax, but if the shares are transferred in specie to the beneficiaries the capital gains tax liability will be deferred until the beneficiaries dispose of them.

This is why the beneficiaries and their accountants should confer to decide who wishes to retain the shares and who wishes to dispose of them.

It will then be a matter of which strategy saves the most tax – cash them in now and have the estate pay the tax, or transfer them and let the individual beneficiaries pay the tax. A major benefit of shares is that they can be sold in part so the transactions can be tailored to each beneficiary’s individual situation. Property does not have this unique benefit.

 

Monday, 10 June 2013

Anybody considering investing should be aware of the way the franked dividend system affects the after tax return.

Suppose you received a dividend of $700 – if it was fully franked it may carry franking credits worth $300.

Thanks to imputation you are entitled to use those credits to pay your own tax with. In other words they are as good as cash, as you can even claim a refund of the credits if all your tax is paid.  As the credits represent value, you have to pay tax on them. Consequently, even though you received only $700,    you have to declare $1000 ($700 + $300) as taxable income. That’s the bad part – now comes the good bit.

If the shares were held by your superannuation fund, and that fund was in accumulation mode, it would be paying a flat rate of tax of 15%. The tax on $1000 is $150, but you have the whole credit of $300 available. In other words, $150 goes to pay your tax on that dividend, and the $150 left over can be used to pay tax on other income or even to reduce the entry tax on deductible contributions.

If you earn between $37,000 and $80,000 the tax payable on that $700 dividend would be $325 less $300 in credits – your franked dividends are almost tax free. If you earn over $180,000, the top bracket,  the effective tax on franked dividends is still just 23.6%.

Let’s sum it up. For lower income earners franked dividends are tax free and give an extra bonus because they reduce tax from other sources. For most income earners the tax is tiny.  Whichever way you look at it, it sure beats paying your full marginal rate of tax on bank interest.

Monday, 10 June 2013

Anybody considering investing should be aware of the way the franked dividend system affects the after tax return.

Suppose you received a dividend of $700 – if it was fully franked it may carry franking credits worth $300.

Thanks to imputation you are entitled to use those credits to pay your own tax with. In other words they are as good as cash, as you can even claim a refund of the credits if all your tax is paid.  As the credits represent value, you have to pay tax on them. Consequently, even though you received only $700,    you have to declare $1000 ($700 + $300) as taxable income. That’s the bad part – now comes the good bit.

If the shares were held by your superannuation fund, and that fund was in accumulation mode, it would be paying a flat rate of tax of 15%. The tax on $1000 is $150, but you have the whole credit of $300 available. In other words, $150 goes to pay your tax on that dividend, and the $150 left over can be used to pay tax on other income or even to reduce the entry tax on deductible contributions. 

If you earn between $37,000 and $80,000 the tax payable on that $700 dividend would be $325 less $300 in credits – your franked dividends are almost tax free. If you earn over $180,000, the top bracket,  the effective tax on franked dividends is still just 23.6%.

Let’s sum it up. For lower income earners franked dividends are tax free and give an extra bonus because they reduce tax from other sources. For most income earners the tax is tiny.  Whichever way you look at it, it sure beats paying your full marginal rate of tax on bank interest.

Monday, 3 June 2013

Do you want to make a guaranteed 50% on your money between now and June 30th?  Then take advice about making a non-concessional contribution of $1,000 to superannuation.  Provided you meet the eligibility guidelines, the Government will give you a tax-free bonus of $500, which will see your $1,000 miraculously turned into $1500.

The maximum government co-contribution is $.50 for every $1 of eligible personal super contributions made in a financial year and is subject to an income test.  The maximum co-contribution of $500 is reduced by 3.333 cents for every dollar that the taxpayer’s total income exceeds $31,920.

As income rises the co-contribution reduces by $33.33 for each $1,000 of additional income, until it cuts out at $46,920 a year.

For co-contribution purposes you must be less than 71 at the end of the financial year.

 

Your income is your assessable income plus reportable fringe benefits. To be eligible for the co-contribution, you must have received at least 10 percent of your income from what is called “eligible employment” – usually income from salary or wages or by being self employed. . Eligible employment generally means anything resulting in your being treated as an employee.. 

Just be aware that the employer compulsory superannuation does not count for the co-contribution.  To be eligible you must make an additional contribution from after tax dollars.  This is not subject to the 15% entry tax. 

27 May 2013

There may be no tax cuts coming on 1 July, but it’s still smart in most cases to bring tax-deductible expenses into this financial year if possible.  It may be getting a bit late to paint your investment properties or do major repairs on them, but a deduction that is available to all investment borrowers is pre-paying interest. 

Let’s assume you have an investment loan of $200,000 at 6% and that it is on an interest only basis as I have always recommended.  If you earn $100,000 a year now and prepay a years interest, that’s $12,000, your tax saving will be $3850. 

A benefit of doing this right now is that you will have protected yourself from any interest rate rises in the next 12 months if they should occur.

Make sure you liaise with your lender because you can’t simply plonk $12,000 into the loan account and then claim a tax deduction for it.  Doing it this way will result in the lender simply taking the repayment off the principal and you suffer a double whammy.  You will not be eligible for a tax deduction of $12,000 and you will have reduced your tax-deductible debt by $12,000 and, with it, your future tax deductions.

Be careful if you have a line of credit loan as they work like conventional bank overdrafts.  They do offer greater flexibility than ordinary fixed rate interest only loans but, unfortunately, this flexibility does not extend to prepaying interest.

 

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Noel Whittaker is a director of Whittaker Macnaught, a division of St Andrew's Australia. This advice is general in nature and readers should seek their own expert advice before making financial decisions."His email is noelwhit@gmail.com

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