No Boundaries

Noels' Money Column

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

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Monday, 1 March 2010

The eligibility rules for Centrelink benefits are continually being tightened but there are still avenues to increase your entitlements if you seek good advice.

One of the simplest strategies is to spend money improving your home, or going on a holiday. The value of the family home and any adjacent private land of up to two hectares are exempt from the assets test, therefore spending on items such as renovations or repairs enables you to improve the asset, enjoy a better lifestyle and at the same time boost your benefits.

It is common for people to take a holiday when they retire but in some situations it may be worthwhile to take it earlier, or at least prepay it.

These strategies may be particularly effective if a spouse has died and the survivor moves from the couple assets test to the single assets test. Suppose a couple had assessable assets of $650,000 - well below the maximum allowed under the assets test as a couple. Unfortunately the cut off point for the single pensioner assets test is $626,000, so the surviving partner would lose their pension, and most of the fringe benefits, on the death of their loved one. By spending $70,000 on renovations and travel, the assessable assets are reduced to $580,000 and a part pension is retained.

It is also a useful strategy for a person who is trying to receive the Newstart allowance. Suppose a person aged 53 had total assessable assets of $200,000 including cash and managed funds of $180,000. No Newstart would be payable because the cut off point is $178,000 for a single. Spending $25,000 on the home and on travel would reduce assessable assets to below the threshold and so Newstart would be payable as long as the applicant had passed the income test.

Question: I am 63 and self employed doing casual jobs around the neighbourhood. My taxable income for this financial year will be $4700 which is under the taxable threshold. Will I be eligible for the $1000 government super co-contribution if I contribute $1000 from my earnings?

Answer: You appear to be eligible for the co-contribution because on the information supplied you are self employed.

Question: I am 81 and my wife is 78. Our wills stipulates that if one of us should die $50,000 goes to our daughter, $50,000 goes to our son, and the remainder to the surviving partner. I sthere any tax payable on these amounts? We are both aged pensioners.

Answer: If the amount bequeathed is in cash there would be no tax payable by the beneficiaries but if money was left to them in the form of assets such as shares there could be capital gains tax to pay if these assets carried a capital gains tax liability and they sold them. However, in that case, there would be no CGT triggered until the assets were actually disposed of. May I congratulate you on clever estate planning, because too many pensioners in your situation leave all their assets to each other and find themselves with a severe reduction in their pension when one spouse dies and the remaining spouse is assessed under the single assets and income test.

Question: I was wondering if you have heard of any proposals by the Government to tamper with the current negative gearing rules, particularly in relation to claiming rental expenses against income.

Answer: For as long as I have been writing columns in this newspaper there have been rumours that the government is going to change the negative gearing rules. Obviously this matter is likely to be addressed in the Henry review of taxation but I would be most surprised if any major changes occur. Remember, it was tried once and was quickly repealed.

22 FEBRUARY 2010

“How do we help our children financially?” is a much asked question. It sounds simple enough but can become a challenging task.

In our home we work on two basic tenets. First, a parent’s primary duty is to help their children become the best they are capable of being. Second, it is better to progressively gift them assets when they are young and battling instead of waiting until a time when you are 85 years of age, and they might be nearing retirement.

Of course, these two goals may not be complementary. Every human being needs to learn self reliance, but every time you do things for them which they should be doing for themselves, you decrease their ability to become self reliant. That is why we walk the tightrope of giving a helping hand where it is needed and yet not shielding them from problems which will help them grow.

But achieving that goal need not necessarily mean giving all your children equal amounts of cash. One of your children may be totally fulfilled working as a counsellor for a non profit organisation – the other may have the talent and drive to be a high income earning professional. As like tends to marry like, you could easily find yourself in a situation where one of your children and their partner earns ten times the earnings of the other one and their partner.

Given these circumstances it may be extremely difficult for the lower earning family to give you grandchildren without your help because they may find it impossible to live on one income. Surely, if all other things are equal, this is the child that should be favoured in the early stages if you have spare money which can be used to help out.

Financial incentives for saving work well too. If you are trying to encourage your child to save a deposit for a home you could offer to give them a dollar for every dollar they save, up to a set figure. It’s a win win - they get 100% on their money and you get the joy of watching them become smart savers.

Certainly it’s appropriate to help if your child faces a financial crisis because of an event such as illness that is our of their control,. But it’s a different matter entirely if they are in financial strife through financial ineptitude, because as sure as night follows day, they will never learn to manage money properly if you keep bailing them out. As painful as it may be, you are much better off to sit back and watch the power being turned off and the car being repossessed, because these are the lessons they need to get their lives in order. Moral support, yes – money, no.

Yes – it is a challenge, but remember two other basic principles. It is better to teach them how to make money than to give it to them, and what you don’t spend in your lifetime they will. Think about that next time you are scrimping on a holiday.

Question: In a recent column you mentioned the case of the 52 year old wife and the husband turning 60 in November. From what I read, I got the impression that as soon as one turns 60 years old, one can freely withdraw from their super. Is this correct, or are there conditions that have to be met before one can withdraw from super - i.e. one should retire from work?

Answer: You can withdraw your superannuation freely once you reach 65 but at age 60 you have to trigger a condition of release. To do this you have to resign from a job - it need not be your main job. Of course, a person aged 60 could stay in their present job and access part of their superannuation as a lump sum by use of a transition to retirement pension.

Question: We have just built a new property and unfortunately have to move for work reasons. We have never lived in the property but expect to move in after two years of renting it. Will we be eligible to claim the property as our main residence and avoid CGT?

Answer: If you rent the property and then move out of it you will be liable for CGT on a pro rata basis according to the time it was rented out. But if you move into it for a while before you rent it out you will be able to be absent from it for up to six years without losing the CGT exemption provided you do not claim any other property as your principal residence in that time.

Question: My husband and I are both 50 years old and a financial adviser suggested we change our principal and interest home loan to an interest only loan so we can feed funds into superannuation. Once we retire the plan is to pay the mortgage out with the superannuation. Our home is worth approximately $900,000 and we have a $250,000 mortgage.

We have approximately $140,000 super between the two of us, and have teenage sons, so our expenses will be high for the next ten years. What do you think of this strategy?

Answer: That is very good advice because money salary sacrificed to super loses just 15% whereas money taken in hand would normally lose at least 31.5%. Also, because of your age you have little fear of the laws changing to restrict the amount that can be withdrawn tax free once you reach 60.

15 February 2010

One of the great tragedies of life is the amount of money that were fritter away. The solution is to use a tool called a budget, to take control of your finances and ensure that you start to capture some of your hard earned dollars and not waste them.

If you do a budget and stick to it, you will make sure that your savings get the priority they deserve. There are two ways to do it: (1) Prepare a detailed budget, or (2) Do what I call a Clayton’s Budget - that’s the budget you have when you haven’t got a budget.

If you want to do a detailed budget you will need to list all your expenses on a piece of paper and review it regularly. This is far too much trouble for most people, so if you are one of these, use the Clayton’s Budget. It works well and takes little time.

First, decide on the level of saving and investment necessary to reach your goal, and have that deducted from your pay and placed in a separate bank account. Your investment program is in place.

Next, add up all your fixed essential expenses such as rent, loan repayments, insurance, and car registration. Then divide the total by the number of pay days in the year. For example if the total comes to $26 000, and you get paid fortnightly, divide $26 000 by 26 which is $1,000. This is amount should be taken from each pay and banked into another account that is kept just for paying the bills you just listed. Provided you use this account for these bills only, you should never have a problem paying them again. The money will always be there waiting for them.

Now open special purpose accounts for your Christmas and holiday spending and put an appropriate amount in each of these each payday. That takes care of them.

Look what you have achieved when you do this. Your money plan will be on track, there is money waiting to pay your bills, and your investment program is up and running. Provided you don't go dipping into those special purpose accounts, and you avoid the temptation to borrow money for items that fall in value, you will have your financial affairs in order.

Question: Am I able to deposit up to $500,000 of capital gains from a sale of a property if I am a sole trader consulting for one company only and working approx 20 to 40 hours per month? I am 64 years of age.

Answer: As you are under 65 you can contribute to super, working or not, but you should understand that non concessional contributions are limited to $150,000 a year and concessional contributions to $50,000 a year. Fortunately, as you are only 64 you can bring forward three years non concessional contributions and contribute $450,000 in one go. The tone of your question indicates to me that you are trying to reduce capital gains tax - if that is the case be aware that only $50,000 can be claimed as a tax deduction.

Question: What world is Noel Whittaker living in with his $12 per $1,000 a month home loan repayment rule? Firstly $400,000 is not going to buy any more than a small unit - a loan of $500,000 plus is needed for a decent family home. Using Noel's rule gives optimal repayments of $6,000+ a month ($72,000+ per year) - more than the average income. Then he has the audacity to conclude with the statement "any spare funds can be directed to investments." How should an earner on an average income meet Noel's rule when they struggle to meet the minimum monthly loan repayments? Not everyone is on a six (or seven) figure salary like readers could be lead to believe by reading your column.

Answer: Your statement assumes that everybody who reads this column owes 100% of the value of their house. There are many Australians who have relatively small home loans and this is due to a variety of reasons that include downsizing, fast repayment of debt because of two incomes, marital break up or being in receipt of a legacy. The question for them is whether they should start an investment plan immediately or hold off until their house is paid off. Because of the way compound interest works there is very little interest to be saved by speeding up repayments on a housing loan once the term is down to ten years. People who are fortunate enough to be able to pay $12 a thousand a month on their housing loan are therefore better off to leave the payments at that level and take advice about borrowing for investment.

Question: I am a 34 year old woman. I have never invested before but am now at the stage where I would like to start to build up a nest egg. I am married, with a combined income of around $150,000, a mortgage of $449,000, and savings of $23,000. I immigrated to Australia in 2008 and so have very little super built up. Currently I put all my savings into my mortgage to offset it. I have no knowledge of stocks and shares but feel there could be a way of investing my savings more wisely. What is my next step?

Answer: Congratulations on your awareness that it is better to start an investment plan sooner rather than later. Your next step should be to talk to an investment adviser with the aim of making a long term plan for your future. The adviser should be able to help you decide when you want to retire, how much you will need then, and what strategies are available to speed up the process. There are now a wide range of managed funds for people who are not comfortable choosing their own shares and the adviser will help you find one suitable for you.

Monday, 8 February 2010

Dunn & Bradstreet have just released their quarterly Consumer Credit Expectations Survey and it presents a worrying picture indeed. 15% of Australians expect to apply for an increase in their credit card limit in the coming months, and more than 43% of Australians expect they will need to use their credit card to pay bills because it is the only way they can get by.

A third of all Australians indicated they were now concerned about the amount of money they have spent over the Christmas period, while 10% believe they will have trouble paying for the items they have bought.

Let’s get one thing perfectly clear – if you have to use your credit card or any other form of borrowing to pay your bills you are living beyond your means, and are spending more than you earn.

It’s the start of a vicious cycle. You can’t live on what you earn so you borrow money to make up the difference. But the borrowings themselves require extra expenditure by way of loan repayments and your already insufficient income is further reduced by having to find loan repayments. As the loan repayments take a bigger chunk of your income you need to borrow more each month to keep up, and your financial situation gets progressively worse.

Painful as it may be, the only option now if you have trouble paying your bills, is to reduce your expenses drastically. If you continue to overspend your financial situation will get tougher and tougher, and you are almost certainly going to end up with a very bad credit record.

The best way to get on track is to draw up a simple budget. Next week I will show you how to do it.

Question: My husband is a 75 year old self funded retiree and I am 71 and work part time. We would access government benefits only if we are eligible and only if we really had to. We have three children who have agreed the family home can be left to one person. What are the pros and cons of leaving the family home in our wills, or transferring ownership earlier, and in both situations - being self funded or being a pensioner?

Answer: There is a price to pay for every decision you make. If you transfer the house to one of your children, and continue to live in it, you could find yourself dispossessed if the relationship breaks down and the house becomes part of the property settlement. For five years the value of the house will be counted by Centrelink as an asset but then would cease to exist for pension eligibility purposes. Depending on your other assets this may enable you to claim a part aged pension and the accompanying fringe benefits. Of course, once you put yourself under the aged pension system you leave yourself open to changes in the regulations which are looking increasingly likely as the government struggles to balance its budget. In view of your statement that you have no great desire to access the Centrelink system my preference would be to retain the home and allow it to pass to the appropriate beneficiary when you die. This will give you maximum control and flexibility while you are alive.

Question: We would like to retire in four years time. I am 56 years of age earning $96,000 per year, and my wife is 54 and earns $30,000. We own our home worth $300,000; have shares in a managed fund of $186,000, plus $652,000 in super. We have a CBA loan and a margin lending loan worth $126,000 - paying interest only. I currently salary sacrifice $850 a fortnight into super. We have an additional cash flow of $2,000 a month - should I increase my salary sacrifice contributions, pay off the loans or invest in shares?

Answer: Part of your income is in the 39.5% bracket and part is in the 31.5% bracket therefore you can make substantial tax savings by salary sacrificing up to $50,000 a year into super as such contributions will lose just 15% entry tax. The investment loan should be on an interest only basis while you are still working to maximise your tax benefits and the increased contributions to super will be providing a growing sum that can be withdrawn tax free when you reach 60 to pay the loans off then. The most tax effective way to invest in shares would be through your super.

Monday, 1 February 2010

There are indications that many first home buyers who jumped into the market when interest rates were at record lows are now experiencing financial difficulties.

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. 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 .

THREE. 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.

FOUR If you are 55 or over, seek advice about boosting your household income by accessing part of your superannuation as a transition to retirement pension.

FIVE 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: I am 63 and retired. In 2009/10 I shall make a net and discounted capital gain profit of $180,000 from the sale of my investment property. I intend to make a before tax maximum concessional contribution to my super fund in order to minimise income tax exposure.

Can I withdraw this super contribution tax free by income stream and/or lump sum in 2010/11 and thereafter?

Answer: The maximum deductible contribution you can make is $50,000, and it will suffer a 15% contributions tax, so you will still have a hefty amount of capital gains tax to pay. You could certainly withdraw any part of your superannuation tax free now that you have reached 60 and retired.

Question: I was born in 1946 and my wife in 1948. I will be able to retire at age 65 – when will my wife be able to retire?

Answer: She can retire whenever she wishes but pensionable age for a person born in 1948 is 64.5 years. Once you turn 65 you may be eligible for a part Centrelink Age pension and money held in your wife's name will not be taken into account until she reaches pensionable age herself.

Question: My wife and I are thinking of buying a second property, however, I am the main money earner (95%) and pay quite a bit of tax. We want to reduce my tax but I cannot get the property loan solely on my own. Can we get the loan in both our names and keep the title in my name only to get the maximum tax benefit?

Answer: Keep in mind that buying an investment property is usually a long term process and you could be in very different tax brackets if you sell it in twenty years time. However, I do agree that it is better to take a tax break sooner rather than later so talk to your accountant and your bank about the possibility of buying the house in your name with the loan in your name but with additional security over the additional house and also a guarantee from your wife. This should keep everybody happy.

Monday, 25 January 2010

Superannuation can provide opportunities to save capital gains tax in certain circumstances.

First understand you can’t simply transfer an asset into superannuation to avoid CGT – any transfer is regarded as a disposal, which will trigger CGT if there is a profit. The way to reduce or eliminate CGT is to contribute part of the proceeds of the sale into super and then claim part of the contribution as a tax deduction.

The maximum that can be claimed is $25,000 in any one year but transitional measures will allow those aged 50 and over to claim $50,000 a year until June 2012.

CASE STUDY: Julie, aged 63, who is retiring in June 2010, has decided to sell in July 2010 an investment property which she bought three years ago for $390,000 and which would now sell for $490,000 after agent’s commission and other expenses. The taxable gain is $100,000, but after the 50% concession is applied, the realised capital gain will add $50,000 to her present taxable income of $30,000 a year. She makes a contribution to superannuation of $200,000 from the sales proceeds, and claims $50,000 of it as a tax deduction.

There will be an entry tax of 15% ($7500) levied on the deductible proportion of $50,000 but there will be no entry tax on the undeducted portion of $150,000. This strategy has wiped out her CGT bill. She has also substantially added to her superannuation retirement nest egg.

There are two important rules to note. You cannot contribute to superannuation after age 65 unless you pass a work test, which involves being in paid employment for at least 40 hours over 30 consecutive days and you can’t claim a tax deduction for your contribution if an employer has made contributions for you in the year you wish to claim the tax deduction unless your PAYG income is no more than 10% of total income..

As always take good advice before you act as getting it wrong may negate the entire benefit.

Question: I am 65 years old and will retire in a year or so. I have about $50k in listed shares. Would it be better for me to sell those shares and put the money into super?

Answer: It depends on the extent of your other assets because the main purpose of superannuation is to save tax. If you have a large superannuation balance now, and substantial funds outside super, it would certainly be worthwhile investigating transferring the shares to super. However, if your financial assets are fairly small you may well find that transferring into your superannuation would not save you any tax.

Question: I am trying to open up a business and set up a family trust. How will the trust work for me? People have been telling me to set it up a certain way.

Answer: The purpose of a family trust is to put a shield between your family and potential creditors, and to minimise tax by giving you the ability to divert income to other family members who may be on lower taxable incomes than you would be if all the income from the business flowed to you. A discretionary family trust usually works well if you are starting a business but it is essential you get advice from an accountant before the business commences. It is extremely difficult to change direction once the business is a going concern.

Question: I am 68 and my husband is 71. Between us we have $120,000 in super and own our own home worth approximately $475,000. We have no other debts. Currently we receive an age pension.

I have inherited a unit worth $250,000 in today’s market which is currently rented for $300 per week. My husband is keen to downsize and wants me to sell the unit and put the money into a beachside unit of higher value than our current residence. I am reluctant to sell as the unit is an asset paying an income. As you can see we have little superannuation. I don’t mind losing my share of the age pension in order to retain the unit.

Should I hang on to the unit, or sell and downsize with all the money going into a new up-market unit

Answer: First make sure that the unit you have been bequeathed does not carry any capital gains tax liability because, if it did, capital gains tax would be triggered if you sold it. If it is free of CGT you need to decide whether a better lifestyle is more important than having an income from the unit. The unit may pay you an income but you need to keep in mind that your aged pension will be reduced if you kept it, but it would not be reduced if it was sold and the funds put towards buying a new property to live in. Another disadvantage of keeping the unit and renting it out would be ongoing expenses such as rates and maintenance and possible tenant damage. My inclination is to go for the better lifestyle – if money gets short as you get older you could always consider a reverse mortgage.

Monday, 18 January 2010

Recent queries from readers show there is still confusion between account based pensions (allocated pensions) and annuities.

An account based pension is the most popular form of income for retirees. They accumulate money in superannuation while they are working and then when they retire, convert their superannuation fund to an account based pension fund. When this happens, the fund itself becomes a tax free fund. The allocated pension drawn out of it is tax free if they are aged 60 or over..

You can vary your pension and make lump sum withdrawals, and when you die, the unused balance is available for your estate.

When you buy an annuity, you hand the insurance company a lump sum in exchange for a guaranteed income for a set period. How much money, if any, is available at the end of the period depends on the terms of the annuity contract. Often people invest in annuities that will pay them an income for life but which also includes a special provision that if they die within 10 years, the unused portion is paid to their estate.

An account based pension is much more flexible than an annuity but the investor is subject to the performance of the fund. If markets do well and earnings are good, the account based pension fund should grow in value and provide a hefty income in retirement. If markets do badly, you risk running out of money. In contrast, the annuity is inflexible but you do receive a guaranteed income stream for the term of the annuity contract.

Both the account based pension and the annuity are valuable tools for retirees. Just make sure you always consult your adviser and be fully aware of the implications of each product before you invest.

Question: I am 65 years old and will retire in a year or so. I have about $50k in listed shares. Would it be better for me to sell those shares and put the money into super?

Question: I am trying to open up a business and set up a family trust. How will the trust work for me? People have been telling me to set it up a certain way.

Question: I am 68 and my husband is 71. Between us we have $120,000 in super and own our own home worth approximately $475,000. We have no other debts. Currently we receive an age pension.
I have inherited a unit worth $250,000 in today’s market which is currently rented for $300 per week. My husband is keen to downsize and wants me to sell the unit and put the money into a beachside unit of higher value than our current residence. I am reluctant to sell as the unit is an asset paying an income. As you can see we have little superannuation. I don’t mind losing my share of the age pension in order to retain the unit.
Should I hang on to the unit, or sell and downsize with all the money going into a new up-market unit?

Answer: First make sure that the unit you have been bequeathed does not carry any capital gains tax liability because if it did capital gains tax would be triggered if you sold it. If it is free of CGT you need to decide whether a better lifestyle is more important than having an income from the unit. The unit may pay you an income but you need to keep in mind that your aged pension will be reduced if you kept it, but it would not be reduced if it was sold and the funds put towards buying a new property to live in. Another disadvantage of keeping the unit and renting it out would be ongoing expenses such as rates and maintenance and possible tenant damage. My inclination is to go for the better lifestyle – if money gets short as you get older you could always consider a reverse mortgage.

Monday, 11 January 2010

Banks are offering higher and higher interest rates, especially if you are prepared to lock your money away for three years or more, but before making long term commitments like this you should understand the difference between tax on bank deposits and tax on franked dividends from Australian shares.

It works like this. Suppose you received a dividend for $700 – if it was a fully franked dividend it may carry franking (or imputation) credits worth $300. Your $700 dividend comes from after tax profits, and that $300 is your share of the tax the company has paid on those profits.

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

Suppose you are in the 15% tax bracket, which now extends to $35,000 a year. The tax on $1000 is $150, but you have the whole credit of $300 available. In other words, $150 goes to pay your tax on that dividend, and the $150 left over can be used to pay tax n other income you may have earned in that year.

If you earn between $35,000 and $80,000 the tax payable on that $700 dividend would be $300 less $300 in credits – your franked dividends are tax free. If you earn over $180,000, the top bracket, the effective tax on franked dividends is still just 23.6%

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

Question: I am a 55 year old, sole low income earner, with a new family to feed, a $20,000 credit card debt, $100,000 owing on my mortgage and I have $60,000 in my superfund. I have to borrow more money to sustain the household. Should I take money out of my super to reduce my debt? What should I do for the long term apart from strict budgeting and government benefits?

Answer: You cannot withdraw your money from super at age 55unless you sign a statement that you are permanently retired. However, you could start to draw a transition to retirement pension from your super fund which would increase your cash flow to help you pay your current commitments.

Question: We have an investment property which we plan to move into in three years time and then we will sell the family home. This will leave us with a substantial amount of money. We will both continue to work for a few years and we are cautious about super funds. What do you recommend we do with our money so we can live on it as long as possible?

Answer: There is no need to be cautious about super as long as you understand that it is not an asset like property or shares but merely a vehicle that lets you hold assets in a low tax environment. The advantage of super is that you save tax and that your money is protected from creditors if you get into financial difficulties - the disadvantage is that your money is tied up until your preservation age and you are always open to changes in the law. When the proceeds of your property are in the bank you should seek advice to confirm that superannuation is appropriate for you and if so, what mix of assets best suits your goals.

4 January 2010

The start of a new year is a great opportunity to have a good look at your financial affairs and take steps to make changes to ensure that you are making the most of your financial fire power. Remember, the best map in the world is useless if you are lost and don’t know where you are, so take an hour or so to make a list of all your assets and liabilities. Don’t include items such as furniture or motor vehicles as they have no long term value.

Start with your debts and divide them into two categories. The first category is for non deductible debt, which will comprise your housing loan and your personal loans. The second is deductible debt - money that has been borrowed to invest in property and shares. The cost of the interest on your deductible debt is much lower than the cost of the interest on your non deductible debt as the former gets a subsidy from the tax office because of negative gearing. Therefore, you should make sure that all your deductible debt is on an interest only basis – this will free up money to speed up the repayments on your costly non deductible debt.

Of course you should pay off your credit cards before attacking your housing loan because the credit cards carry a higher rate of interest.

If you have line of credit loans, make sure you keep your deductible component separate from your non deductible component, and don’t fall into the trap of depositing your salary into your deductible line of credit loan and then withdrawing money from that loan for personal spending. As the tax office treats each withdrawal as a new loan, the interest on the redrawn portion will not be deductible and you could very quickly lose all your tax benefits.

Question: I own a property, and am looking to buy another. I am currently residing in a rental property paid for by my employer, while my existing property is my principal place of residence for CGT exemption purposes. I may need to rent out the new property I am looking to buy, however it is intended to be my principal place of residence in two to three years time. What are the CGT implications of renting this property immediately after buying?

Answer: If you rent out the new property immediately it will be classified as an investment property from day one and so may not be eligible for stamp duty concessions when you buy it. If you move into it, and eventually sell it, you will be liable for CGT on a pro rata basis based on the time it was rented out. For example, if you owned a property for ten years, and rented it out for two, you would be liable for CGT on just 2/10ths of any profit. Bear in mind you would be eligible for the 50% discount too so CGT should be minimal.

Question: I turn 50 years old in March . I am confused as to when the different superannuation contribution limits for those under or over 50 apply in my case. This has become relevant because of the proposed budget changes where the cap will become $25,000 for those under 50 and $50,000 for those over 50. I am aware of the penalty of high excess tax if I get this wrong. What can I contribute in the 2009/10 financial year?

Answer: Provided you turn 50 during the financial year ended 30 June 2010, you can make total concessional contributions of up to $50,000 without penalty during the financial year commencing 1 July 2009.

Question: Interest only loans are favoured in property investment for their effectiveness in minimizing tax. How can these loans be repaid without having to sell the property? Is a sinking fund the answer?

Answer: I believe a sinking fund is the best strategy you can use but it is important to choose an investment vehicle that will not give you taxable income which will negate the tax benefits of the investment loan. The only two vehicles suitable are insurance bonds and superannuation - the most appropriate one will depend on your age. Your advisor will be able to discuss the pros and cons of each of these vehicles with you but in simple terms the amount of money that can be placed in insurance bonds is limitless, comes from after tax dollars, and can be accessed at any time. In contrast, you can contribute to superannuation in pre-tax dollars but you lose access until your preservation age and there are limits on the amount that can be contributed.

Monday, 7 December 2009

Becoming wealthy is much easier if you start when you are young but it is a sad fact that human nature gets in the way. Until the age of 30, most people spend their money on having fun - then between 30 and 50 they battle to buy a house, pay it off and cope with the school fees. At that stage they suddenly realise that retirement may be less than fifteen years away and desperately start scrimping and saving to try and get together enough money for retirement.

It doesn’t have to be like this – if a person learns good money habits in their teenage years it takes little effort to retire with a large portfolio.

This is why my new book Beginner’s Guide to Wealth is the perfect gift for any young person at Christmas time. As earning a good income is the foundation of wealth, the early chapters teach them how to improve their skills and with it their income. The later chapters explain the best ways to use the surplus money they have accumulated.

The publishers Simon & Schuster have decided not to release the book until January but I have managed to snare some advance copies. The book is available for $24.95 at www.noelwhittaker.com.au where you can view a full table of contents.

Remember, investing is like climbing a mountain. It’s easier to start early and walk up the easy track, rather than leave it to the last minute and sprint up the face.

Question: Which imputation fund has the best track record? I'm looking to put some of my super money into a fund rather than direct shares, but I would like some income – what fees would I have to pay?

Answer: This is something you need to talk over with a financial advisor because there are a large number of imputation funds and some are biased towards growth and others are biased towards income. People who are borrowing for investment would favour the first, but if income is your major consideration you would favour the last mentioned option. Your question does not make it clear whether you are investing outside super with funds that have been redeemed from super or whether you are planning to buy shares within your own super fund. Just make sure you understand that in most cases it is much more effective for tax purposes to hold imputation funds paying high income within the superannuation environment.

Question: My father died last year and left to both of his grandchildren, aged 10 and six years - $20,000 cash plus an equal share in a portfolio of blue chip shares for when they turn 21. Before the global financial crisis the shares were worth about $75,000 each – but not sure now. What do you suggest is the best way to invest or maintain this? There are no conditions but obviously I want something very secure and something which won’t affect our overall tax. I don’t mind keeping the shares as they are - but in whose name? Is it wise to convert to something like a share based investment?

Answer: Your father was obviously a keen share investor and it would be reasonable to believe that he would expect the shares would continue to be held by the children while waiting for the market to recover. I would prefer to leave the shares in the children's name because there is no children's tax implications to worry about as they were legacies. As the children grow older you could put them in touch with a stockbroker and then they could have an ongoing say in the make up of their portfolio.

Question: I read, in one of your previous columns, the optimum home loan repayment is $12 per thousand per month. What does this mean and how does this equate on a $400,000 loan with a 25 year term?

Answer: As you travel through life trying to pay your bills and build wealth at the same time, you should understand that becoming wealthy is like a game of monopoly - the one who does best is the person who can control as many assets as possible. The purpose of my $12 a thousand rule is to enable you to pay your house off in a reasonable time with a minimum of interest and still have money over for investment. On a $400,000 home loan optimum repayments of $12 a thousand a month ($4800) would have the loan paid off in nine years if rates were 6% or ten years if rates were 8%. Because the term is relatively short the rate does not matter too much. Any spare funds can then be directed to investment.

Monday, 30 November 2009

Reverse mortgages are highly effective when used in the right circumstances, but there is still a great degree of misunderstanding about how they work.

The great benefit of reverse mortgages is they enable retirees who are asset rich and cash poor to improve their quality of life while they are still young enough to enjoy it. A loan of just $50,000 could enable them to replace their ageing car that is continually breaking down, refit their kitchen with new appliances and even go on a decent holiday.

Lenders have tried to reduce the undesirable effects of an increasing debt by restricting eligibility to people of mature age, insisting on a low loan to valuation ratio and also setting a limit on the amount that can be borrowed. For example, a lender may limit the amount that can be borrowed by a 65 year old to 15% of valuation and for a 70 year old to 20% of valuation.

The average age of admission to a nursing home is now 85, so if a 70 year old owned a house worth $400,000 and borrowed $50,000, the house would be worth $728,000 in 15 years if capital growth averaged four percent per annum. At that stage the debt would be $191,000, so there would still be a huge margin between the debt and the house value.

The fine print differs between lenders so intending borrowers should involve their family, financial advisor and solicitor to make sure they clearly understand the advantages and disadvantages of the proposed strategy. A good option to prevent the debt growing is for the family to chip in and pay the interest. If the parents took out a reverse mortgage of $50,000 the interest would be about $4,000 a year which would only be $1,333 a year each if split between three children.

Look for a loan that offers progressive draw downs. This allows you to have money available at short notice, yet you are not paying any interest until a withdrawal is made. Obviously the slower you draw the loan down, the slower the debt will grow. This also has benefits if you are receiving an age pension because the withdrawal of a large lump sum may cause you to be assessed by Centrelink on the extra money.

Question: 16 months ago we bought a house and have been renting it back to the previous owners - we presently live in a unit. The previous owners will be ready to move out soon and we will move into our home. We then want to rent out our unit - however I am concerned we may have to pay capital gains tax – is this correct? We are unsure how the tax issue will affect us to make the venture worthwhile.

Answer: There is no capital gains tax payable until an asset is sold. I am sure you know that your residence is free of capital gains tax but you need to understand that you cannot have two principal residences. If you eventually claim the house as your principal residence you will be liable for CGT on any increase in value in the unit from the date you moved out to date of sale. When you sell the house there should be very little CGT to pay because it will be apportioned on a time basis. For example, if you owned it for ten years and rented it out for two years you would pay CGT on just 2/10ths of any gain. .

Question: I wish to draw down on a line of credit facility which is attached to my home loan and make a deposit into my parent's mortgage offset account to effectively negate their loan and any interest charges. As interest on my line of credit is variable I think that this is a way of getting around my parent's fixed, and higher, interest charges. Upon loan maturity in 12 months they will then re-negotiate and pay me back the monies I advanced. Will this work from a technical perspective and is there in fact a net benefit?

Answer: Your proposal seems fundamentally sound provided your parent's bank is prepared to credit interest from the offset account against the interest payable on their fixed loan account. If the money remains in the offset account there should be no problems whatsoever in returning it to you at the appropriate time.

Question: Can you please explain the rule that governs the principal place of residence being rented out? I have not heard of it until recently.

Answer: You can be absent from your residence for up to six years without losing the CGT exemption provided you do not claim any other property as your principal residence in that time. You do not have to return to the property before six years has elapsed to maintain the tax free status but if you own it for more than six years you must return to it and live in it to keep the exemption alive. Once you have re-lived in the property the six year period restarts.

Monday, 16 November 2009

I have often written about the value of salary sacrificing to super because it enables you to take advantage of the difference between the 15% tax levied on deductible contributions and your own marginal tax rate which may be as high as 48.5%. However, a couple of readers have written to say they are concerned that the rules regarding withdrawal of lump sums from super may be changed to prevent you accessing your super before age 67. This would put super in line with the proposed changes to pensionable age.

I think it is most unlikely, because money in superannuation is not counted by Centrelink until you reach pensionable age. Also, the government is well aware that it is very difficult for some people to find work after age 60. This is why the current rules allow you to access your superannuation once you retire after age 55, even though you cannot qualify for a pension until age 65. If your resources run low before you reach pensionable age, you simply apply for other government benefits.

Can you imagine a situation where a person was aged 65, with $1m in super, and was able to qualify for government benefits simply because they could not access their super until age 67.

No, the government is not trying to make us work until age 67, but you need to understand that government budgets are coming under increasing pressure as the population ages. This is why it is important to take advice long before retirement which will give you time to accumulate a nest egg and rely less on handouts from the government.

Question: My partner and I are both 53 years of age and would like to retire at 58. We both salary sacrifice as much as we can - $35,000 for me and $95,000 (last year for her) for her - although the tax benefits are not as helpful for me but I am trying to reduce my assessable income as I will have to pay capital gains tax. We both own a house and will have $120,000 each to put into super from the impending sale of an investment property. In these days of falling super returns would it be wise to change from a growth to cash option strategy until the market improves? I feel as though as soon as I salary sacrifice into super I am losing hard earned money. We are a same sex couple and therefore will continue to have separate super schemes until any legislative changes become law.

Answer: You are not losing your hard earned money when you salary sacrifice to super, you are simply moving it in a tax effective manner to an environment where income tax is just 15 percent. Only you can decide when the market has bottomed but as you are just 53 you most likely have 30 or 40 years of living ahead of you and therefore can take a long term view. I believe trying to second guess the market is a very bad strategy and you are better off to decide upon an asset allocation with your adviser and then stick with it in good times and bad. Just be aware that total sacrificed amounts for people aged 50 and over can now no longer exceed $50,000 a year from all sources so it may pay to seek advice to ensure you do not exceed the limits.

Question: Can you advise if the new contribution limits include the contributions tax components. For example, if a person salary sacrifices say $100, of which $15 makes its way to the ATO, is the $15 to be included in the $50,000. Does this also include the employer’s 9% contribution.

Answer The whole contribution goes into the fund and then is treated as taxable income by the fund. As funds pay income tax of 15% you are effectively losing 15% of your contributions when the funds books are done.

9 November 2009

Recently a couple in their late fifties asked me whether it was better to buy an investment property or salary sacrifice as much as possible into super. If the investment property was a viable strategy, they also wanted to know how to finance it.

Salary sacrificing to super is a great option for anyone who is near retirement because it's unlikely they would be affected adversely by any rule changes, and it also enables them to take advantage of the difference between the 15% tax on super contributions and a marginal tax rate of at least 31.5% if they take the money in their pay packet.

If they decide on the investment property, my recommendation was that they borrow 100% of the purchase price. This can be achieved without mortgage insurance if they offer the bank a mortgage over their existing house property, as well as the property to be purchased. Salary sacrificing to the maximum will enable them to create additional funds in super which could be withdrawn tax free when they retire to pay off their investment debt.

Buying an investment property would work well if they find a bargain, but if they make a bad choice they could find themselves with costly repairs and maintenance bills and also find that capital gain is minimal.

As they already owned their own house, I pointed out they should consider shares to provide diversification, but they felt reluctant to do this because they "know nothing bout them". This is easily solved by using a managed fund where full time professionals make the buy and sell decisions, or by opting for an index fund that simply tracks the movements of the stock exchange. A further benefit of shares is that you can start small and add to your investment as your confidence grows. This is not possible with property as you have to outlay at least $300,000 to buy something reasonable.

Question: What advice would you give to a beginner looking into managed funds as a form of savings? What should I look for in selecting a managed fund?

Answer: I recommend you form a relationship with a good adviser at an early an age as possible. He or she will be able to help you formulate goals and monitor progress so that changes can be made when it is appropriate. They will also help you choose managed funds which are appropriate for your circumstances.

Question: I read an answer to a question re tax deduction claims against rental income, the answer states "get a depreciation report from a quantity surveyor". Why would that be necessary? Is that in relation to the building or the furniture and fittings?

Answer: There are a huge range of tax deductions available when you buy a rental property. These include building allowance in many cases and depreciation on hundred's of items that can even include the motors on your garage doors and the timing devices on gardening water installations. For a once only fee of about $550 tax deductible a quantity surveyor will access the entire property and almost certainly find items that you would never think to include if you were doing it yourself. The schedule prepared also saves considerably in accounting fees.

Question: My wife and I have a young family and are going to outgrow our car soon. We have a combined income of $105,000 with $35,000of equity in our home. The car we have is probably worth about $10,000 as a trade-in. What about re-draw on our mortgage or would a separate car loan be better? What would you suggest would be the better option

Answer: Ideally you would redraw part of your mortgage for the car and increase your total home loan payments. However, because you have a relatively small equity in your home the bank may not allow you to do this. The simplest option is to take out a personal loan - just make sure you opt for the shortest term you can afford to minimise interest

Question: My husband and I both work. I am 52 years of age, and my husband will turn 60 soon. He has $500,000 in his super fund and I have $200k. We have a house worth $2m and have built another for our sea-change retirement. Right now we owe about $600,000 on the new house. When my husband turns 60 should we use his super to pay off the mortgage on the retirement home? Our plan is to sell our current house when we retire and use those funds to live off.

Answer: You are both relatively young so you have lots of time left to recontribute to super with funds that you have withdrawn from it. It does seem a reasonable strategy for your husband to withdraw $600,000 to pay off the mortgage on your new house, as long as you do not intend to rent it out and this can be done tax free once he reaches 60. The $150,000 annual limit on non-concessional contributions has not been changed so it would be a simple matter to return the funds to super once the current house has sold. Of course if your husband retires at 65 he will be unable to contribute unless he passes the work test which involves working just 40 hours in 30 consecutive days.

Monday, 2 November 2009

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

If the bond is redeemed early the proceeds are taxable as normal income but the holder is entitled to a rebate of 30% which effectively makes the bonds tax free for most investors at any stage. Suppose an investor earns $65,000 a year and cashes in a bond for $50,000 which cost them $40,000. The tax on the $10,000 profit will be $3,000 but the rebate will also be $3,000 so the holder will have no additional tax to pay.

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

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

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

Question: We are in our mid thirties with two young children. We are weighing up whether to either buy an investment property or to buy a house to live in. We are currently renting and have a reasonable amount of money in the bank. In the current market we do not feel comfortable investing our money in any other way but property. We are looking at investing for the long term for our retirement.

Answer: If you are looking to invest for the long term I would prefer that you bought your own home. Any capital gains will be tax free and any work you do on the house will add value to it and won’t end up in the landlord’s pocket. It will also give you and your children stability of tenure because it is fairly common for tenants to be forced to move when the landlord decides to sell the property.

Question: My wife and I are part self funded retirees. We have lost the greater part of our life savings in this financial crisis. As our shares went down in value Centrelink adjusted the value and increased our part pension.

We have 200,000 $1 units in a company that stopped paying redemptions 15 months ago and distributions 12 months ago. These units have just been officially revalued at 61 cents in the dollar, but unlike shares it seems we are still going to be deemed to have an asset value of $200,000 not $122,000.

Are you able to enlighten us as to the true position?

Answer: Centrelink can consider a revaluation of assets at current market value at any time, and in certain circumstances you can also seek to have possible frozen funds reviewed,. You should approach Centrelink as soon as possible. If you find it difficult dealing over the telephone just drop into a Centrelink Office, and seek a review of the assessment.

Question: My wife is 46 years of age and a member of a defined benefit superannuation fund that allows her to access a super pension at age 55. She is contributing the maximum amount into the fund. I am 40 years old and a member of an accumulation fund. We are both employed full-time and have surplus funds - $700 pre-tax per fortnight - to invest in super. Should we open an accumulation fund in my wife's name, or salary sacrifice additional contributions into my fund?

Answer: I would prefer that your wife opened the additional accumulation account because she is six years older than you and is less likely to be affected by any future rule changes. Just make sure she does not exceed the maximum contribution amount for her age which is now $25,000..

Monday, 26 October 2009

Insurance bonds are growing in popularity since the amount you can place into superannuation has been reduced. Unfortunately, it’s a sad reality that most Australians (and even some financial advisers) can’t get their heads around them.

This is a great pity because they are one of the simplest and most tax effective investments available. All you have to do is make an investment into the bond and sit back and watch it grow. Then, after you have owned the bond for 10 years you can withdraw all or part of the proceeds free of tax.

They are great for saving tax because, like superannuation, the fund pays the tax on the investor’s behalf. If you have money in superannuation the fund itself pays income tax at 15 percent, but your money is tied up until at least age 55. There is also a limit on how much can be contributed to this low tax environment. Insurance bond funds pay a higher rate of tax (30 percent), but there is no limit on contributions and you can access your money at any stage.

Access is a major feature. Your money is not tied up for 10 years and you can withdraw all or part of the balance whenever you wish. If you do withdraw your money early, the profits will be fully taxable, but you will be entitled to a 30 percent rebate to compensate for the tax already paid by the fund.

A major advantage is that all earnings accrue in the form of bonuses so (unless you cash in the bonds before 10 years have passed) you can ignore them when you prepare your tax return. The benefit of not having to declare any earnings each year makes insurance bonds especially useful investments for people who do not wish their taxable income to be increased by investment income as it may reduce eligibility for child care payments, or the superannuation co-contribution.

Insurance bonds are offered by several fund managers but it's important to seek out expert financial advice to ensure the one you invest in is appropriate for your circumstances. A major benefit of insurance bonds is that investors can switch between the underlying assets in the fund with no capital gains tax liability at any time. We’ll work through some detailed case studies next week.

Question: I read about shared property going to the surviving partner. Does that mean even if the Will states that half is to go to the wife and half to the children, the shared property would in fact go to the wife only, she being the surviving partner?

Answer: If a property is held as joint tenants the deceased's share will go to the co-owner irrespective of the terms of the Will. If the property is held as tenants in common the deceased's share is able to be bequeathed in the Will.

Question: If someone wants you to go guarantor for them do they first need to have the loan approved on their own merits but need you because they have no credit history? If you go guarantor does it mean they can borrow more money even if they can't afford to repay the amount they want to borrow?

Answer: There are a number of reasons a person may be unable to obtain a loan without a guarantor – these include bad credit history, insufficient deposit or questionable income. You need to clearly understand that when you act as guarantor you a promising to stand behind the debtor and make good their debt if they are unable to pay it. It also means you are taking on a risk that the banks in their wisdom are not prepared to do. If you do decide to go guarantor take legal advice and make sure your liability is limited to a set sum – otherwise you may find yourself in serious financial problems if you discover you have backed a loser.

Monday, 12 October 2009

Last week's announcement by the Reserve Bank that interest rates at emergency levels were no longer appropriate is a strong signal that the interest rate cycle is about to move upwards again.

There have been the predictable headlines about mortgage repayments going up but it is important to understand that rising rates carry advantages and disadvantages for everybody. If you are a home buyer you may well have the chance to snare a bargain because increasing home loan repayments may bring forced sellers into the market. Yes, you will pay more in interest but this will even out over time when rates start to drop again. Remember, it is called the rate cycle because rates rise and fall continually. The good news is that what you save by bargaining hard will probably outweigh the extra interest.

For cashed up investors the higher rates on term deposits will be welcome but anybody who has money in fixed rate bonds will find the capital value of the bond will fall as rates rise. You can avoid the capital loss by holding the bonds till they mature but inflation between now and then will erode the real value of your asset.

Centrelink will increase the deeming rates used to calculate pension eligibility under the income test as rates rise. This will reduce the aged pension for all those who are subject to deeming. Fortunately it is possible to get safe returns that are higher than the deeming rate so pensioners who take good advice should not be worse off.

In theory rising rates are a negative for shares as higher borrowing costs reduce company profits while a drop in household disposable income can hit sales. However, strong companies usually maintain their dividends in these conditions, so investors can still enjoy a tax effective income stream while having the opportunity to add to their holdings if prices fall.

Question : I will probably retire in March next year aged 62. I understand I can sacrifice $50,000 including employer contributions in a full year. However, as I will only be working for approx. 75% of the year, can I sacrifice the whole amount or does it have to be pro rata?

Answer : As long as you are under 65 you can contribute to super without even working at all, so the length of your employment in the year is not relevant. Just be aware there is no point in salary sacrificing below $35,000, the point where the 15% bracket stops, because salary sacrifice contributions lose a 15% entry tax.

Question : My husband and I are in our early 50s and have been married for three years. We only have $60,000 in super due to property settlements in previous marriages. We each own an unencumbered house; we live in one and rent the other out and have bought a holiday house which is part let to cover about half the mortgage. We plan to retire to the holiday house and use rent from the other houses to live on. We earn about $120,000 p.a. from salaries but still have two dependents in high school. Are we on the right track to plan not to live on superannuation in retirement?

Answer : You can both contribute to superannuation until you are 65 so you have plenty of time to sell assets and put money into superannuation if your adviser feels that is the appropriate strategy for you. My concern is that you are over-exposed to the residential property market, and will face increasing repair bills as you and the properties age at the same rate. At some stage it may be worthwhile considering selling one of the properties and putting the proceeds into quality Australian shares - meanwhile try to salary sacrifice as much as you can into super to make it grow faster.

Question : I am 53 and work part time earning $35000 p.a. I salary sacrifice $200 per fortnight to super which has a balance of $72000. My wife who is 57 and works part time for $40,000 p.a. has $100,000 in super. We own our home. My wife has received $500,000 from an estate. What should we consider when investing this money, particularly with regard to buying an investment property?

Answer : Most investments in super end up being share based, so it is you who must make the decision about whether residential property outside super, or shares inside super, will perform best in the long term. An alternative strategy is to have a foot in both camps by buying an investment property and borrowing to a level where the outgoings equal the income (neutrally geared), and at the same time putting part of the legacy into super.

Monday, 5 October 2009

Recently I wrote an article which recommended first home buyers try to save as large a deposit as possible before committing to a home mortgage. One reader took me to task saying that the amount of money a potential home buyer would lose in rent could easily outweigh any savings in interest that would happen if they delayed buying their home in order to save a bigger deposit.

Obviously, individual circumstances must be taken into account, but many younger first home buyers do have the opportunity to live at home or save on rent by sharing with friends. However, the main thrust of that article was that home ownership is an important commitment and no first home buyer wants to put themselves in a position where they lose their home because they cannot cope with increased repayments when interest rates inevitably rise.

The home owner's grant has now been reduced and I was horrified to hear one young person claiming on television that they had to jump in and buy a house before September 30^th because they could not afford to do it if they waited. Remember, the grant for a person buying a new home is dropping by only $7,000, and a new home costs at least $300,000. What sort of potential difficulty is this person getting into if the loss of $7,000 means a difference between buying now and renting because they are unable to buy without it.

Of course, home ownership is a worthy aim, but anybody considering buying a home should do a budget and factor in at least $45 a week for the extra expenses of home ownership such as insurance and rates. They should also base their repayments on a minimum of $8 a month for each thousand dollars borrowed. That's $2,400 a month on a loan of $300,000. This will give them a good safety buffer if rates rise.

Question : Fourteen years ago our daughter received a small inheritance. As she had very little income, she did not qualify for a home loan, so the bank suggested I buy a house with her – which we did for $70,000. My daughter paid the house off when she received a lump sum as a gift. Both our names are on the title, but I have never lived in the house. In about 18 months she has to sell it to relocate. The house is worth about $400,000. Is there any way I can avoid paying CGT or reduce it? Would there be any benefit in transferring the house to her name only. I am a self funded retiree and although I could access the money from my super, I don’t want to. I am also planning to sell my home in the near future.

Answer : It would have been much better if the bank had suggested you go guarantor because then you would not have been a co-owner and you would not now be liable for CGT. There is nothing to be gained in transferring the property to her before sale because this will still trigger CGT. If you are a self funded retiree under 75 you could talk to your adviser about returning to work for 40 hours in 30 consecutive days which would enable you to pass the work test and so qualify to make a concessional (tax deductible) contribution to superannuation of up to $50,000. This could eliminate or reduce the CGT.

Question: I have had an investment property for almost six years now and have been told that if I sell the property after six years the capital gains tax is reduced. Is this the case? If so, how much is the CGT reduced by?

Answer: I think the person you have been speaking to is getting confused with the six year rule regarding a person’s own home. This enables a person to be absent from their residence for up to six years without losing the CGT exemption provided they do not claim any other property as their residence during that time. This does not apply to investment properties that have never been lived in by the owner.

Monday, 28 September 2009

Recently I had the joy of becoming a grandfather for the first time. But unfortunately the joy was accompanied by feelings of guilt. This is because I was the one who pushed the idea of investing just $2.73 a day, for a newborn baby and keeping up that investment until the child turned 25. Why $2.73 a day? Because that is $1,000 a year.

Unfortunately, I never got around to starting. But on the days that I choose to feel guilty I run the numbers to calculate what my three children would have had if I had invested $1,000 a year into a managed fund whose returns matched the All Ordinaries Accumulation Index which includes income as well as growth.

The figures are staggering. My eldest son, now 27, would have $171,000, second son, now 26, would have $129,000 and daughter, now 24, would have $94,000. These are returns of 10.8%, 10.2% and 9.6% respectively and have been achieved at a time when the Australian stock market has had one of its worst periods in recorded history.

Notice the impact of time on the investment. Because the youngest is four years younger than the eldest, her theoretical portfolio would have been worth about half as much as his, because the length of time of her investment would have been four years shorter.

These figures encouraged me to do some more calculations. If we made no more contributions to the eldest son’s $171,000 portfolio, it would grow to $7.5 million at age 65 if the investment could average 10% per annum. That’s a return of $7.5 million for a total investment of $27,000 (27 years x $1,000).

When you look at these figures you understand why I feel guilty as my failure to act has cost my kids almost $400,000. But it also raises the question that we must all ask ourselves – why don't we start these programs? It wasn't lack of knowledge and it wasn't a matter of not having the money available, it was simply procrastination. After all, $2.73 a day isn't going to amount to much, and putting it off for a week or two isn't going to change the outcome. The trouble is that weeks drag into months and then into years, and before you know it all your kids are grown up and you are holding your grandchild in your arms.

This week October arrives – a stark reminder that Christmas is not far away. It may also be a reminder that there are many important things you have been putting off that need to be done. Why not list them now and make a start today.

Question: My partner and I have a combined income of $115,000. We have a mortgage of $113,000 with 12 years left to pay it off. We currently have $70,000 obtained through an inheritance. Should we pay this money off our mortgage or should we use it for other financial investments such as a managed fund?

Answer: You should be trying to maximise your deductible debt and minimise your non deductible debt, therefore pay the money off your mortgage and then talk to an adviser about borrowing for the managed funds. The interest on the new loan will be 100% tax deductible.

Question: I am 52 years of age and my wife is 55. Our current net income is $100,000 per year however we plan to 'retire' to lifestyle income of about $30,000 annually within the next two years. We have $600,000 in superannuation plus 100% equity in our home ($550,000) and 80% equity in an investment property also worth $550,000. What strategy should we use to supplement our proposed lifestyle income?

Answer: If you can afford it you should be salary sacrificing your gross salaries down to $35,000 each, the level where the 15% tax rate finishes, as this will enable you to pay a maximum tax rate of 15% while you are currently working. The investment property is obviously positively geared so leave the loan on an interest only basis to free up your cash now. It would also be worthwhile talking to an adviser because doing some part-time work after you cut down will enable you to boost your retirement income and minimise the amount you need to withdraw from your superannuation

Question: Can my self-managed superannuation fund earn the same 8.9% interest rate I'm charged on my home mortgage by depositing the superannuation funds into something akin to an offset account?

Answer: Your superannuation fund is a separate entity to you and its funds cannot become intermingled with yours until you reach a situation where you can start to draw from it. Therefore, your proposed strategy is not possible.

Monday, 21 September 2009

Rent and save or buy now? Unless prices are going up quickly you are often better off to rent.

Suppose you want to buy a house for $300,000 and have a deposit of $30,000 plus legal fees after the first home owner’s grant is taken into account. If you buy now, you will have to borrow $273,000 when the mortgage insurance premium is added. Repayments over 25 years would be $1,930 a month with total interest payable $306,000. Yes, you would be paying $606,000 for the property.

If you rent for two more years, and save diligently, you would only need a loan of $240,000 and there would be no mortgage insurance. Repayments of $1,930 a month on the $240,000 loan would enable you to pay the loan off in just 18 years with interest payments of $189,000. Taking time to save for a bigger deposit has saved you $117,000.

No, I don’t know which way property prices in your area are going to move. However I can tell you that savvy property buyers spend every waking hour researching the property market in their area so they know where the trend is heading, and so they will recognise a bargain when they finally come across one.

The results of investing time in this manner are that you will know more about the market than the majority of buyers and sellers. Keep doing your research and without doubt the property you want will eventually appear at a price you can afford.

Question: My partner and I have bought a property to live in. We have reduced the home loan to nearly $10,000 and then bought another house to live in redrawing from the previous property's loan. Subsequently, we decided not to sell the first property but rent it out. I have been told by a friend that I cannot claim a tax deduction on the interest for the full balance of the redrawn home loan as the balance on the original home loan was around $10,000 and only that amount is eligible for a tax deduction. Is this true? Am I better off selling the property? I will lose all my equity if I sell, since the market is 10% less than when I bought it initially.

Answer: Your friend is correct. The redrawn loan was used for a private purpose, to buy your own residence, and so the interest is not deductible. Only you can decide whether the original property has strong growth potential, but when thinking about selling, you will need to decide if any future tax savings will be more than the capital loss you will suffer on the sale. Furthermore, once you rent the property out it will be harder to sell because it is unlikely to be kept as well as it was when you were living in it and also tenants make it harder for the agent to conduct inspections from potential buyers.

Question: I have three term deposits in local banks totalling $100,000 and earning approximately 8.5%. I would like this investment to return me $20,000 per annum – can you advise how I can do this?

Answer: Remember the higher the return the higher the risk. You would need to earn 20% per annum for a deposit of $100,000 to produce $20,000 a year and it’s not possible to get this with safety. You are better off to accept the safe return from the bank and sleep well at night.

Question : I have recently redeemed the full unit holding in several managed funds and will include the capital gain in my 2009 return. During the years I held these funds, capital gains were incurred when the managers sold at a profit. These gains were included in the supplementary section of each year’s tax return. Will the ATO allow me to subtract the supplementary capital gains from the final gain incurred on full redemption?

Answer : The capital gains that have been distributed to you by the funds, relate to their own trading activities, whereas capital gains made by you when redeeming units in your name, are required to be included in your own tax return. You cannot offset one against the other.

Monday, 14 September 2009

Borrowing is the best way to create wealth. The system in Australia is biased against leaving your money in the bank, because there is no capital gain and you face tax of up 46.5% on the earnings. However, if you borrow for investment, the Government pays up to 46.5% of the interest because of negative gearing and when you eventually cash in the investment you only pay CGT on half the profit if you have kept the asset for over a year.

If possible you should try to borrow the whole purchase price of the asset because this puts greater leverage at work for you. For example, if you bought an investment for $100,000 and put down $5,000 deposit you have doubled your money when the asset arises to $105,000. If you put down $20,000 deposit you would not have doubled your money until the price rose to $120,000.

Of course the converse is true as well. Just as gearing magnifies profits, so does it magnify losses.

This is why you should not borrow for investment unless you have a good asset base, a secure income and are prepared to take a long-tern view. You can usually do well with good property and good shares if you hang on long enough but if you are forced to sell them in a sick market, you could face heavy losses.

Often, it is better to delay borrowing for investment until you have a large equity in your home. In this situation you can take out a home equity mortgage which will provide the deposit for the property or shares you buy. This will make margin calls most unlikely and also give you maximum leverage. As always, take advice.

Question: We are 49 and 48 years old with two kids aged 14 and 13. We want to retire in 10 -15 years with a stable investment income of $4,000 a month. The $4,000 would not be used for rent but for food, petrol, travel and entertainment. Currently, we are renting now but own a Melbourne home worth approximately $500,000 rented at $1,300 per month. We have another property valued at $375,000, mortgaged for $110,000 which collects an income of $2,000 per month. We also have $700,000 in cash, but little in superannuation. Our combined income is $110,000 per annum. Our youngest child goes to a private school but we have a policy that can be used to pay for the school fees over the four years if necessary. How can we achieve our retirement goal?

Answer : You are well on track because you would need a retirement portfolio of around $600,000 if you wish to draw an income of $4000 a month. Your present assets appear to be close to $1.5 million so provided you do not buy a very expensive residence, everything should be fine. If you are prepared to leave the bulk of your cash untouched until you retire, you should be putting it into superannuation where the tax on the earnings will be just 15 percent. By all means use the insurance policy to pay for the school fees, and salary sacrifice as much as you can afford in the meantime.

Question : A recent article of yours related to a reader who had taken money out of their super fund to lend to their daughter for a bridging loan to help buy a house. My understanding is that this isn’t allowed?

Answer : Unless your superannuation is unrestricted non preserved you cannot get access to it until you reach your preservation age, which is at least 55, and satisfy the necessary conditions of release. However, once you do gain access to it there are no restrictions on what you can use it for. Therefore, it is quite in order for a person to use part of their super to help a family member. Of course, if they are on Centrelink benefits, the gift or loan would be treated as a deprived asset and the benefits would be reduced.

Question: I am in the 38% tax bracket. I have a $500,000 investment property with a $195,000 mortgage on it. The tenant is paying $1,600 per month. I am about to reach the stage where the property is positively geared and will be paying tax on the profit. I have five years to go before retirement. Can you please advise the most effective way to manage these finances over the next five years?

Answer: The most effective way is to leave the loan on an interest only basis and at the same time create a sinking fund to pay out the debt by salary sacrificing as much as you can to superannuation. If you are over 50, you can sacrifice up to $50,000 into super which will reduce your taxable income right down and ensure the rents are not being taxed at 38% any more. There is no point in reducing your salary below $35,000 where the 15% bracket cuts out as salary sacrifice contributions lose a 15% entry tax. Withdrawals from super are tax-free once you reach 60 so the recommended strategy will enable you to maximise your tax breaks now while building wealth in a tax effective manner.

7 September 2009

It’s a fact of life that family situations change. An improvement in your finances, or an increase in family numbers, can mean that you wish to improve your lifestyle by upgrading your home. Of course this raises the question of moving or renovating.

No matter which option you choose there are going to be hassles. As a person who has both moved and renovated, I can assure you that both create major disruptions in your lifestyle. However, my suggestion is to renovate if possible. A good rule of thumb is that moving from one house to another will cost you around six percent of the price of the new home. For example if you sell a house for $350,000 and buy one for $500,000 you would be looking at close to $30,000 in expenses. These include agent’s commission, legal fees and stamp duty, loan fees and removalist fees. That is a huge loss of capital.

The main danger of renovating is to overcapitalise, which means that you have spent so much on your home that it is now far more expensive than the rest of the houses in the street. You can avoid this by asking an agent to give you an appraisal of your home’s value today to see how it compares with those around you. If its price today, plus the renovations, does not exceed the average price in the street, overcapitalising should not be a problem. Let’s assume your house is worth $350,000, and the average price in the street is $450,000. You could safely spend $100,000 in renovations.

It’s also essential that you have a building inspection on the property as it stands now to ensure it is structurally sound and capable of being renovated. Failure to do this may mean huge costs when the construction work starts.

Question : In a recent article you mentioned that a CGT event can be eliminated or reduced by offsetting it with a deductible contribution to super. You wrote: "Just be aware that this may not be possible if the income from employment is more than 10 per cent of total assessable income". What does this mean?

Answer : Usually, you cannot claim a tax deduction for your super if an employer is paying superannuation for you. However, there is a concession to enable people such as self employed doctors who perform a small amount of work for employers like hospitals to claim a tax deduction for their super as long as their PAYG income does not exceed 10 percent of their total income. For example, a person could earn a total of $150,000 a year which included $14000 of PAYG income and qualify for a tax deduction under the 10 percent rule. The capital gain itself is added to the total income when these figures are being done and this can sometimes enable people to qualify when they normally would not.

Question: Even with the super tax breaks, the Tax Office still levies taxes on the profits earned by my money in the super fund. However, this year it is likely to be a loss due to the share market downturn. Can I claim the loss as a tax deduction?

Answer : Your super fund is a separate entity to you, and is liable for income tax on its profits in the same way as you are, albeit at a different rate. Any capital losses can only be used within the fund. Therefore you cannot claim any of the fund’s losses on your own tax return.

Monday, 31 August 2009

Two great strategies for achieving wealth are salary sacrifice to super, and making a contribution in after tax dollars so as to qualify for the co-contribution. However, lower income earners who are eligible to adopt both strategies are often undecided as to which is the best one to adopt.

If you earn less than $35,000 go for the co-contribution. There is no point in making salary sacrificed contributions, and losing 15% entry tax, when you are in the 15% tax bracket anyway. A non concessional contribution of $1,000 would entitle you to a co-contribution of $1,000 from the government provided your total income did not exceed $31,920. Once your income rises above this figure the co-contribution tapers and cuts out entirely once you earn $61,920.

Even though the co-contribution reduces as income rises, making a co-contribution can often provide a better outcome than salary sacrifice. Think about a person earning $50,000 a year. If they wish to make an after tax contribution of $1,000 to super the cost to their pay packet would be $1,460 because they are in the 31.5% tax bracket. But the reduced co-contribution of $345 would mean a total return of $1,345 for a gross outlay of $1,460.

If that same $1,460 was salary sacrificed to super it would lose $219 (the 15% contributions tax) and they would have $1,241 in super. The first option gives them an additional $104 in super.

As always, it pays to take advice. Your financial advisor will be able to do the calculations for your situation.

Question : What are the advantages of having an allocated pension rather than having money in a super fund and just drawing once or twice a year. Are the interest rates the same in a super fund and allocated fund? Can we just draw our interest and leave the nest egg there? I am semi-retired and have a very good super. I would like to put it all in a bank account and live off the interest but my wife tells me we would pay too much tax. What would be the advantages of having the money in the bank?

Answer : The benefits of being in the in the allocated pension phase is that your fund is a tax-free fund and so should produce higher returns than a super fund, but you are required to draw out a set sum each year. The benefit of leaving your money in super is that there is no requirement to make withdrawals, but the disadvantage is that the fund itself pays income tax at 15 percent per annum. If the effect of tax is ignored, the funds should give roughly the same return as long as they have a similar mix of assets. If you withdraw all your super and place it in the bank, you will pay tax at normal rates on the interest but senior tax offsets could substantially reduce it. Your accountant will be able to do the figures for you. Also bear in mind that the taxable component of money in super will suffer a death tax of 16.5 percent if left to a non dependant – there is no such tax on money in bank deposits.

Question: I earn $44,000 and am wondering if I can salary sacrifice $9,000 so that my tax bracket is lowered to $35000 (15% tax bracket) and if my employer agrees, can some of the sacrificed amount be directed to super and some to a credit card? Do only some industries allow salary sacrifice to credit cards/loans or is it up to each employer?

Answer : You can certainly salary sacrifice for superannuation if your employer is agreeable, but salary sacrifice is not a viable option for items such as credit cards and school fees, unless you work for a non profit organisation which works under a different set of rules. Your pay officer is the appropriate person to talk to.

Question : I have a house worth $400000 with $150000 still owing and super worth around $380000. Would the best strategy be to put all available spare money into the home loan or plough as much as I can into salary sacrifice?

Answer : Your best strategy depends on your age. For example, if you are less than 40, the lack of access makes salary sacrifice to super less attractive, but if you are 50 or over you should go for it as hard as you can. This is because salary sacrificed contributions lose just 15 percent, whereas money taken in your pay packet loses 31.5% or more. Fortunately your loan is down to a level where interest rate rises should not drastically affect you.

24 August 2009

Just before the Federal budget was handed down I flagged the possibility of a change in the rules regarding transition to retirement pensions (TTRs). I was half wrong - they didn’t get a mention in the budget, yet the reduction in the amount that can be contributed to super as a tax deduction has somewhat watered down their effectiveness especially for high income earners.

The essence of a TTR is that you reduce your gross income by salary sacrificing a big chunk of your income into super, and then making up the shortfall in your net pay by starting a transition to retirement pension.

Think about a person aged 55 earning $55,000 a year who has $155,000 in super. If they salary sacrificed just $18,500 a year, and then started a TTR of $13,000 a year, their super would be boosted by $63,000 at age 65.

Many of those close to retirement have seen their superannuation balances hit heavily by the global financial crisis. This is why it is so important to take responsibility for your own finances and use every legal strategy possible to build up as much in super as is possible when you retire. An extra $63,000 or so more mightn’t sound like a huge sum in the scheme of things, but with the growing problems in the health care system, it may make the difference between immediate healthcare and waiting for months for treatment after you retire.

Question: My partner and I are both 30 and have a $300k mortgage on our house valued at $650k, around $30k in blue-chip shares, and a combined gross income of $200k pa. My salary is $125k and I am currently salary sacrificing $8k into super on top of my employer’s contribution. We are paying off the mortgage at $4k per month to minimise the interest payable over the life of the loan. Is this the best approach or would you suggest we should be increasing our investment in shares and reducing our mortgage repayments?

Answer: Your current term is just under 10 years which I regard as the optimum time frame for paying a loan off. In view of your relatively young age I suggest you consider suspending your $8,000 a year additional salary sacrifice to super and look at a home equity loan of around $100,000. The cost to your salary packet will be virtually unchanged but you will have much more money working for you.

Question: My mother is in her late 70's and on the single aged pension. She doesn’t receive a full aged pension because of the income from her savings after a review by social security. She has money in a deemed pension saving account and a small bond investment. Can she roll cash into an allocated pension to maximize her aged pension or is it too late?

Answer: As your mother is over 75 she cannot contribute to super and therefore cannot start an allocated pension. If she is receiving a part pension she should be getting most of the fringe benefits, including the health card, so the best way to optimise her situation may be to place some money into high interest bank accounts offering around 4%.

Question: If I have a credit card and transfer the money into a bank account to buy shares is the interest that I pay on my credit card claimable at tax time? I would be extremely careful and print off receipts when transferring money to prove where it went.

Answer: Yes, as long as the money is borrowed to buy income producing assets such as shares, the interest will be tax deductible. It doesn’t matter what loan arrangement you use.

16 August 2009

This is a good opportunity to think about tax because the Tax Office has just released details of their compliance program for the current financial year. As can be expected, the list includes the usual suspects but the problem for the taxpayer is that we now work on the self assessment system and any wrong claims that you make in your tax return will be unlikely to be picked up until you receive a Tax Office audit. If you are one of the victims of an audit this can result in a nasty shock because heavy penalties can apply.

The cash economy always receives scrutiny, but the Tax Office is also well aware that some business owners try to use loans or forgiveness of debt to distribute private company profits to shareholders without paying the correct amount of tax. Another target is private use assets. For example, it is not uncommon for a family business to buy a boat in the name of that business even though the boat is used solely for the pleasure of the business owners.

Capital gains is another area. The Tax Office matches real property sales information with people’s private tax returns and it is a simple matter for them to find out if a capital gain has been overlooked, or entered in the wrong year’s tax return. Remember, it is the date of the contract, not the date of settlement that is the appropriate date for real estate contracts.

Of course, it is always important to take advice when you are putting in a tax return but another great resource is the book “Saving Tax On Your Investment Property” written by tax expert Julia Hartman and myself. It is packed full of information and a unique feature is that it contains the whole tax office audit questionnaire. The book is just $29.95 and is available at most good bookstores or online at www.noelwhittaker.com.au .

Question : Is it possible for a self managed super fund to invest its funds in a building society, and for the returns/withdrawals being tax free if over 60?

Answer : Yes, a superannuation fund can invest in interest bearing accounts, provided that strategy is in line with the funds investment strategy. Withdrawals will be tax free for members aged 60 or more and the fund will pay no tax if the members are in allocated pension phase.

Question : I have a question relating to a capital loss I have incurred this financial year in relation to shares - I can't get an answer out of the tax department. Do I have to carry any losses over to the next financial year and offset against any gains? I thought I could use this loss this year to reduce my taxable income.

Answer : Unless you are a trader, you cannot offset capital losses against your ordinary income. They can only be offset against capital gains. If you do not have any capital gains in the current year, the losses will be carried forward to be offset against future capital gains.

Question: I am 44 years of age and a couple of years ago I was advised to place $200,000 into superannuation. I have bought into a hotel, as an investment, and would dearly love now to have these funds to pay off some of the debt. Is there anyway I can get access to my money?

Answer: The laws regarding access to superannuation are designed to make it difficult to withdraw prior to your preservation age. To gain access you will need to prove genuine hardship and also be in receipt of government benefits for at least 26 weeks. The trustee of you super fund will be able to give you the full criteria.

Monday, 10 August 2009

In turbulent times it is easy to become focussed on the gyrations of the market and overlook the importance of getting appropriate advice when making major decisions.

A recent email from a reader is a classic example. He signed a contract to sell property in April and settlement of it was due in June. As he was over 50 he and his wife were each eligible to contribute $100,000 to super as a tax deduction at that time and he had arranged for this to happen prior to June 30^th.

Unfortunately the property did not settle until after June 30^th.He had held off making the superannuation contributions for two reasons – insufficient funds, and a belief that the postponement of the settlement date to July 2009 meant that capital gains tax would not be payable until the current financial year.

Only a week ago he found to his horror that it is the DATE of the contract, not the settlement date, that is the appropriate date for capital gains tax purposes. Even though his property did not settle until after June, capital gains tax is still payable in the financial year ended June 2009. This error of judgement meant that he was unable to claim a tax deduction for superannuation contributions to offset the capital gain, and is now liable for a large amount of unnecessary tax.

I pointed out to him that he could have taken out a short term loan to make superannuation contributions prior to June 30^th – the interest would not have been tax deductible but he still could have enjoyed a tax deduction for the contribution itself.

This is just one of many stories that continually cross my desk. Just remember it is important to take advice BEFORE the event – it can be impossible to chance strategies once the deed is done.

Question : I have had $12,000 invested in a managed fund (global share fund) for a couple of years. The money was invested as a long term strategy, but as the return has been very minimal (no capital gains), I thought it was time for a change. One option is to reduce the mortgage via an off-set account, or would you recommend another managed fund in a different sector?

Answer : The problem with cashing in your global fund now is that you will be converting a paper loss to a real one at the worst possible time. We all know the markets will eventually recover – we just don’t know when. Therefore, I suggest you hang in there and wait for the recovery. At the same time you could diversify by putting any spare funds into an Australian equity trust.

Question: I am self employed and bought my business vehicle from our home line of credit about 3 years ago. As such, technically I will be paying off the car for the term of the mortgage. At the moment my accountant claims the interest portion each year as a tax deduction. Our home loan is currently around $200 000 and we're looking to pay it off as soon as possible. Would it be worth selling the car and putting the cash (about $25000) back into the loan and then leasing a new car to claim the full amount?

Answer: Obviously you would need to discuss this with your accountant to ensure you comply with the tax regulations but it would certainly make sense to reduce your non-deductible debt by $25,000. You would need to make certain that the cost of selling one car and buying another would not outweigh the interest savings. If possible, try to maintain your present home repayments on the reduced loan amount, as this will speed up the term dramatically.

Question : I am 70 years old with some health problems and since my spouse died, my son and his family have moved in to the family home and are helping to look after me. If I "will” my home (purchased pre 1985) to my son, what are the tax implications he may incur if he remains in the home, as he wouldn't want to sell.

Answer : As the home is your residence, it will be free of capital gains tax irrespective of when it was purchased. For tax purposes, your son will be deemed to have acquired the property at its market value at your date of death. If he remains in the home it will become his residence and he will retain the CGT exemption as long as he lives in it.

Monday, 3 August 2009

Unfortunately more than a third of Australians aged between 45 and 54 expect to have a mortgage when they retire. This is sad news indeed, but take heart – the first step in solving a problem is to face it. You’ll be amazed how quickly you can get ahead of your mortgage once you focus on getting it paid off quickly.

Mortgage repayments are usually expressed as factors. For example, repayments of seven dollars a thousand a month—that’s $1,400 a month on a loan of $200,000—will pay it off in around 25 years if interest rates are seven percent. However, these should be regarded as the absolute minimum, as it gives no protection in the unlikely event of interest rates rising. If rates went to 8.5 percent, repayments of seven dollars a thousand wouldn't even cover the interest and your loan balance would start going up.

Fortunately a small increase in repayments can make a big difference to the term of your loan. If you pay back eight dollars a thousand a month—that’s $1,600 a month on a loan of $200,000—you’ll slash the term to 18 years. Think about it: increasing your mortgage payments by just $46 a week can reduce your interest from $231,000 to $159,000, which saves you $72,000.

Imagine if you were aged 47 now and had a mortgage of $200,000. Leaving the payments at $1,400 a month would mean that you would still owe $99,500 at aged 65. By raising the payments by just $46 a week, the mortgage would be paid off at age 65.

Many people face a bleak retirement because they never get around to taking the action that is necessary to get their affairs on track. The benefits in the future far outweigh the extra effort needed today. Believe me, it’s worth it. The full aged pension for a couple is just $479 a week – can you imagine living on that and struggling with mortgage payments as well?

Question : I am 63 and my wife is 60. At the beginning of this financial year we converted our super fund into a transition to retirement fund. We are taking a minimum 4% pension from our super fund while still working. Our salary is mostly sacrificed into super and is less than 10% of our total taxable income. Also before this financial year we thought we would contribute personal deductible and undeductible contributions into the super fund. I understand the salary sacrifices and personal deductible contributions are taxed going into the super fund at 15%, but what about future income from these contributions? -Is it taxable? Doe we need two accounts - one for the tax-free pension account and one for the accumulation account, and in future years is the minimum pension of 4% annually reassessed on the total value of the fund, not just the pension component?

Answer : It is not possible to make contributions to a TTR fund, so I assume you are making contributions to a separate superannuation fund. All income within the TTR fund is tax-free, but income within the superannuation fund will be taxed at the normal superannuation rate of 15%. The minimum pension will be calculated on the balance of the TTR fund only.

Question : In your column I have seen you mention several times a 'line of credit loan.' Could you please explain the meaning of this?

Answer : A line of credit loan works like the old fashioned come and go overdrafts. A credit limit is established and you are free to make deposits and withdrawals at any stage as long as you do no exceed the agreed limit. They can be a trap if the borrowings are for investment because any deposits into the loan are regarded by the Tax Office as a permanent repayment of debt and withdrawals are treated as a fresh loan. This is why borrowers should not fall into the trap of paying their salary into the loan and then redrawing it for private expenditure.

Question : My husband is 66, and has an allocated pension. He also has a small superannuation account remaining from when he retired in July 2007. I am 63, still working full-time and salary sacrificing into super. I am due to inherit some money, and would like to pay it into my super while I am still working and eligible to contribute. If I inherit too much to be able to contribute it all to super, would I be able to contribute some of it into my husband’s super account, in order to put as much of my inheritance as we can into super?

Answer : Unfortunately, you cannot contribute superannuation for your husband if he’s over 65 unless he is able to pass the work test which involves 40 hours in 30 consecutive days. However, it may be worthwhile encouraging him to get a part time job so you can boost the amount you have in super. Don’t forget you could make a non concessional contribution of $150,000 now and a further one of $450,000 next financial year as you are under 65.

Monday, 27 July 2009

Success or failure seldom comes in one single cataclysmic event - usually it is the result of countless small actions done, or not done, over many years. John F Kennedy summed it up. “ There are risks and costs to action. But they are far less than the long range risks of comfortable inaction." Yes, the price of inertia, or failure to act, is a high one. In fact figures released by American Express, show that inertia is costing Australians almost $6 billion a year.

This inbuilt reluctance to take steps to move from where we are, to where we want to be, is called procrastination. There are only two ways to beat it – the first is to tackle it head on, the second is to put strategies in place to make sure that essential tasks happen automatically and are not just more chores to be done when you get around to it. I call them “set and forget”.

Converting your home loan repayments from monthly to fortnightly is a great example. All you have to do is complete a bank debit form and then put it out of your mind. It is a guaranteed way to save a fortune in interest and is effortless. Borrowing for investment and reinvesting the dividends is another great way to boost your finances – once it is all in place you have nothing else to do but pay the interest.

According to the research key areas where inertia costs us big dollars are expensive mobile phone plans, inappropriate credit cards, overpriced air tickets, and unused club and gym memberships. Most of us can make large savings in these areas and the way to get going is to simply dedicate one hour of your life to getting started.

Begin by listing all the things in your life that you pay regular fees for and then sort them into two piles – discard or keep. The discard pile is for things you haven’t used in the past six months like unused subscriptions or club memberships. The keep pile is for must haves like bank accounts and credit cards.

By now you will probably be amazed at how much money the items in your discard pile are costing you. Cancel them right away and if you’ve got a housing loan, make sure you increase your home loan repayments by the amount you are saving so the actions you have just taken will give you long term benefits.

Question: Should I buy an investment unit for a widowed working parent who will rent the unit? My husband and I are both on permanent salaries above $75,000. Our mortgage stands at $280, 000 and our home is currently valued at $500,000. The cost of the investment property is $235,000 and is three doors down from us in an upmarket residential area. We have no other investments. In this current economic climate we are not sure what to do.

Answer: If you believe the property has strong capital growth potential you could consider buying it, but you will need to charge the parent a market rent if you intend to claim the outgoings, including interest, as a tax deduction. It need not be a high market rent and you could discount the normal rent by say 10% because you would have a stable tenant and no ongoing management fees.

Question : I have $11,000 saved for my 17 year old son. He is at school and has a part time job earning less than $450 a month- hence no super guarantee. Would it be better to put $1000 in a super account for him and enable him to get the co-contribution, or keep the money invested and use it for uni fees in a couple of years to reduce any HECS debt he may incur?

Answer : I suggest you give him $1000 which he can place into superannuation as a non-concessional contribution, and so qualify for the $1000 co contribution. If you keep this up for the next six years, you will have given him a very healthy start to his retirement portfolio at little cost. Any surplus money could then be directed to HECS.

Question : I bought a piece of vacant land for $90,000 in 2003 and paid off the loan by 2007 only to then use it as collateral to buy a rental home for $135,000. I now have the home rented for $185 per week; the repayments are $230 a week. The vacant land is valued at $205,000, so should I sell it in a depressed market and pay off the $135,000 loan?

Answer : Provided you believe the land has potential for capital gain I would do my best to hold it as capital gains tax will take a chunk of the proceeds if you sell it, and you will be losing some of the tax breaks you are now enjoying on the rental property. I suggest you obtain a Quantity Surveyor’s report on the rental property to ensure you are maximising the tax deductions.

20 July 2009

Raising age pension eligibility age to 67 is a wake up call to all Australians of the importance of preparing for your own retirement, and of not waiting around in the hope that the government will do all the work for you.

Today let’s think about Mr Average. He is aged 51 and who earns $58,000 a year – the official average weekly wage figures. Let’s assume he had no superannuation until 1988 when the compulsory 9% employer contribution was introduced, and in that year he earned the then average wage of $24,000 a year. If he remained in steady employment, and his income remained in line with average weekly earnings he should now have $149,000 in his employer super fund if that fund had earned 9% per annum.

When planning for retirement one of the first jobs is to work out when you want to retire, how long you think you will live, and how much you believe you will need then. In this case I am assuming he will retire at 65, he will live until 85, and the income he needs when he retires is $3,500 a month in today’s dollars indexed for inflation. Bear in mind this is an average income earner on $58,000 a year now.

To achieve this goal he would need to have financial assets of $757,000 at age 65.

If his wages increase by 4% per annum and the boss continues to contribute 9% of gross wages his superannuation should have risen to $647,000 at age 65. That’s $110,000 less than what he needs.

How does he make up the difference? A simple way would be to work until age 67 - then his superannuation should be worth $786,000.

Another is to contribute to super from his own resources which would be a reasonable thing to ask seeing that the $647,000 he is likely to have has all been provided by his boss. If he made additional salary sacrificed contributions of just $383 a month, that’s $326 after the 15% contributions tax, he would pick up an extra $110,000 which would enable him to reach his goal of $757,000 at age 65.

The above example is a graphic demonstration of the way average income earners can use the miracle of compound interest to ensure they have a profitable retirement. But, just remember, investing is like climbing a mountain – it is better to start early and walk at a normal pace up the slow route than leave it until the last minute and try and sprint up the cliff face.

Question : Last year we withdrew $200,000 from super (my husband is 64) and lent it to our son as a bridging loan to help buy a house until he sold his other one). He has now given us a cheque. Is it a good time to put money back into super, or should we put it into a bank account until we see how the markets are going?

Answer : I see no problem with your putting it back into superannuation so you can enjoy the low tax rate superannuation offers. If you are nervous about the market, you can always hold it in a cash option within the fund until you are happy to switch it to a more share based option. It would be worthwhile to work out your tax position if the money was left in an interest bearing account, because if you are both retired you may be paying very little tax in any event.

Question : Recently in your column a reader advised that they were considering "pre paying" their loan interest in order to receive some tax benefits that financial year. In your response you advised that you can only pre-pay interest on a fixed loan. I have not heard of this concept before. Could you please explain it and advise whether it is an advisable strategy for investment loans?

Answer : The purpose of prepaying a year’s interest prior to June 30^th is to enable you to claim the tax deduction in that same year. It gives you comfort in knowing that the next year’s interest is taken care of and you cannot be affected by any interest rate rises. Furthermore, if you are moving into a lower tax bracket, because of the tax scales changing, it gives you a bigger tax reduction. Prepaying interest cannot be done on line of credit loans as they work like the old ‘come and go’ bank overdrafts – instead you need to make a special arrangement with your bank who will quote a rate and tell you the amount you need to pay to cover the coming year’s interest.

Question: I am 63 years old and have around $400,000 in my super fund. I plan to sell an investment unit for about $300,000 to top up my super before taking an allocated pension. Can I elect to contribute the capital gain to super even if I decide to keep some of the money from the sale in a term deposit to avoid capital gains tax? Should I consult a financial planner?

Answer: You should certainly be taking advice, because getting it wrong can be very costly. You are eligible to contribute to superannuation, because you are under 65, but you generally cannot claim a tax deduction for any additional contributions if you work for an employer who is paying superannuation for you. We are now early in the financial year, so it may be possible to get around this by salary sacrificing the bulk of your salary, if you are employed, to superannuation and paying your living expenses from the sale of the unit - your total deductible contributions from all sources cannot exceed $50,000 in this financial year.

Monday, 13 July 2009

As we enter a new financial year it’s timely to think about the role of cash in your investment portfolio. It is a fundamental principle that you should spread your funds over three areas – cash, property and shares – but how much you should have in each of these areas depends on your goals and your risk profile.

The role of cash is to give you liquidity whenever you need it but the problem with cash is that you have no chance of capital gain, and you also pay tax in full on the income. In contrast the bulk of the returns from property and shares usually come by way of capital gains on which there is no tax until you sell. Also, if the income from your shares comes by way of franked dividends, you may pay no tax on the income at all if you earn less than $80,000 a year.

Another fundamental principle is that whenever there is a chance of capital gain, there is a chance of capital loss. This is why you should never buy property and shares unless you have a 5-10 year time frame in mind – this will give you time to ride out the down cycles.

Obviously it is a waste of your precious recourses to leave money idle in savings accounts earning minimal interest. So if you have a home mortgage use most of your spare cash to reduce the loan, provided you have a redraw facility you can always get your money back when you need it.

If you don’t have a mortgage, but aren’t prepared to invest in property and shares at this stage, you can maximise your returns by using some of the online accounts offered by the banks or even putting it on term deposit. If you chose the last mentioned option I suggest you don’t lock it up for more than a year. It would be a shame to locked into a rate if the interest rate cycle starts to move upwards again.

Question : I have approx. $270,000.00 in savings and would like to invest in the property market. My aim is to reduce my tax. I cannot decide if I should use the entire amount as a deposit to buy one property or use the amount to buy multiple properties.

Answer : Becoming wealthy is like playing Monopoly – the person who controls the most property wins. This is why hefty borrowing can speed you on the way to wealth. The problem is that it will also speed you on the way to bankruptcy if you get over- committed and are forced to dump your properties at a bad time. You will need to do some feasibility studies taking into account the security of your income and the amount of your other assets; then you should be able to borrow to a level where you can maximise the potential gearing, but still minimise the risks. Also I suggest you borrow for shares as well as property to provide diversification.

Question : I hear so much about compounding interest. Do you have an example of how I can start it working for my three young children?

Answer : An investment is said to compound when the earnings are left to grow and are not withdrawn as they are paid – this enables you to enjoy interest on interest. For young children the best example may be to open an online interest bearing account with one of the major financial institutions. As the interest is credited monthly they will be able to see for themselves how they are receiving interest each month on the accrued interest from previous months.

Question: Can I move my $50,000 in super to a managed fund and start salary sacrificing to that fund?

Answer: Unless you have reached an age where you can access your superannuation you cannot withdraw the money and invest it in a managed fund. However, you can switch the money presently held in superannuation to a growth option within your existing fund, if the fund has such an option, or you could roll the money from your present fund to a new fund that has the bells and whistles you are looking for. You can only salary sacrifice to superannuation.

Question: My friend has recently inherited $70,000 and doesn't know what to do with it. She is 51 years old, rents, and hasn’t worked for a long time. She is currently on unemployment benefits, but is looking for employment. If she doesn't find a job by the time the money arrives I believe Centrelink will cut her benefits until she has exhausted all the money. Is there anything, such as an income stream, she can receive and still keep her Centrelink benefits, or can she put the money into super and access it early?

Answer: It is highly unlikely that she will lose all her benefits if she keeps the $70,000 in the bank, but if she transferred it to superannuation it will not be counted by Centrelink until she is 65. If she is still unemployed at 55 she will be able to withdraw it in whole or part tax-free provided she signs a statement that she is permanently retired, which would probably be a realistic assumption if she hasn’t found a job by then. Of course if she has found a job, she would not need to withdraw it. The FIS people at Centrelink will be able to help her do the numbers, but she should leave sufficient money in the bank to see her through to age 55, as money in superannuation will be inaccessible until then at the earliest.

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

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