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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.

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30^th June 2008

Welcome to another financial year - of course it will bring its challenges as well as its opportunities, but there is one thing we do know for certain - the new year has ushered in another round of tax cuts.

The 15 percent band will now stretch from $6000 to $34000, the 30 percent band will now range between $34001 and $80,000 and the top rate of 45 percent will now cut in when income reaches $180,000, not $150,000 as it is now.  The power of the tax cuts over the last eight years will become apparent when you consider that in the financial year ending June 2000 just prior to the introduction of GST, a rate of 20 percent was levied on taxable incomes between $5401 and $20700 and at 47 percent on incomes of $50,001 and over. 

The July 1, 2008 tax cuts mean an extra $600 a year for a person on $70,000 a year, $1100 a year for those on annual incomes between $80,000 and $150,000 and $2600 a year for high income earners.

The tax cuts give you the opportunity to understand some very powerful principles. These include “you don’t miss what you don’t get”, “pay yourself first” and “little things add up”.

If you have a home loan the simplest and most effective strategy is to contact the bank tomorrow and increase your home loan repayments by the amount of your tax saving. Even small amounts can make a huge difference over time. For example, if you had a home loan of $200,000 over 30 years at nine percent the present payments would be $1609 a month and you pay over $380,000 interest in that 30 year period. Just raising the payments by $92 a month would chop the term by six years and save a massive $94,000 in interest. If rates dropped to eight percent, as forecast, the higher repayments would shorten the loan to just 20 years.

If you don’t have a home loan simply arrange for a direct debit to a high interest on-line savings account or talk to an adviser about starting an investment loan. A tax cut of $1100 a year in after tax dollars is equivalent to a tax deductible interest payment of $1709 a year for a person in the 40% tax bracket. This would go close to funding the interest on a margin loan of $20,000. Imagine the feeling of converting your “tiny tax cut” to a portfolio of shares worth $20,000.

These are just two ideas to get your mind working, but above all you must act right now and have faith in the power of money growing. If you put it off for a few weeks I guarantee you will never get around to it. Remember your hard earned tax cuts are going to end up in somebody's pocket – make sure it is yours.

Question:   Would you recommend buying an investment property given that interest rates have increased and are forecast to increase further?

Answer:    It is never a bad time to make a good investment, and rising interest rates should mean a slackening in the property market.  I am sure there are bargains to be found but unfortunately there will be many people looking for them.  You will need to keep researching the market and inspecting properties until you find one that is a genuine bargain – this is usually a neglected property in a top location owned by a vendor who is desperate to sell.

Question:   How does increasing/decreasing the interest rate by the Reserve Bank affect the economy?  If the trading banks increase their rates, thus generating more income and reducing the spending money of their borrowers, they must offer higher rates to their investors and thus put the generated increase back into the economy. If they retain the increased revenue then they must distribute it to their shareholders, again putting it back into the economy. 

Answer:   The purpose of raising interest rates is to slow down the economy because rate rises take money out of people’s pockets, which mean they have less to spend.  Furthermore, it tends to make people wary of taking on new projects or spending money on non-essential items.  Also, higher rates mean that companies may earn less because of reduced sales and higher borrowing costs – this tends to put a dampener on share prices.  Unfortunately it’s a very blunt instrument, because we are still suffering critical labour shortages, and retailers are still advertising interest free terms.  Both these factors tend to negate the effect of rates going up.

Question:   My 80 year old mother has offered to provide me with a significant amount of money - $200,000, either on an interest free loan or as a gift to assist with a home purchase.  She is a self-funded retiree, and receives no pension or other government-provided income.  Whilst the offer is attractive, I don't want her to have any problem with the Tax Office on this.  Would she be liable to pay tax on the investment value of the money she provides?  Would I be liable for any tax by accepting such a generous loan or gift?

Answer:    If she makes you a gift or an interest free loan there should be no tax ramifications for her.  Just be aware that you will have no interest to claim as a tax deduction if you use the money for investment.

24^h June 2008

It’s hard to believe today but in 1977 in Brisbane, average earnings were $14,410 a year and a house cost around $31,000 – just 2.15 times earnings.  Prices crept up slowly, but by the year 2000 the average house still cost $143,000 or 3.44 times the then average wage.  Thanks to the boom house prices skyrocketed in the period between 2000 and 2007, and the average price of a home now is $410,000, or more than seven times  earnings.

Think about it in practical terms.  A first home buyer who wants to buy a $410,000 house, the average price, will have to save at least a $50,000 deposit and then have the ability to make mortgage repayments of $2900 a month or $667 a week.  It’s obvious why there is a rent crisis.

The Rudd government has announced a significantly expanded national rental affordability scheme to encourage investors to build up to 100,000 new affordable rental properties.  Under the scheme, the Commonwealth will provide private investors with tax credits for 10 years for new properties that are rented at 20 percent below the prevailing market value.   To further assist prospective landlords, State and Territory governments have agreed to provide $2000 a home by way of cash payments or concessions on stamp duty.

That all looks good on paper, but it’s a lousy deal for mum and dad investors.  On the government’s own figures, the rent on a three bedroom home would fall from $350 to $280 a week, which is a reduction in rent to the landlord of $3640 a year.  After allowing for the $6000 tax credit, they are only $2360 a year better off than if they went their own way and found their own tenants.  To make it worse, they are now locked in to a rent controlled environment, and all the problems that go with that.

There are also huge potential problems if they wish to resell.  Does the buyer raise the rent and forego the tax benefits, or do they look for a less restricted investment in which to place their hard earned dollars?  Recently I took part in a debate on this on ABC Radio National on their Australia Talks programme.  One of the other panellists was Professor Terry Burke, Professor of Housing Studies, Swinburne University Institute for Social Research.  He claimed the scheme had worked well in Germany and was aimed mainly at institutional investors.  Frankly, if I was CEO of a large institution, that’s the last place I’d want to put any part of the company’s assets.

Question  :  My husband and I intend to take long service from our teaching jobs and visit our son overseas for three months next year.  We have thought of renting out our home and then renting a unit for ourselves so that we can easily leave for our holiday and feel that our 19 year old daughter who lives with us, is safe and without the need to care for our home in our absence.   We will be able to rent for less that our rental income, but should we reduce our income for the year by making further superannuation payments so as to reduce our taxable income? We are looking at this also as a 'try before we buy' option to see if unit living is suited to us in retirement in a few years.  We also have a unit that we rent out for the negative gearing benefits.  Is our thinking sound ,as we want to avoid putting ourselves into another tax bracket as a result of the income we will receive by renting our home.

Answer :   You should be using every strategy available to reduce your salary so that your rents do not get eroded in tax, but be aware that from 1 July the 30% bracket now goes from $34,000 to $80,000 which is quite wide.  As long as your total income stays within the tax band, you have nothing to gain by reducing it any further.  I strongly suggest you engage a quantity surveyor to prepare a depreciation report on the property – this will provide a schedule of tax deductions which will help you minimise tax further.

Question:   My wife and I have a combined income of $200,000 and live in a $400,000 apartment with a $270,000 mortgage also have an investment property worth $240,000, still owing $210,000.  We would like to buy a house, which will probably cost $600,000; however, we are trying to avoid spending more than 30% of our income on a mortgage.   We could not make up our minds on whether we should put in extra repayments to pay off our apartment in 10 years time or go ahead with the purchase of a $600,000 house?

Answer:  You will need to do a budget to satisfy yourself you can afford the repayments on any property you decide to buy, but you should also consider whether you are getting too many assets in the residential property basket.  An option may be to sell the apartment if it can be done free of capital gains tax, and minimise the amount you need to borrow for the new home.  You could then borrow back for investment and the interest on this new loan would be tax deductible.

Question:   I’m unable to get my head around how interest works on credit cards.  I have a gold Visa with a 44 day interest free period - if I charge $25 on the 1st, $50 on the 15th and $100 the 30th, do I have 44 days interest free for each separate charge?

Answer:      When the statement arrives you will notice that the entire balance must be paid by the due date - this is normally about 25 days from the date of the statement, therefore your total interest free period will be 25 days plus the time that has elapsed from when you buy an item until the statement date.

16^th June 2008

We used to suggest that you pay off your home loan in full before starting an investment program, but because of the way compounding works, we now recommend you pay off your loan over 10 years – no faster.  If you have enough money to pay it back quicker, the surplus cash is better used to increase the number of assets that you are controlling.

Because of the way compound interest works, the large earnings come in the later years of any program. Invest $1000 a month at 10% for five years and you get $77,000 – increase the term to 15 years and it becomes $415,000. If you can make it 30 years the finishing sum leaps to $2.3 million.

It’s the same with loans.

Let’s assume you owe $150,000 at 9%. If you choose a 30-year term the monthly payments will be $1207 and you will pay a total of $284,000 in interest. To cut the term back to 20 years needs just $157 a month more, in which case the interest will drop to $168,000 (a saving of $73,000). Now it’s not too difficult to increase your payments by $157 a month, but if you wanted to cut the term from 30 years to 10 years you would need to pay $1900 a month – an increase of almost $700 a month.  In short, small extra payments can make a big difference when the term is long, but the effect dwindles away as the term shortens.

Once the term is down to around 10 years, extra payments don't help you much. In the example above, there is just $78,000 still to be paid once the term is down to 10 years.

Once you appreciate how small monthly amounts can be valuable in shortening a long-term loan, and that starting early makes a massive difference to an investment program, it is clear that it is possible to have your cake and eat it too. Just reduce your home loan to a reasonably short term and then borrow for investment.

Question  :  We are both retired. I am on a disability pension and my wife is on a carer’s pension. I have $130,000 in super and receive a partial disability pension from the State Super Scheme.  We would like to help our son and we believe we can give him $12,000 over the next 12 months.  We would like to help him attain wealth and wonder what is the best way?

Answer :  You should not give away more than $10,000 in a financial year, because that could adversely affect your benefits.  The best way to help him depends on his financial situation.  For example if he wants to buy a home, you could help him with the deposit, but if he is unable to stretch himself to that level, you could consider a regular investment plan into a quality share trust.

Question  :  I am finding it difficult to become a millionaire while I am on the pension.  I retired with about $80,000 which I invested in shares and now have over $300,000 in shares and $100,000 in bank term deposits.  During this time our capital has been assessed by Centrelink at the deeming rates and our pension has been reduced accordingly.    Share prices have increased by 200 to 300 percent but dividends have not increased by that amount.  Thus most dividends are only 3 to 4 percent at present share prices.   Thus I am gradually selling shares and investing in bank term deposits at slightly higher rates than Centrelink’s deeming rate.  Any comments?

Answer :  There is a fable about a wealthy man who kept his money buried and every night dug it up and looked at it.  One night it was stolen and he was devastated, but his neighbour pointed out that the theft made no difference to his life because all he did was look at the money and never spend any of it.  Our welfare system is designed to help people with inadequate resources, not to make them millionaires  I suggest you enjoy the fruits of your wise investment over the years and draw down on your capital for home improvements and holidays whenever you wish.  Spending money in this fashion is not penalized by Centrelink so you will also enjoy an increase in pension as well.

Question:   I am 56, in a good job and my wife is 57 and working part-time.  We have no dependants and low debt except for a mortgage that I would like to pay off when I retire at 60. The house is currently worth around $850-$950,000 and I would like to make renovations to the kitchen, dining room and a bathroom estimated at $100,000.  What would be your recommendation to fund these renovations?

Answer:   Fund the renovations by increasing your present housing loan by $100,000 and negotiate repayments of interest only.  Then salary sacrifice a major part of your salary to provide a tax-free sum to pay off the mortgage when you are 60 or older.

Question  :  I pay $220 into my super after tax per pay.  I earn $45,000 a year and wish to increase my savings. If I change my after-tax contributions to before-tax and increase it by another $100 to $200 a pay, will my employer still have to pay the 9% to super and at what point does the 9% cut out.  I have 3 years left on my fixed term loan and will only have about $60,000 left to pay, so would it be in my best interests to increase my super and save on the tax until my fixed term expires?

Answer :  The employer should continue to pay the 9% on your gross salary but unfortunately there are some unscrupulous employers who will not.  Therefore you should get the arrangements confirmed in writing before you enter into a salary sacrifice situation.  You have not given your age but understand that money in superannuation is inaccessible until at least age 55 so the proposed strategy works better for people who are 45 or older.

3^rd June 2008

The end of the financial year is fast approaching, so there’s no time to lose if you are in a position to reduce your tax. .

The upper limit for the 15% personal income tax band rises from $30,000 to $34,000 on July 1 and the limit for the 30% band will go from 75,000 to 80,000. If you are changing tax brackets, try to defer income until after June 30 where it will be taxed at a lower rate.  An easy way to do this is to place any spare funds on term deposit with all interest payable after June 30^th. 

Conversely, if you have deductible expenses such as repairs and maintenance on investment properties, try to bring them forward so that you will enjoy your tax deduction at the higher rate. 

You can bring forward expenses by prepaying 12 months interest on your investment loans or margin loans.  Pre-paying a year’s interest on a loan of $300,000 may cost you $24,000, but you could get up to $11,160 back as a tax refund. This strategy will require negotiation with your lender – you can’t just bank the equivalent of a year’s interest into the loan account, because all the lender will do is take one month’s interest and credit the rest to the principal.  

CGT can take a chunk of any investment profits, but remember that the relevant date is the date the sales contract is signed.  Therefore just deferring signing a contract until after June 30^th can change a situation so that the CGT is paid when you are in a lower tax bracket. It also gives you an extra year’s use of the money you owe the tax man.

Anybody who is eligible to contribute to super but who does not have an employer making contributions for them, could also reduce CGT by making a tax deductible contribution to offset the capital gain.

CASE STUDY – A couple are retired and in their early sixties.  They sell an investment for $600,000 which triggers a $400,000 capital gain.  This will be reduced to $200,000 when the 50 percent discount is allowed for and CGT will be calculated by adding $100,000 to the taxable income of both.  They could contribute $250,000 each to super and apportion it $100,000 concessional and $150,000 non concessional.  This will create a tax deduction of $100,000 each which will wipe out the capital gain.  The only tax is the 15% on the $100,000 concessional contribution – much lower than the possible 46.5%. 

Question  :  One thing that has puzzled me is that when retired, a person may work up to 10 hours per week.  Does that really mean a maximum of 10 hours per week or can you average it out over a year and work full time for 13 weeks?

Answer :  A person can work as long as they like when they are retired, but if you are aged between 65 and 75, you have to pass the work test to be eligible to contribute to superannuation.   This involves working a minimum of 40 hours in 30 consecutive days. 

Question:   We understand that getting a car loan tagged onto the mortgage can be a bad idea as you can end up paying for the car for a long, long time.  What if you voluntarily make additional payments to cover the additional amount?  We are currently paying $150 a fortnight on a five-year car loan and my rough calculations indicate we would pay less than the $6,000 total in interest if we transferred the remaining amount to the mortgage.  We would then continue to pay the $150 a fortnight but onto the mortgage instead.  By consolidating our debt we also see a benefit in gaining advantage from our free redraw if required.

Answer:   I have no trouble with a consolidation loan as long as the borrowers do as you suggest and increase their repayments by the amount they would be paying if they took out a separate personal loan.  This strategy allows you the benefit of a higher interest rate and at the same time prevents you falling into the trap of spreading short term consumer finance over 30 years.

Question :  I am 75 and have been considering helping our children by giving them some money now. My reasoning is that they need the funds now due to their own children’s education costs – rather than later in life.  Would the children have to pay tax on moneys received from their parents?

Answer :  I think what you propose is a splendid idea and as there is no gift duty, the money will be received by them tax-free.  Of course they will be taxed on any earnings generated by the money and you should take advice before making the gift in case it adversely affects your Centrelink benefits.

Question:  Does receiving an inheritance affect my taxable income for the financial year?  If so, how can I invest to overcome that?

Answer:  An inheritance by itself should not affect your taxable income, but bear in mind that death does not trigger CGT it merely transfers any capital gains liability to the beneficiaries, who will suffer CGT if they sell the assets.  Obviously there would be no CGT to worry about if the inheritance was merely in the form of cash, but the interest on such invested cash would form part of your income for the current financial year.  You could get around this by placing the money on a term deposit with interest payable after June 30^th.

28^th May, 2008

The latest round of interest rate rises, combined with dearer petrol, is putting pressure on family budgets.  This is why it’s important to take an hour or so to put your finances under the microscope to make sure you squeeze the most out of every dollar. 

One of the first places to look should be your bank accounts.  Often the banks lure you in with offers of great deals but then change the conditions after you’ve got used to the particular product you have.  A typical example is my wife’s cheque account.  As she is the sort of person who likes to keep a healthy balance “in case of emergencies”, she uses a cheque account with a major bank that is styled Cash Management Trust.  We recently discovered to our horror, that it was paying POINT two percent interest.  Obviously we quickly opened an online account paying seven percent and moved the funds to it, but years of not bothering to check the rate has cost us hundreds of dollars in lost interest.

If you have money on term deposits, you will almost certainly receive a letter from the bank just before the expiry of the deposit telling you it will be automatically renewed unless you instruct otherwise.  This is a great time to check what safe rates are available in the market because often the automatic rate is less than what is available elsewhere. 

One of the best places for any spare savings is to pay it into your mortgage.  As long as you’ve got a redraw facility, you will be able to take it out again if you need it, but in the meantime you will be earning an effective nine percent after tax.  Not too many investments can beat that. 

Question  :  I am single, 65, working fulltime and earning $45,000 per annum.  I am looking to semi-retire in late 2008 and work lesser hours for the following two years. Last year I purchased my first property with a $180,000 loan (25 years) paying it off at $1237 per month.  I have $90,000 in super to which I contribute $60 per week after tax.  I have few assets and savings and will be happy to live a simple life.  What will be the best way to service my loan upon retirement?  My three adult children are prepared to take over the loan when I can no longer undertake the payments.

Answer :   Talk to an adviser about withdrawing all the money you have in super to reduce the loan to just $90,000.  As you have reached 65 this is allowed.  You could then salary sacrifice $17,000 a year of your salary into super which would reduce your total income to $28,000 a year.  You would then make an extra undeducted contribution of $1000 to super and qualify for the co-contribution of $1500.  The growing sum in super should enable you to quickly create a sum to pay the house off.  You could always make small tax-free withdrawals from super if the need arose.

Question  :  If I buy an investment property now and sell after I am 60 years old, what capital gains apply?

Answer :  Your age is of no consequence when capital gains tax is being calculated.  However, if you are eligible to contribute to superannuation and no employer is making contributions for you, it may be possible to eliminate capital gains tax by making a contribution to super and claiming part of it as a tax deduction.

Question  :   I have found that apart from lack of true access to and free choice in the use of my allocated pension money, the biggest disadvantage is worrying about share market volatility and its effect on my funds.   I am 65 with about $450,000 in 3 funds, and plan to take it all out tax-free and place it with a bank at 7%.  From the ATO web-site calculator, (including Medicare levy and Senior Australians Tax Offset), I reckon that I'll be up for about $3,000 tax per annum.   I reckon the $3,000 tax 'slug' would handsomely repay me in peace of mind, compared to worrying over the possibility of a another stock market 'crash' and a huge loss of my capital.  Is my reasoning sound?

Answer :  That is one option, but you should understand that you may live for another 20 years and that interest bearing accounts give you no capital growth.  Furthermore, your income will drop if interest rates fall as is predicted.  A better option may be to talk to your adviser about re-weighting your portfolio so it has a lot less exposure to shares.  This will give you time to ride out the inevitable market falls.

21^st May 2008

It had to be the most leaked budget in history so it was all a bit of an anti-climax when Treasurer, Wayne Swan got to his feet to read his speech.  However, as usual, there were a few nasties hidden away in the fine print.

From 1 July 2009 the definition of income for Centrelink purposes will be changed to include salary sacrificed superannuation contributions. This will affect those who receive family assistance or pay child support, as well as anybody below pensionable age.

From that date, eligible income for the superannuation co-contribution will also include salary sacrificed contributions.  No longer will a person on $58,980 a year be able to salary sacrifice $30,000 to super to reduce their income to a level where the full co-contribution of $1,500 is payable.  The changes for eligibility for the co-contribution do not take effect until June 2009, so a window of opportunity will stay open for two more financial years – a higher earning person who wants to grab two lots of co-contribution could make a contribution for the current financial year and a further contribution for the year ending June 2009.

Another clever strategy that got the chop was salary sacrificing for negative gearing purposes.  There’s nothing new about doing this, I wrote about it extensively here five years ago, but it was one of those techniques that would have to fall into the “too good to be true” category. 

Think about a family where the husband earns a high salary and the wife has become a full-time mother. They jointly bought an investment property, when they were both working, to enjoy the tax breaks presented by negative gearing, but now that she has stopped work, they have a tax problem. Because she has no taxable income she cannot use the normally tax-deductible shortfall created by the interest and rates being more than the rents.

Until now, the husband could go to the employer and ask that the entire interest bill be salary sacrificed out of his gross income. If his salary is $85,000 a year, and the total interest bill is $15,000 a year, his salary is reduced to $70,000. There is no FBT because investment loan interest is tax deductible.  Even though he owns only half the asset it enables him to effectively claim 100% of the interest, while his wife receives 50% of the rents virtually tax free.

The FBT rules have been changed to disallow this from budget night.

The big losers in the budget are single pensioners.  Most pensioner couples can scrape by on the full age pension of $23,754 a year but it’s a tragedy when a spouse dies and the survivor, usually a widow, has to get by on just $14,217 a year.  That’s an immediate drop in income of $183 a week with barely any reduction in living expenses to compensate.

They are the battlers who Labour forgot.

12 May 2008

When the markets are having one of their inevitable downturns, it’s a good idea to focus on the things you can control ,and not dwell on those that you can’t.  For example, if you are 55 and over and still working, the no-brainer is a transition to retirement pension (TTR) because it’s the best way of saving tax there is.

Consider an employee aged 55 with $400,000 in super is earning $110,000 a year which produces a take home pay of $77,250.. Because their house is  paid off  they have a surplus income of at least $18,000 a year.  They reduce their gross salary to $30,000 a year by salary sacrificing $80,000 of it into super.

The entry tax of 15 percent on that contribution is $12,000, which means their superannuation gets an immediate boost of $68,000.  However, the reduction in salary means that their take home pay is reduced by $51,300. 

Immediately they are $16,700 better off as they have gained $68,000 in superannuation while losing $51,300 in their pay packet. 

To compensate for the reduction in their take home pay, they commence a TTR pension of $40,000 a year.  Because they are under 60, it will be fully taxable but will enjoy a rebate of 15 percent.  Consequently, their total taxable income will be $70,000 on which tax is just $10,650 after the application of the 15 percent rebate of $6,000 a year.  A bonus is that they will now qualify for the mature workers tax offset of $500 a year, which reduces their PAYG tax to just $10,150 a year. 

So far so good, but it’s important to understand that a TTR is not a set and forget strategy. Once the employee reaches 60, all TTR income will be tax-free which means more take home pay as there is an immediate reduction in tax. The $100,000 maximum deductible contribution for persons over 50 will be abolished after June 2012, so they will need to reduce their salary sacrifice contribution to $50,100 after allowing for the employer’s additional 9% contribution. The after tax salary will now be bigger because of the lower salary sacrificed amount, so they would reduce the TTR pension to just 4% of the fund balance.

For such a simple and effective process, the benefits are huge. If no TTR strategy was put in place, and the funds earn 8% per annum, the superannuation balance at 65 would be $907,400. However, the use of a TTR would boost it to $1,391,500

That’s an extra $484,100.

It’s a well known adage that procrastination is the thief of time.  What is not so well known is that it is also the thief of money.  The above examples illustrate how small changes in your financial affairs today can make a huge difference down the track.

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Question: We have a investment property and need to do renovations on it. For tax purposes should we borrow off our investment property (interest only) or on our home?

Answer: It doesn't matter which property you borrow against - the tax deductibility depends on the purpose of the loan.  I suggest you use the property which is least likely to be sold.

Question:   Several friends have borrowed money against their investment properties claiming the money is for further investment initiatives.  However, they then redirect the money to pay off their mortgages, or do renovations on their own residential properties, which they permanently live in. Is this legal and if not, why does the lender or ATO not seem interested in tracking this?

Answer:  We now work under a self- assessment system – this means you can put anything you like in your tax return.  However, it is highly likely that most tax-payers with investment properties will face an audit one day, and when this happens, offenders will be hit with heavy penalties as well as back tax.

Question  :  I am a director of a business and have just taken out a mortgage on my principal place of residence. Can I salary sacrifice into my mortgage so I can use before tax dollars?

Answer : Unless you work for a non-profit organisation, your options for salary sacrificing are limited to superannuation, laptop computers, and a few other minor items. If you are older, you could investigate salary sacrificing a large part of your income into super and then eventually taking out tax-free withdrawals to pay off your housing loan.

Question  :  I recently read an article you wrote on investment properties where you mentioned generous depreciation allowances. We have had investment properties in Queensland since 2003 and our accountant said not to claim depreciation because when we sell we would have to pay capital gains from the depreciated value to the sale price. We took his advice but wonder if there is a way around it. The properties were purchased under a family trust.

Answer : Certainly part of the money claimed for depreciation is clawed back when you sell, but it is still better to enjoy the tax deduction today, as it is being paid in today’s dollars and not in some deflated future dollars. Also, the tax rates may be more generous in the future, which is another reason to claim everything you can today.

5^th May 2008

Today I’m going to tell you a true story that shows how honest people with the best of intentions can find themselves suffering financial loss through no fault of their own.

Some years ago a woman who had never married met a widower who had several grown up children.  They decided to spend the rest of heir lives together, got married, and bought a home to live in.  They each contributed half the purchase price and made a pact that on the death of one of them, the survivor would remain in the house.  Then, when the survivor eventually moved out of the property and sold it, half of the proceeds of the home would stay with that person, probably to fund entry to a nursing home, and the other half would be given to the family of the person who died first.

When husband died the widow continued to live in the house until declining health forced her into a hostel where she is living today.  The home was sold for $600,000 to provide the accommodation bond for the hostel and in accordance with the promise she had made to her late husband, she paid $300,000 (being half the proceeds of the home) to her late husband’s children.

Now all that sounds very reasonable, but unfortunately Centrelink saw it differently.  In their eyes she had gifted away $300,000 which sum was to be treated by them as a deprived asset, and subject to the deeming rules for the next five years.  Because she had done the right thing she lost most of her pension, and also was forced to pay much higher fees for her accommodation.  It was the ultimate double whammy.

Of course with the benefit of hindsight it’s easy to say that the couple should have documented their intentions, but they come from an era where your word is your bond.  They simply acted with the most honest of intentions and the widow had no hesitation in honouring the agreement.

I would like to be able to tell you that this is an isolated incident, but the sad news is that this is just the tip of the iceberg.  Other occurrences that have come to my notice include a case where a pensioner unwittingly gave her house to the only child because she no longer needed it when she entered a nursing home, and a situation where a pensioner signed over two thirds of the home to the child in exchange for the child moving into the home to care for her.  In both cases the pension was lost.

This is just another illustration of the importance of taking expert advice before executing wills and entering into arrangements with family members.  Centrelink have a free financial advisory service which is available to all their clients, but anyone whose affairs are complicated should take other advice as well.  Often a few hundred dollars in fees will save tens of thousands of dollars in lost benefits and legal fees.

Question  :  I am 61 years of age, have $170,000 in super and $40,000 in shares. I currently salary sacrifice $200 per week and put $20 per week towards the co-contributions scheme.  Can I place my super money into a transition to retirement pension and draw an amount of around $500 per week from it; continue to work full-time and salary- sacrifice my weekly wage?  My gross weekly wage is $830.  Does this mean I wouldn’t have to pay income tax if I salary sacrifice my full wage, and if so what happens at tax time? 

Answer :  The overall strategy is fine but there would be no point in reducing your salary to less than $30,000 a year because this is will be the cut-off point for the 15% bracket and salary sacrificed contributions lose a 15% entry tax.  The PAYG tax would be calculated on the reduced salary and adjustments if necessary would be made at the end of the financial year.  Before you salary sacrifice you should satisfy yourself that your employer will not reduce their compulsory nine percent contribution. 

Question :  I have retired but am still eligible to contribute to super.  Can I claim a tax deduction on any part of my contribution?

Answer :   As long as you are eligible to contribute, and no employer is paying superannuation for you, you can claim a tax deduction for part of your contribution.

Question  :  I have a longstanding allocated pension which is providing a monthly income stream.  From your recent columns I note that this fund has been tax-free from 1 July 2007 as has the income received.  Will such income be totally disregarded when income is also received from other sources?

Answer :  Withdrawals from super under the new system are totally disregarded for those aged 60 and over.  In other words, making a withdrawal from superannuation would be no different to drawing money from a bank account.

Question  :  If a person has four different investments,  and two are doing badly and the other two are doing well, which of the four should they get rid of?

Answer :  It’s not a simple answer because you need to canvass with your adviser the reasons why some of your investments are outperforming others.  For example, a company with good potential could be out of favour with the market and it would be a mistake to sell prematurely.  Also remember, a good investment portfolio should be spread across a variety of asset classes and it is common for one asset class to be performing well while another is performing badly. 

Question  :  I have been saving into managed funds for quite a few years and need to withdraw around $100,000 to buy a house. I believed I had been paying tax on them along the way, but now someone has told me I am up for capital gains tax when I withdraw. Is this true? I thought all I'd be paying is any applicable exit fee.

Answer :  You would have been paying tax along the way on the distributions, just like you would pay tax on income from rents on a property, but when you sell the asset you will still be liable for capital gains tax on any capital growth.  This would happen too, if you sold a property and made a capital profit.  If you have been reinvesting distributions, you may find that the CGT is relatively small because you would have already paid tax on the distributions and they now form part of the cost base.

30^th April, 2008 

It’s well known that paying off your non deductible housing loan should be one of your first priorities, but I am continually receiving questions about the best way to pay off investment loans where the interest is tax deductible. 

The decision is an easy one if you have both a housing loan and an investment loan, because the lack of deductibility of the interest on the housing loan means that the real cost of the payment could be as much as twice that on the investment loan - the former is paid from after tax dollars and the latter is paid from pre tax dollars.  Without question, keep your investment loans on an interest only basis until that non deductible housing loan is out of the way. 

Once you’ve reached the stage where the housing loan is paid off, you then have to decide between making principal and interest (P&I) repayments which will see the loan reduce each month, or using interest only where the balance never reduces.  Both strategies have merits.

If you are trying to create a safety cushion for yourself and also put yourself in a position where you want to buy more investment assets a P & I loan is a good way to start.  Every month your equity is building as the loan reduces, and you are also giving yourself a good safety cushion against rates rising.  Then, as your equity builds, you can borrow for more shares or property. 

However, if you are 45 or more, a much better strategy may be to leave the loan on an interest only basis, and salary sacrifice as much as you can afford into superannuation.  This will create additional funds in superannuation that can be withdrawn tax-free at age 60 to pay off the investment loan.  In the meantime, you get to enjoy the benefits of the tax breaks of negative gearing.

Question:   I am currently renting a property but have two investment properties, which I make extra repayments into.  Once I have enough equity in both properties I was hoping to withdraw this equity to purchase a house to live in.  Would I be breaking any tax laws or would I be better paying interest only on both properties and saving my money for a new deposit?

Answer: Your best strategy is to pay interest only on your properties and plough all your spare funds into an offset account.  When you do find your residence, this will enable you to withdraw the money from the offset for the deposit while retaining the present level of gearing on your investment properties.

Question  :  I am 42 and my husband is 45.  I work full-time, earn $75,000 a year before tax, have a defined benefit superfund and $15,000 in managed funds.  My husband earns $100,000 a year before tax, has $250,000 in super, $10,000 in managed funds and shares valued at $10,000.  We own our home worth $450,000, three investment properties worth $400,000, $350,000 and $250,000, earnings rents of $450, $360 and $300 a week with a combined debt of $700,000.  We have cash of $180,000 in the bank, currently interest offset to the investment loan $700,000.  How should we restructure our finances?  Should we keep current arrangements to pay the mortgage or invest more in managed funds.  Should we be salary sacrificing into super?  With current incomes, do you think we can pay off $700,000 in 10 years?  Our monthly mortgage repayment is $4838 and we estimate a cash surplus of $15,000 yearly.

Answer :    Provided you are prepared to lose access to your money until age 55 I suggest you move the $180,000 from the offset account to superannuation in your husband’s name.  This will increase the tax benefits from negative gearing and the once only contribution, together with the employer nine percent contribution will mean that your husband will have approximately $820,000 in super at age 55 if his fund can achieve 10 percent per annum.  By then your rental properties should be worth $1.5 million if they can achieve four percent capital growth a year.  This will give you the ability to pay off the $700,000 loan and together with all your other assets should see you well placed for retirement.  Doing this will give you a range of options at age 55 - my preferred strategy would then be to use the rents to make the interest only payments on the loan and let your superannuation grow further.  By the time your husband is 60 his superannuation should have grown to $1.4 million if no further contributions are made and then you could take out $700,000 tax-free to pay off the loans.

Question:   I am 56 and sacrificing my entire salary into super, which is with a balanced fund. How can I compare the performance of this fund, bearing in mind fees and return etc, with perhaps another fund manager?

Answer:  Bear in mind that salary sacrificed contributions incur an entry tax of 15%.  Therefore, unless you are seeking to maximise the co contribution, there is no point in salary sacrificing to a level where the net salary is less than $30,000 a year - this is where the 15% tax band finishes.  Your adviser will be able to help you assess the relative performance of your fund, but you should understand that comparisons can be misleading, because one fund may have a much high risk profile than another.  I suggest you choose a fund that suits your risk profile and your goals and stick with it.

23^rd April 2008

Whenever you think about financial affairs, there are a few things that are really simple including spending less than you earn, and never borrowing for things that depreciate.

But the moment the government gets involved, regulations become complex, and family tax benefits is one such area. While financial planners have sophisticated computer programmes to assist them, the programmes are expensive and beyond the reach of the average household.  

Fortunately, for those receiving family tax benefits, help is available via a computer programme called MOTHER (Maximize Our Take Home – Everything’s Relevant). 

Creator, Glenn Thorpe, advises that when changes made this year to the tax scales and the low income tax offset, interact with Family Tax Benefit Part B, some families could be $2,000 richer by ensuring joint income is split optimally.

For moderate income families a 50/50 income split is not the best way to maximise income.  For example, a family splitting $41,000 income $30,000/$11,000 gains $2,000 over a $20,500/$20,500 split.

These quirks mean any family with a combined income of under $120,000, who can allocate income or deductions to either partner, should identify its optimum income split and arrange its finances accordingly. 

Even small transfers, such as re-allocating deductions or interest income can help. Sometimes reducing the lower-earning partner’s income by allocating $1,000 of deductions to them provides a benefit of $280 more than if the deduction was allocated to the higher-income earning partner. Sometimes allocating $1,000 income to the higher earning partner can provide the $280 benefit.

The situation for lower income families receiving Parenting Payment is even more critical.  If a family with $30,000 combined income splits income 50/50 it loses $2,900 in family income compared to splitting 80/20. 

Adjust your affairs early in a financial year to take advantage of this situation.  While self-employed families’ allocation of income can often be done after 30^th June, the allocation of income or deductions from other sources generally depends upon in whose name an asset is placed.  For instance, bank interest from joint accounts is usually split 50/50.

Glenn’s programme normally sells for $99. However, as a special deal to readers, it is available free until 30^th June. Simply go to http://www.simpeff.com  and follow the prompts to download.

I recommend it to you and compliment Glenn for his generosity in letting you have a free trial.  If it’s appropriate for you it will pay for itself many times over.

Question :  You have made reference to capital gains tax being payable in the year the sales contract is signed.  Consider a scenario where the buyer defaults on settlement in July, having exchanged contracts in June - an unlikely but possible outcome in my own case.  I would have thought that CGT would be payable in the year the gain is generated.

Answer :  You are not liable for capital gains tax until the transaction is completed.  The date of the sales contract is the relevant one when you are working out how much tax you should pay, but of course there can be no tax payable if the transaction falls though.  Bear in mind that your tax return is normally done months after the transaction settles.

Question  :  You recently suggested that a reader buy share based insurance bonds for their grandchildren.  How does one go about buying these bonds and is there a minimum amount that needs to be invested?

Answer :  Most insurance bonds require an initial investment of $2000 but you can make additional contributions for $100 a month or more if you wish.  A financial adviser will be able to help you choose an appropriate one, but I strongly suggest you look for a share based bond if you have a long term in mind as these will give much higher returns than case based bonds. 

Question  :   I was very interested in your article on Insurance Bonds as an inheritance for grandchildren and wonder how you would rate them as compared to a DIY share portfolio over a period of 5-10 years. 

Answer :  If you hold shares within the insurance bond structure, the tax is paid within the fund and after 10 years the proceeds can be redeemed in whole or part tax free.  Consequently, there is nothing to include on your tax return each year.  If you hold the shares in individual names you will pay tax each year at your marginal tax rate and will also pay CGT when you cash them in.

15^th April 2008

Buying that first home has always been tough, and over many years governments of all persuasions have introduced, and then abandoned schemes, to help low income people get a foot in the door. 

The latest one,  to be introduced in July, is the First Home Saver Account which is modelled on the superannuation system and is designed to work similarly to salary sacrificed contributions where the investment is made from pre tax dollars less a 15 percent contributions tax. 

The deposits will be made from after tax dollars, but will be boosted by a government contribution that will reduce the effective tax rate to 15 percent.  There is a limit of $10,000 on deposits to the account in any financial year and only $5000 of the deposit will qualify for the government contribution. A couple are allowed $10,000 each so will obviously have a much better capacity to save.

Think about a couple who earn $50,000 each and are in the 30 percent tax bracket.  If they contribute $10,000 into the account the first $5000 will qualify for a contribution of $750 being 15 percent of the first $5000 deposit - this 15 percent is the difference between their 30 percent marginal rate and the 15 percent concessional rate.  If they are in a low tax bracket, the rebate would still be 15 percent or $750, and if they in the 45 percent bracket, the rebate would be $1500. 

Income tax within the fund will be just 15 percent a year, just like superannuation, so the scheme allows first home owners to grow their savings in a low tax environment.

The scheme is not means tested but the government makes no secret of the fact that it is designed for people who are struggling to save a deposit.  This is why money in the fund cannot be withdrawn for four years even if the would-be borrowers receive a financial boost such as a big increase in pay or a legacy.  .Withdrawals during those four years will only be allowed in cases of extreme hardship. 

The scheme may help a small number of people, but first home buyers still face the risk that increases in home prices over four years may negate the benefits of saving a larger deposit.  After all, a couple who can pay $400 a week rent and also save $10,000 a year, would be able to make the payments on a mortgage of $352,000.  This, together with the First Home Owners Grant and a small deposit, might be enough to get them started provided they had a secure income and were satisfied they could handle the higher payments due to the smaller deposit.  Alternatively, they could ask their parents to go guarantor, or else consider one of the new types of loans where lenders offer an interest free portion in return for a share of the capital gain in the home. 

Question:   I am 45 with $75k in super and a house worth $800k. My mortgage is $350k and my income is $110k.  With the goal of being comfortable in retirement at age 60, would it be better to downsize the house now to have no mortgage and put those funds into super, or should I hang onto the house, pay it off over the next 15 years and then downsize and live off the returns, assuming it capitalises well?

Answer:   Provided you can handle the mortgage payments comfortably, and you feel the house has good growth potential, my preference is to keep it, as it should produce a substantial tax-free gain over time and give you a good lifestyle in the meantime.  It may be worthwhile talking to a financial adviser to work out exactly how much you need in retirement, and what strategies you need to put in place now to help you stay on track.

Question  :  I am retired with my main source of income being a superannuation pension.  As there is a 20% tax offset for medical expenses in excess of $1500 and gifts to charities are tax deductible, I have so far kept detailed records of these items.  In the future I anticipate that my superannuation pension will be tax-free and it is unlikely that I will have a taxable income.  Under these circumstances, I see no point in keeping detailed records of medical expenses and gifts, but is there something I am overlooking?

Answer :  As you point out, the concession for medical expenses is a tax offset which means it is only of use to you if you have taxable income to use it on.  I agree with your reasoning.

Question  :  We have recently sold our home and will have $240,000. We are currently renting ($430 a week) and are not looking to buy for 12 months. We are about to upgrade our old car with a new one and would like some advice about whether we should take out a personal loan for the full amount of the car, borrow some money and top up with the funds from the sale of our house.   We plan on spending up to $50,000. We have a combined income of $130,000 (before tax).

Answer :  A purely theoretical approach would suggest that you pay cash for the car and do not pay expensive non deductible interest to buy it.  However, experience tells us that lump sums, once spent are very hard to replace.  Therefore I suggest you keep your funds intact and borrow for the car.  If you pay it off quickly the interest will be minimal.  Also prefer a loan that gives you the flexibility to make lump sum payments without penalty.

Question :  I have a margin loan of $150,000 for shares valued at $250,000.   I have now paid off my home loan.  Would I now be better off closing the margin loan and using $250,000 as a redraw from my home loan?

Answer :  The benefit of switching to a loan that is secured by a mortgage over your home is that you should be able to negotiate a cheaper interest rate and should free yourself from the possibility of margin calls in the future.  Also, if you are an experienced and aggressive investor, you will be able to increase the amount you can invest in shares using borrowed money.

10^th April 2008

The Reserve Bank (RBA) left the cash rate unchanged at 7.25% pa at its Board meeting last week, and downgraded its tightening bias further.  In layman’s terms this is a strong indication that we must be getting close to the top of the interest rate cycle and that rates will soon start to fall or at least stay where they are.  This is not so much because of the global financial instability, but rather because they now see tentative evidence that domestic demand is slowing as the rate rises start to bite 

The RBA is all but saying don’t panic.  The bank noted “inflation should decline over time, provided demand slows as expected”. The “as expected” bit is telling, because previously, including as recently as last month, they noted uncertainty about the extent to which demand was slowing and that … “a significant slowing in demand from its pace of last year is likely to be necessary to reduce inflation overtime”. Reference to uncertainty about how quickly demand is slowing is gone this time. So too is the old broken record reference to the need for a substantial slowing in domestic demand is gone.

Of course, the bank cannot come out and say that further rate rises are unlikely because that would send the wrong message.  They would rather hint that tough times may still be with us so that the effect of the rate rises will be ongoing.

None of this is to say that the RBA could not switch back to an aggressive tightening bias if the June quarter CPI (i.e. the one after next) is a shocker or there is evidence that the effect of the rate rises are slowing.  Nevertheless, all the data coming across my desk at the moment indicates that conditions will get worse before they get better.  House listings are jumping as more and more over-committed vendors put their properties on the market, and retail sales seem to be in a slump.  On any reasonable view, rates will get lower before they go higher. 

Question  :  Can you please advise the best way to deal with my mother selling her home and moving in with us.  Her house is currently worth around $500,000.    She is 83 and does not want her pension to be affected.  We had considered her keeping the house and renting it out – would it be better to sell it?

Answer :  You will need to seek specialist advice on this as it is a minefield.  One option is for your mother to use the granny flat provisions to purchase a life interest in your home.  This would assist in keeping her pension entitlement, but you would need to be cautious about doing this if it is likely that your mother will need aged care in the future.  The current rules are that if she needs to move into aged care within two years from the date of purchasing the life interest, the life interest can be assessed as an asset for determining the accommodation and possibly deemed for Income Tested Fees.  If she keeps the house and rents it out, it will become an investment property and will be assessed at market value under the assets test; the income will be assessed on two thirds of what is received.  It would be possible for your mother to keep and rent the house if she moved into aged care, with the asset and income being exempt, but not if she started to rent it out before she moved into aged care.  It is possible for her to leave her house vacant, or have a caretaker live there, for up to two years with it still being considered her principal residence and, as such, exempt from pension testing.

Question:   I have $200k in shares, of which $90k is funded by a margin loan.  My home loan is currently at $150k.  I am looking to pay off my home loan with the value from my shares, then borrow the money back again to purchase the shares again so the interest is tax deductible.  Is there a way I can do this without realising the capital gain?

Answer:   The moment you dispose of your shares you will trigger a taxable capital gain and if you had the shares for less than a year, you will not be eligible for the 50% discount.  If you have a large unrealised capital gain, another option may be to use all the income from the shares to reduce your housing loan and at the same time increase your margin loan by the amount you have paid off the housing loan.  This may be a slow process to start, but will accelerate as time passes and your loan reduces and your share portfolio grows.

Question  :  You recently stated “if you have been reinvesting distributions, you may find the capital gains tax is relatively small because you would have already paid tax on the distributions and they now form part of the cost base”.   You reply  has me wondering what the position is regarding dividends reinvested under the DRP system or otherwise to purchase shares.  Should what you say also apply to the cost base of new shares purchased with distributions that have or will attract tax on the shareholder?

Answer : All dividends and distributions are taxable whether deposited into your bank account or used to buy additional shares or units in the investment that paid the income to you.

Question  :  You stated in part "... if you are aged between 55 and 60, the income stream for an allocated pension will be taxable but will qualify for a 15% rebate - this will make it tax free for most people."  Could you expand upon how this offset works for the 55-60 age group?  We are self-funded retirees aged 54 (with super valued at over $1m) and were working on the principle to delay drawing on our super until after 60 when it is tax-free. Our income needs until then were to be provided by various geared investments that we currently have.  We would rethink this strategy if super income 55-60 had minimum effective tax payable.

Answer :  Suppose a person aged between 55 and 60 drew an allocated pension of $36000 a year.  The 15% rebate would give rise to a tax offset of $5400 and this is available to reduce their tax on income from all sources.  As the tax on $36000 is $5400 the allocated pension would be tax-free for them if they had no other taxable income.  Of course if they had income from other investments, the amount of that would need to be taken into account when calculating how much allocated pension should be drawn tax-free.

2^nd April 2008

Despite the latest rise, indications are that we are getting close to the top of the interest rate cycle and rates will stay flat or start to reduce over the next year.  However, this is of little comfort to those who are struggling to make ends meet because their housing repayments have increased by $150 a week or more.

Mortgage stress is a scary experience, but not half as frightening or expensive as being forced to sell your home, rent elsewhere and then re-buy when your finances improve.  That exercise could cost you more than $40,000.  This is why it’s important to do everything in your power to hang on to your home.  Here are some tips.

ONE.   Can you find more money by cutting back on non essential items or by one or more of the family members getting a second job?  An extra $100 a week coming into the household could make a huge difference.

TWO.  Are you being paid what you are worth? Australia is suffering a major jobs crisis so don’t be frightened to ask for a raise in salary or change jobs if you believe you are underpaid. 

THREE.  If credit card debts and personal loans are the problem think about consolidating then with the home loan. Beware, this will only work if you stay away from future consumer debt and raise the repayments on the increased home loan balance so the overall term is shortened not lengthened .

FOUR.  Can you take in a boarder to help with rates insurance and electricity? If you do,  be careful that the money they give you is treated as a contribution to household expenses and is not actual rent – otherwise you could find yourself losing part of your capital gains tax exemption as you are carrying on a business in part of your residence.

FIVE  If you are 55 or over, boost household income by accessing part of your superannuation as a transition to retirement pension.

SIX   Don't ignore the problem - it isn't going to go away. Also don’t be afraid to ask for help. If you are having trouble managing school fees, talk to the principal as many schools have schemes to assist families in these circumstances. If things get really tough, don't be too proud to ask for emergency food and clothing from organisations like Lifeline. They have counselling services which can help ease the emotional strain as well.

Finally, an ounce of prevention is worth a ton of cure, so take the time to prepare a detailed budget before you sign a contract to buy a home and base your repayments on eight dollars a thousand a month at least.  This will give you a cushion if interest rates rise and will slash the term of the loan if they fall.

Question  :  My wife and I have $470,000 dollars to invest and would like about a 12% return with low risk if this were possible.  We would be happy with between 8%-8.5% if this could be guaranteed with no risk.  Are any of these returns at all possible, and if not, what advcse can you give us please as to the best way forward for us?  We cannot afford to gamble with this money under any circumstances.

Answer  :  There are many kinds of risks and these include credit risk by investing in high rate risky debentures and also opportunity risk which means you stay in the apparent safe haven of cash and miss out on better returns in property and shares.  I suggest you talk to an adviser about your concerns and jointly agree upon a portfolio that is appropriate for your goals and risk profile.  In the long term I believe inflation plus 6% is reasonable but you would need to accept volatility in the portfolio to get returns at this level.

Question  :  Last year, I inherited a large number of shares within the one company which over the past year have increased in value from $350,000 to approximately $550,000. I also own an apartment with a $320,000 mortgage, but I do not wish to continue living in this apartment for long.  I would like to move into a house within the next year. I am 25 and earn $60,000 per annum, and am wondering if it is a better choice to leave the shares as they are, or to sell them, pay the CGT and re-invest in a house to live in, with a mortgage less than $150,000 and then use my income to further invest in property and shares.

Answer :  You would need to tread carefully here because if the shares were bought by the deceased after September 1985, you would be deemed for CGT purposes to have acquired them for the amount paid by the deceased.  This may be much less than their value at date of death and so would give rise to a much greater CGT liability.  You may be better off to sell the apartment in which you live as such a sale would probably be CGT-free and then use the dividends from the shares to help with the repayments on the new home.

Question  :  When I retired in 1991 I rolled over my ETP into both an allocated pension and a lifetime annuity.  I understand the pension will be tax-free but I have not read anything about the annuity.  Will it also be tax-free, as it was purchased with ETP monies and has always been eligible for both a deduction for the deductible amount and the 15% tax offset.

Answer : From 1 July, all monies from superannuation sources, including annuities, have been tax free for those aged 60 and over.

Question  :  I am 56 and have $15,000 in savings and two superannuation funds worth $12,000.  I am in a housing commission home and my fortnightly pension is $540.  I do occasional casual work (which is not regular), but takes my fortnightly income to $600 - $650.  All of my benefits and rent are based on my gross income so I pay exorbitant tax and also my rent goes up when my income goes up.  If I deposit $5000 of savings into super, I can still get the higher level of interest from my credit union, but I must put $50 in per month to maintain this, which is not always affordable.  How do I maximise my income and make allowances for my retirement without being unduly penalised.

Answer : Any money you have in super is not assessed by Centrelink until you reach pensionable age, which in your case is 65. Therefore, you should place as much of your spare savings in super as you can. You can reduce the effect of casual earnings on your benefit by salary sacrificing as much as you can afford into superannuation, as this will reduce your income for Centrelink purposes. A further benefit of doing this is that you may qualify for the Government co-contribution, which will enable you tor receive a gift of $1,500 if you make an undeducted contribution of $1,000 to superannuation.

26^th March 2008

It’s fast becoming decision time for all of you who took part in the T3 float in November 2006 because on 29 May 2008 you will be asked to pay a further $1.60 to make your shares fully paid.  There is no denying that anyone who bought T3 has been on a winner because, as I wrote at the time, it was a lay down misere. Think about it – Telstra offered you the opportunity to buy its shares on 55% deposit with interest free terms for 18 months. Best of all, even though you had paid for little more than half of the shares, you were still entitled to the full dividend. 

At date of writing, T3 were selling at $2.70 which is a hefty capital gain on the initial instalment payment of $2. The icing on the cake is the franked dividends that have come as well. They total 28 cents with a further dividend of 14 cents to be paid on 7 April.

Investors like me who have stuck with Telstra through good times and bad have enjoyed franked dividends totalling $2.75 a share. ,If you hold T3, your choice is to take the money and run before May, or simply hang in there and pay the extra $1.60 a share then. If you decide to sell, you have to decide whether you will sell before the dividend is paid, or collect the dividend and then sell at a price which will probably be about 14 cents lower than the current price because the buyer will not receive the dividend. The best strategy will depend on your tax position.

Another factor to consider is the loyalty bonus.  The T3 prospectus stated "If you hold your Instalment Receipts until 15 May 2008 and pay the final instalment on time, you will receive an additional share for every 25 instalment receipts held".  On the face of it, it would seem that anybody who has held T3 from the beginning will be entitled to an additional Telstra share for every 25 instalment receipts held

Unless you are strapped for cash, my preference is to take up the offer and stick with Telstra. They are one of the bluest of our blue chip companies and, love him or hate him, Sol Trujillo has turned the company around. Their 3G network has been one of the world’s most successful telecommunications investments and they are gaining increasing market share in their broadband products. Yes, the road ahead may still have bumps along the way, but the indications are that the journey will still be a rewarding one.

Question:   I am 54, semi-retired and self-employed, with super and shares worth over $500,000.  How can I minimise my future CGT most effectively if I move into an investment property I have owned and rented out for seven years?  I intend to live in the property for at least five years and sell the house my wife and I currently live in.

Answer:   The CGT on the rental property will be apportioned on a time basis.  For example, if you own it for a total of 12 years, and rent it out for seven, you will be liable for CGT on 7/12ths of the increase in value.  However, as you’ve had it for over a year you will be entitled to a 50% discount, which will reduce the taxable gain to just 3/12ths of any increase after buying and selling costs and capital expenditure has been taken into account.

Question :  You recently stated regarding cashing in units in a managed fund, “you may find that Capital Gains Tax is relatively small because you would have already paid tax on the distributions and they now form part of the cost base”.  Does this mean that in keeping a record of the cost of the units allocated for reinvestment of income I should add the cost of the tax I pay on the income e.g. if I receive a dividend of $100 reinvested, and on paying 30% income tax, would the cost base of the units allocated be $130? 

Answer :     You cannot add the tax you pay to the cost base of the investment but I will give a simple example which I hope will make everything clear.  Suppose you invest $100,000 in a managed fund and that fund makes a taxable distribution of $10,000.  If that distribution was reinvested the cost base of your investment for CGT purposes would rise to $110,000, and you would have to declare $10,000 as taxable income.  Tax at your marginal rate would be payable on that extra income.

Question  :  I am 51 on a salary of $62,000 per annum and would like to retire at 60.  I have super of $180,000 and own my home worth $700,000.  I am very keen to invest most of my cash savings of $100,000 into aggressive superannuation Australian equity managed funds.  Am I correct in believing that once this money is invested in super it would be inaccessible until I am 55?  I also have a $220,000 line of credit and am thinking of investing $100,000 of this in the same type of funds, claiming the interest on the borrowing as a tax deduction, however I have concerns about the 15% entry tax.  I would appreciate your comments on these strategies.

Answer :  Yes, the money could not be withdrawn until you reach 55 and retire, but a member of a superannuation fund can always change the asset mix within that fund when they wish, or roll the balance into another superannuation fund.  If you borrow money to place funds into superannuation you cannot claim a tax deduction for the interest - there is no 15% contributions tax on undeducted contributions.  The entry tax applies only to contributions for which somebody has claimed a tax deduction.

10^th March 2008

An innovative, yet unethical, trading practice has reared its ugly head at Australian investors - and it’s making speculative traders millions, as it scares the living daylights out of investors. 

It works like this.  Suppose you are a major trader in world markets and want to make a fast buck out of the present uncertainty.  First of all you go to an institution and pay a fee to borrow a few million dollars worth of shares in a heavily traded company such as BHP, Rio or the Commonwealth Bank.  You then dump these shares on the market and deposit the sale proceeds in an interest bearing account where they can earn you a safe seven percent.  This is called short selling because you are effectively selling shares you don’t own in the expectation that their price will be cheaper in the future and you can buy them back.

If all goes as planned, the selling pressure you have created will drive the price of the share down and in a week or month or so you can buy them back at a cheaper price and then return them to the institution you borrowed them from in the first place. 

The growing popularity of margin lending is another factor that works in favour of the traders.   The traders prefer shorting shares that are favourites of investors who use margin lending because they know that the selling pressure and price slumps caused by short selling, will trigger margin calls for those investors who are heavily geared.  The borrowers are forced to dump their shares on a falling manipulated market adding further selling pressure and pushing the price down further.  Once again, the traders win.

But wait – there’s more.  If a person takes out a margin loan the lender in many cases has control over the shares it holds as security.  During the recent market turmoil it’s been discovered that some margin loan lenders were the ones who lent the shares to the speculators who in turn caused the pressure that triggered the margin calls that had such a devastating affect on the portfolios of those who had borrowed.  That is a huge conflict of interest.

Of course the by product of this volatility is investor nervousness.  Retirees are now glued to their computer screens at night watching the value of their superannuation go up and down and most of them don’t understand that their worries are due to the activities of traders not from any inherent problems in our major companies.

The message to all of you who have invested for the long term, is to sit tight and not to worry.  Price fluctuations caused by traders don’t have a thing to do with the inherent value of the share itself.  Get some revenge on the traders by using price dips as a time to buy, not a time to sell.

Question:   I am 68, my wife is almost 61, and we are both still working. We have two investment properties, one in joint names and one in my wife's name only. I intend to retire in the next 12 months, but my wife intends working for the next two to three years. Is there a way to minimise the CGT on selling these properties, given the recent superannuation changes?  The capital gain is around $125,000 - $150,000 on each property.

Answer:   You can make a contribution to super and claim a tax deduction but be aware that you cannot claim a tax deduction if an employer is paying superannuation for you unless your PAYG income is less than 10% of your total income.  Take advice because you will need to take great care in arranging your affairs so that the property is sold at a time when you are eligible to contribute to super and at the same time claim a tax deduction of up to $100,000.

Question  :  Recently I inherited a substantial portfolio of shares which are now registered in my name.  I have no desire or need to sell these and would like to change the portfolio to joint ownership with my wife and so gain the obvious tax advantage of the split.  Should I wait until after 12 months ownership to convert and what tax if any would apply to the conversion.

Answer :      The 12 months rule runs from the date the deceased acquired the shares not the date of death.   Your accountant will be able to do the CGT numbers for you but keep in mind that you may be able to reduce part of the CGT liability if you are eligible to contribute to superannuation and also eligible to claim a tax deduction for your contribution.

Question:   At the moment I have nowhere to live and no money to find anywhere.  Am I able to withdraw some of my super?

Answer:   Unless you have reached age 55 and state you are permanently retired, you cannot access your superannuation unless you make a special claim under the hardship provisions.  These are designed to make it difficult to withdraw your super prior to your preservation age, and one of the conditions is that you are in receipt of Centrelink benefits.

Monday, 3 March 2008

Big losses make big news, and headlines everywhere are telling us about the pain being felt as plunging markets trigger margin calls and investors who were caught short are forced to dump assets at fire sale prices.  

Yes it can be scary, but the simple fact of life that over the long haul Australian shares have been one of the best investment classes of all with a return of 13 percent per annum for the period January 1980 to January 2008.  This means an investment of $100,000 made 27 years ago in a managed fund that matched the All Ordinaries Accumulation Index (AOAI), would now be worth $3.03 million even taking the recent losses into account. 

It’s another fact of life that borrowing magnifies the outcome – negative or positive.  If you buy $100,000 worth of shares with a $20,000 deposit, you have doubled your money when they rise to $120,000 but have lost everything, at least on paper, if they fall to $80,000.

When you take out a margin loan, the only security the lender has is the shares themselves and so to protect itself, will require that you maintain a margin between what you owe and the value of the shares. This is known as your loan to valuation ratio (LVR).

If the market falls, and the value of your portfolio falls to a level where you are below your LVR, you may receive a “margin call”. This is a request from the lender to provide additional security by way of cash or more shares. If you cannot do this, the lender may force you to sell shares to reduce your debt back to within its agreed loan to valuation ratio. The result may be that you are forced to dump quality shares at the worst possible time.

There have been some huge margin calls that have made the front pages in the last week, but they were invariably the result of heavy speculation in a single stock that has plunged in value.  There have been few, if any, margin calls on investors who have chosen top quality share trusts because the AOAI itself has not fallen far enough to trigger them.  

Margin lending remains a great wealth building tool, but like all tools it should be used with respect.  This means you should start with a conservative LVR, reinvest all income to continually boost your equity and ensure the portfolio is spread across a wide range of blue chip shares to minimise an extreme loss if one of them goes bad.  If possible you should also establish an unused line of credit loan that can be drawn on quickly if the market goes down.  This has a double benefit - it will enable you to top up your margin loan if you do get a margin call so you will never have to dump shares on a bad market, and will also give you immediate capital if you decide to buy while the bargains are still out there.

Question:   I am a single 43 year old with a fixed mortgage of $205,000 and $70,000 in super. When my mortgage comes up for renegotiation I am considering swapping to an interest-only loan for a few years and putting the difference - $600 a month before tax - into my super.  Would this be a sensible option or should I just keep paying off as much of my mortgage as possible?

Answer:    There are merits in your proposed strategy but my concern is that you are at least 12 years away from retirement and would be leaving yourself open to changes in the rules as well as interest rate rises.  It would be a tragedy if you found yourself unable to pay your mortgage repayments and at the same time with a large amount in superannuation.  I suggest you focus on paying off the mortgage until you are 50, and then re-visit the situation.

Question  :  I turn 50 soon.  What is my maximum salary sacrifice amount?  Is it $50,000 or $100,000 until July 2012?

Answer :  Until 30^th June 2012, a person who has turned 50 in the financial year is eligible for a deductible contribution of up to $100,000 for that financial year.  Provided you turn 50 before 1 July 2008 you will be eligible for the $100,000 contribution for the current financial year.  If your birthday is in the second half of 2008, you will have a limit of $50,000 for the year ending 30 June 2008, but $100,000 for the year ending 30 June 2009.

Question:   I am 34 and have no loans or assets. I came back to Australia in November and so I expect this financial year my income will be about $28,000. I would like to take advantage of this low income tax bracket.  I am aware that I can invest $1,000 after tax into superannuation and the government will contribute $1,500.  Is there any other way I can take advantage of my low tax bracket? I have $5,000 to invest.

Answer:   As well as taking advantage of the superannuation co contribution, you do enjoy an advantage in investing in shares that pay franked dividends.  For people in your tax bracket, the dividends are not just tax-free, they also carry a tax-free bonus. 

Question:   Every article I read says you can access lump sums from your super at 60. However a fund manager, and the ATO advice line, told me I have to satisfy a condition of release - eg be retired.  Could you please clarify this for me?

Answer:   You can access your superannuation at age 60 provided you trigger a condition of release – this means you have to retire from a job, it need not be your main job.  You can also access your superannuation as an income stream by starting a transition to retirement pension.

25^th February 2008

Today we will talk about eligibility for the age pension.  The system has changed dramatically since the “bad old days” when even the loss of a dollar of pension meant the end of the prized fringe benefits which enabled the friendly local bank manager to boost his profits by encouraging pensioners to leave all their money in interest free accounts.  Now most of the fringe benefits are available to those who receive a part pension and the deeming system gives pensioners a fair go while rewarding those who make the effort to work their money a bit harder.

The base rate for the aged pension for a couple is now $449.10 a fortnight each, and for a single pensioner $537.70 a fortnight - these numbers prevail provided income does not exceed $232 a fortnight for couples and $132 for singles.  They reduce by 40 cents for each dollar of income earned in excess of these amounts and cut out completely when income reaches $2492 a fortnight ($64,792 per annum) for a couple and $1490.75 ($38,759.50)  for a single person. 

There is also an assets test. Under the assets test the full pension is payable provided assessable assets do not exceed $236,500 for a homeowner couple, and $166,750 for a homeowner single pensioner.  The numbers for non-homeowners are $357,500, and $287,750 respectively.  Assets in excess of these figures are subject to a taper test which means the pension is reduced by $1.50 a fortnight for each additional $1,000 in assessable assets.  

This means that the cut-off point for a homeowner couple is $839,500 and for a single pensioner $529,250.  For non-homeowners the numbers are $960,500 and $650,250 respectively. 

The value of your assets does not include your family 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 part aged pension and all the goodies that go with it. 

You can reduce your assets by gifting part of your money away but seek advice before you do it.  The 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 gift away $10,000 before June 30^th and $10,000 just after it, and so reduce their assessable assets by $20,000.

Question  :  I want to maximise my retirement benefits.  I am 61 and expect to work until at least 65.  I currently work for 4 days a week on a salary of $63,000pa.  My apartment is worth around $480,000 and I am repaying a $43,000 mortgage balance at $552 per fortnight.  The balance of my super is $200,000.  Should I begin an allocated pension now and salary sacrifice accordingly?  Should I stop paying off my mortgage and salary sacrifice instead?

Answer :   Talk to your adviser about a transition to retirement pension.  You could salary sacrifice up to $33,000 into a separate superannuation fund and at the same time convert your existing superannuation fund to an allocated pension fund.  This fund would then be a tax-free fund and you could draw a tax-free allocated pension from it to compensate for the reduced income in your pay packet.

Question  :  I am 62, working, salary sacrifice and live on an allocated pension.  I have an allocated pension fund and a normal type accumulation fund which my wife and I don’t need to touch for the time being.  Can you please advise on tax payable for the earnings and withdrawals on each account for the year ended June 2007.  If tax is nil in each of these instances, what is the point of having an allocated pension now that  30^th June has passed?  If tax is payable at 15% on earnings or withdrawals from the normal account, does the fund pay it or do I, and if so, when and how?

Answer :  The superannuation fund will pay income tax at 15% - the allocated pension fund will pay no tax.  From June 30^th 2007 all withdrawals from the super fund or the allocated pension fund have been tax-free.    It is certainly worthwhile having an allocated pension fund because the after-tax earnings will obviously be more than your earnings within superannuation. 

Question:   I am 36 married and both my husband and I have a combined gross income of $220,000. We have recently purchased our first home and are approximately $480,000 in debt. We have sufficient income to cover our monthly expenses including repayments on the loan (P & I) and our house would now be worth somewhere between $550-$600,000. We are not looking to sell the home. We have no other forms of investment or assets. Can you suggest how we can reduce our debt even more at a rapid pace? Can we enter into an interest only loan with the bank, and if so would it be more beneficial to us in repaying the loan quicker?

Answer:   The ideal mortgage repayment would be $5800 a month if you can afford it because this would have it paid off in ten years with minimal interest.  You could use surplus income to borrow for investment for property or shares – the interest on this loan would be tax deductible.

20^th February 2008

Time seems to pass more quickly as you grow older but it is never too late to adopt strategies that can make a major difference to your retirement. Here are some examples.

He is 48, she is 45 and they are now in the blissful situation where the house is paid off and the kids, even though still living at home, are past the expensive years.  They were too focussed on paying the bills and the mortgage to worry about financial planning, but after visiting a financial adviser, decide they are never going to have enough for retirement unless she gets a part time job.  Finding a job is a cinch in this tight labour market and she has no trouble getting three days a week work which returns $25,000 a year.  If she relies on the boss’s nine percent compulsory superannuation contribution, she will have $148,000 in super at age 65.  However, the simple strategy of making an additional contribution of $1000 a year into super as a non-concessional contribution, to become eligible for the $1500 government co contribution, means that her final super nest egg will be $287,000.  Just putting away an extra $20 a week means an additional $139,000 in retirement.

Think about a woman who is single, aged 55, earning $48,000 a year and has $200,000 in superannuation as well as her own home.  She salary sacrifices $20,000 a year into super.  To ensure the same level of net income is received she starts a transition to retirement pension of $17,000 a year from her superannuation. This saves her $3,750 a year in tax, and  increases her co contribution by $150 a year, - this gives her total extra benefits of $39,000over the next 10 years.

Salary sacrifice is the best strategy of all for boosting your wealth.  Suppose you are in the 41.5 percent tax bracket and were paying $3000 a year in non deductible life insurance premiums – the pre tax equivalent for a person in this tax bracket is $5127.  If they rearranged their affairs so an additional $3000 a year was salary sacrificed to super, and the $3000 premium was paid out of the super, they would give themselves an additional $2127 a year.  That would be enough to pay the interest on a margin loan of $25,000.

These case studies show how simple, inexpensive strategies can make a major difference to the amount of money you have in retirement. No-one can slow the passing of time, but you can make it work for you financially by acting now.

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Question  :  My wife and I are 49 and own our home.  We own $500,000 in shares and also have super.  We also salary sacrifice.  My wife has $170,000 in super, whereas I am in a defined benefit plan.  Should we increase salary sacrifice and live off the shares or sell shares and make undeducted contributions or start a self managed super fund?  I salary sacrifice into a second super scheme and we earn $70,000 a year each.

Answer :  Provided you are prepared to lose access to your money until your preservation age, you are always better off to salary sacrifice, provided your reduced salary is not less than $30,000 a year which is the point where the 15% tax bracket changes to the 30% tax bracket.   It is certainly wise to hold your shares within super so a self managed fund would be appropriate for you if you are a keen DIY investor.  However, you need to take into account the cost of CGT which would be triggered if the shares were moved out of your name.  If an employer is paying superannuation for you, you cannot claim a tax deduction for your own contributions unless your PAYG income is less than 10% of your total income.

Question  :  I am thinking of moving in the near future but I am unsure of how to finance a new home.  I am 55, own my current home worth about $250,000 and have $102,000 in unrestricted superannuation which I am reluctant to touch.  Could you please advise the best method of financing the new home?

Answer :   If you retain your original home you could borrow the entire purchase price of the new home using the old one as security.  The problem with this is that you would be paying tax on the rents from the old home while carrying the burden of a large non deductible debt on the new one.  Unless you have a good reason to keep the old one, you may be better off to sell it and use the proceeds to buy the new one.

Question  :  My son started a school based apprenticeship but doesn't earn enough for the employer to start superannuation for him. Can he start his own superannuation account and contribute the $1000 a year to receive $1500 from the Government?

Answer :  Yes he is eligible to claim the co contribution even if no employer is paying superannuation for him.  If he keeps it up for five or six years, you will be amazed at how much has accumulated.  Even though he won’t be able to access it, it will give him valuable experience in handling money.

Question  :  Recently, prior to turn 65, I established my own superannuation  fund into which I intend to move assets to take advantage of the new financial climate.  I was not working at that time.  Do I now have to work the required 40 hours in a month which applies to people who open funds after the age of 65?

Answer :  Once you turn 65 you will need to pass the work test to be able to contribute.

13^th February 2008  

Rising interest rates mean that it’s vital that you get that home loan under control as soon as you can, so make sure your repayments are at least $8 per  $1000 a month – that’s $2000 a month on the average loan of $250,000. This is based on  a 22 year term if interest rates average eight percent per annum.

Next,  immediately switch to weekly or fortnightly payments. Because there are 26 fortnights, but only 12 calendar months, in a year, you  will be effectively raising your repayments from $2000 a month to $2186 a month – this will save you $61,000 in interest and slash the term to 18 years. And the best news of all is that you won’t even feel the extra payments as they are debited direct to your bank account.

School fees are easy to handle with a bit of forethought. Think about a couple with a three year old who wish to start an investment program to pay $8000 a year school fees when the child reaches 13. The solution is to arrange a regular gearing plan with their financial adviser - they put away a set sum each month, which is boosted with