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.

Monday, 14 November 2011

Much has been written about the importance of having a valid will, but getting the will right is just as important as getting it signed. 

Usually older couples make out what we call “I love you” wills whereby they each leave all their assets to the survivor in the event of a death of one of them.  This might be fine in some circumstances, but it can have devastating consequences if they are receiving the aged pension.

This is because the asset test for a homeowner pensioner couple is much harsher than for a pensioner single.  Couples can own up to $1,018,000 of assets, plus the family home before losing eligibility for the pension - for a single the cut off point is just $686,000. 

Think about a couple with assessable assets of $600,000 and who are receiving a combined pension of $626.50 per fortnight.  If one died and all the assets went to the survivor, they would be assessed as a single pensioner and the pension would drop to just $128.93 a fortnight.  That is a reduction in income of almost $500 a fortnight or $13,000 a year. 

The problem is that a one person household has almost as much household expenditure as a two person household. The surviving spouse could find themselves with severe cash flow problems at the same time as they are trying to cope with the death of their life partner.

A better option may be to leave part of the assets to a relative such as a child.  Of course this does not work in all circumstances - advice also needs to be taken about whether this would have any effect on the entitlements of the recipient ,and whether the money is likely to be lost if that relative has a relationship breakdown. 

Monday, 7 November 2011

Last week Treasurer Bill Shorten confirmed that compulsory superannuation would rise from 9% to 12% over the next ten years.  While that’s good news for younger employees it doesn’t do much for older ones as the change will not even start until 2013/14 when it moves to 9.25%. 

This is why it is important to take steps to secure your own financial future and not rely on what the government want to do. 

Case Study

He is aged 50 and earns $75,000 a year.  Their main assets are their home worth $600,000 with a mortgage of $100,000 and his work superannuation with a balance of $150,000.

Suddenly, their fiftieth birthday has arrived and they decide they had better seek advice before it is too late.

The financial adviser analysed their expenditure and it was agreed that they needed about $55,000 a year in today’s dollars when they retired at age 65.  If inflation is 3% per annum they will need to accumulate $990,000 by the time they retire.

Yes it sounds like a vast sum, nearly a million dollars, but let’s drill down a little. If his income rises by 4% per annum, and his work super earns 9% per annum, there should be $770,000 from that source alone by the time he turns 65. That means they are only $220,000 short of their target.

How do they do it?  Fortunately, they are taking action reasonably early and the problem is easily solved - all they have to do is ask his employer to make additional salary sacrificed contributions of $679 a month to his super fund. This should boost his super by the necessary $220,000 by age 65.

Of course, many things could happen to change the scenario.  He could lose his job or illness could strike the family, and it is possible that his superannuation fund may not achieve the 9%pa that I have used in this example.  On the plus side, he could get a pay rise, or his partner may get a job, or one of their parents could die and leave them a substantial legacy from the sale of the family home. People’s situations are continually changing which is why ongoing advice is so important.

24 October 2011

Today I’ll discuss a sure way to wealth. I call  it the “guaranteed secret of wealth” and it’s based on the concept that money in your wallet gets frittered away, and that everybody will pay their commitments and spend the rest. 

This is why nobody has any trouble paying their PAYG tax or the taxes that are levied through excise and sales, gambling and fuel taxes - they are taken automatically.

Some years ago a person I'll call Pat, came to one of our branches to ask about investing $6000. This is not unusual except that Pat has few assets, lives on a government benefit, and rents a cheap unit.

You would be right in assuming that Pat is like many who live near the poverty line, through circumstances that are often outside their control. What makes Pat different is that she has no intention of staying where she is. She has that resourceful spirit that once made this country great.

The obvious question is "How could somebody in her situation manage to save up $6000?".

The answer is enlightening. Pat has a simple belief - "I never spend a $5 note". Every time a five dollar note comes into her possession it goes straight into a small compartment in the back of her wallet. As soon as she gets home it's transferred to a sealed money box.

She admitted, "on a few occasions I have broken a $10 note and asked for the change in coins so as not to get a $5 note, but that doesn't happen too often".

This is a classic example of the principle that we all pay our commitments, and spend the balance. All we have to do to create wealth for ourselves is to start to make saving a commitment, instead of something we try to do with what's left over.

Monday, 22 August 2011

The flat property market represents a unique opportunity for first home buyers to move towards the goal of home ownership. 

If you don’t own a home now, and are keen to enter the market, your first step should be to prepare a simple budget.  It needn’t take too long, all you have to do is take a sheet of paper and write down details of your income and your regular expenses.  This should enable you to work out how much you can afford to spend in loan repayments - if you are renting now, factor in at least $50 a week for home ownership costs like rates, maintenance and insurance. 

Try to budget for repayments of $8 a thousand a month or $800 a month for every $100,000 you borrow.  This will give you a good safety buffer if rates rise. 

Once you have decided how much you can spend on mortgage repayments you should to talk to a lender  to find if your present position will allow you to borrow the amounts you need – it should also show you what you have to do to qualify if you don’t now.  This may include saving a higher deposit or cancelling some credit cards. 

By the time you do all this you should know exactly what you can borrow and how much it will cost - then you take on the next task which is finding your dream home.  This may take some time but it will be one of the largest outlays of money in your lifetime so don’t rush it.  Just keep in mind the key to good capital growth is finding a well located property and buying it at a bargain price. 

15 August 2011

I have been fielding questions on radio all week about whether it is appropriate to convert your super to cash when the markets are going through a volatile period.  My belief has long been that you should choose an asset allocation and stick with it through thick and thin, but I was surprised  that many listeners believed the only options they had were to leave it in super or withdraw it and deposit it in the bank. 

People who think like this fail to understand that super is not an asset class like property or shares, but merely a vehicle that lets you hold assets in a low tax environment.   Therefore, if you decide to move to cash it can usually be done by changing the asset mix in your own superannuation account.  This is normally a very easy process to do. 

Just keep in mind that moving money to an option designated “cash” does not always guarantee that you money cannot fall if the market does.  There are some funds who have enhanced cash accounts that use blue chip shares to try to improve the yield of that particular option within their fund.  Naturally, funds using this strategy will fall when the markets do. 

Also, remember that there is more to choosing a super fund than the assets it holds.  There are also issues such as the ability to give a binding nomination to the trustee ,and also to use the anti-detriment provisions to obtain a refund of contributions tax when the member dies.  A good advisor will be able to help you with all of these.

Monday, 8 August 2011

Stock markets around the world are going through a turbulent time as the world tries to sort out its many financial problems.

Naturally, this has led to a spate of emails from readers asking whether they should cash in all their share-based investments and place the money in the bank while they wait for the upturn. While this strategy may give peace of mind in the short term, the problem is that nobody is able to consistently forecast what markets will do in the future. To make it more difficult it is also a fact of life that markets tend to bounce back very quickly and unexpectedly when they do.

I believe a better option is to agree on a diversified portfolio and decide how much you wish to keep in each of the three asset classes – cash, property and shares. When you do this, you should keep in mind that property and shares should never be bought unless you have at least a seven to ten year time frame in mind. This will give you time to ride out the inevitable downturns.

I understand the gloomy headlines are depressing, but history shows that it is common for the stock market to have up to four negative years in every ten – this means there are at least six good ones every decade.

Whenever I think about shares, I am reminded of these words from a new investor: “I bought shares for my old age and they are certainly effective – I’ve only owned them a week and I feel 10 years older already”. Yes, owning shares can be scary at times, but that is the price you pay for the benefits that shares bring. Just remember to hang in when the inevitable falls occur, and don’t lose your nerve and sell out at the wrong time.

Monday, 1 August 2011

Legislation to give greater flexibility to the First Home Savers Account Scheme (FHSA) was passed by both houses of parliament in May. 

The changes will enable money in a FHSA to be paid into the account holder’s mortgage if they buy a first home earlier than the existing rules allow. If they have not satisfied the four year minimum qualifying period, the account will remain open until that period has elapsed – then the money will be available to pay down their mortgage. 

Under the original rules the money would have been forced into superannuation.

These accounts certainly enable young people to boost their house deposit because the government is contributing 17% on the first $5,000 of funds deposited each year until the balance reaches $75,000, at which point no further contributions can be made. This is equivalent to a capital guaranteed tax free return of 17% per annum on top of the interest that will be paid by the bank. 

A further benefit is that interest on these accounts will be taxed at just 15%, the same as superannuation.  If a first home saver in the 30% tax bracket deposited $5,000, and received $250 interest for the financial year, tax would take just $37.50, leaving them with $212.50 in addition to their $850 from the government.  This is a total after tax return of 21.25%. 

Used properly, the FHSA scheme can be a useful tool to help young people achieve the goal of buying their first home. However, it is also vital they understand that the secret of making money in real estate is to buy a well located property at a bargain price and then focus all their energies into getting that initial big mortgage down to a manageable size. If they do that they are well on the road to financial success.

Monday, 25 July 2011

I have often written about the benefits of using compounding. Einstein described it as the eighth miracle of the world because the benefits of it do seem miraculous.

However, a reader recently questioned my calculations on the grounds that they did not take into account the effect of tax..

To be a successful investor you need to first understand the fundamentals.  This is why, when I write about the benefits of compound interest my main focus is highlighting the way the maths work.

Of course, the rate of return after tax is a very important issue, but this varies from one individual to another and also depends on the owner of the asset. For example, assets held inside superannuation pay 15% income tax and 10% capital gains tax. In any event, growth assets like property and shares, deliver the bulk of their returns by way of capital gain, which is not taxed until the asset is sold.

Think about a person earning $70,000 a year who invests in a blue chip share portfolio that is averaging 6% growth, plus 4% income from franked dividends. There is no capital gains tax on the growth until they cash in some of the shares which may be many years into the future if they are a long time investor. Furthermore, thanks to the franking system, all dividends are tax-free. As a result there is no tax to pay each year even though the portfolio is growing.

The example highlights the importance of holding investments in the name of the appropriate person or entity.  In any event, I guarantee one thing: a person who puts compound interest at work will end up far wealthier at 65 than one who doesn’t.

Monday, 18 July 2011

The introduction of a carbon tax is to happen in tandem with a change in the lower tax brackets. The 15% bracket will go to 19% and the 30% bracket will rise to 33%. 

Because of a change in the low income tax offset this will not affect everybody, but it does highlight the importance of thinking about your tax bracket when making an additional investment, or even borrowing for investment.

For example, if you earn between $80,000 and $180,000 you are in the 37% bracket. This means that every additional dollar you earn is taxed at 37%, and deductions due to gearing give you a 37% refund from the Tax Office.

Think about a couple where one partner earns $90,000 and the other earns $165,000. It would not matter which one earned interest because each additional dollar of income would be taxed at 37%.

The tax concession would also be the same if they borrowed for investment.

But, if they decided to do this, it would normally be best to have the asset bought in the name of the lowest income earner. The effect on the yearly tax position would be the same, but if they decided to sell it, the lower income earner may pay less capital gains tax because they are way below $180,000 where the 37% band ends.

When you are thinking about making an investment it is vital that you seek advice first to ensure that it is held by the person who will gain the largest tax advantage. It can be very costly to change ownership once the transaction is completed.

11 July 2011

There will be many losers when the new Carbon Tax comes into operation, but the ones who probably stand to lose the most will be self-funded retirees. Because they usually pay no tax there are no new tax concessions available to them, and they may even find themselves paying increased tax on their franked dividends when the 30% marginal rate moves to 33%. 

Those who can qualify for the Commonwealth Seniors Health Card (CSHC) are more fortunate, as they will be compensated with a Clean Energy Supplement, the value of which is currently unclear.

The main benefits of the card are assistance with the cost of prescription medicines, certain other health services, and discounts such as are offered by Great Southern Rail Services.

The card is available to those who are of  age pension age, which is 65 for  males and 64.5 for females. No assets test is applied, but eligible applicants must have an Adjusted Taxable Income (ATI) of less than $50,000 for singles and $80,000 for couples.

ATI is described as the income you would pay tax on, for example, bank interest and dividends.   It also includes reportable fringe benefits and reportable employer super contributions. Account based pensions do not count towards the $80,000 as they are not taxable if you are aged 60 years or over.

Keep in mind that a person may have a taxable income even if they are not required to lodge a tax return due to the level or nature of their income.

If you think you are eligible, visit the Centrelink website.

Monday, 4 July 2011

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

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

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

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

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

Noel Whittaker is a co-founder of Whittaker Macnaught Pty Ltd.  His advice is general in nature and readers should seek their own professional advice before making any financial decisions.  His email is noelwhit@gmail.com

Monday, 27 June 2011

As the baby boomers retire there is a growing awareness of the importance of having a will.  That’s a great start, but the sad reality is that family situations can change, and challenges to wills have become common place. 

This is why it is often appropriate to hold assets in such a way that they fall outside the scope of the will and are thus generally secure from litigation. 

These include assets such as property and shares held as joint tenants, and retirement income stream products like allocated pensions and annuities when there is a reversionary beneficiary. Insurance bonds are also excluded. 

Superannuation is another asset that does not necessarily flow in terms of the will.  The trustee of the fund has the final say as to who gets the proceeds, unless there is a current binding nomination requiring the trustee to pay the proceeds in the manner specified in the nomination document.

The situation where assets are held as joint tenants is the most common, but in this context the term "tenants" doesn't have a thing to do with landlord and tenant, - it refers to ownership of assets such as property and shares. If you buy a house in partnership with another, usually your spouse, you normally have the ownership registered as "joint tenants". This means that, if either party dies, the co-owner, irrespective of the terms of the will, then owns the entire property.

However, if the property is held as "tenants in common" the share of the deceased is transferred in terms of the will of the deceased.

As always, advice is critical. Remember it doesn’t cost – it saves.

20 June 2011

June 30 is almost here – this means it’s time to think about superannuation deadlines.

First, keep in mind that a contribution must be received by the fund before midnight on June 30 for it to count for the current year. If it is late it will count towards next year’s cap, and could possibly push you into excess benefits territory in that year.

The laws get a bit confusing here. The boss has till 28 July to pay the compulsory super for staff for the current year, but it has to be in your fund by June 30 to count for contribution cap purposes. If you are salary sacrificing heavily, make sure you talk to your employer to ensure the contributions are banked on time.

There are strict limits on contributions and penalties for exceeding them can be huge.

Concessional (deductible) contributions are limited to $25,000 but, as a temporary measure, have been raised to $50,000 if you are aged 50 or more. These include contributions from all sources.

Non concessional contributions are capped at $150,000 a year but of you are under 65 you can bring forward three years and contribute $450,000 in one hit.

As always seek advice – superannuation can be a great tax saver. Don’t let penalties for getting it wrong wipe out your tax benefits.

Tuesday, 14 June 2011

Late last year I was sorting out my affairs and decided to cancel a Visa card that was hardly used.  The bank handled it without a fuss and I assume that the card was gone for good. 

It was therefore with some surprise that six months later I received a statement for the cancelled credit card with a debit balance of $129 for a donation to World Vision that had been made by bank authority. 

When I rang the bank to enquire how a cancelled credit card could be reactivated, the bank told me that all direct debits remain current until cancelled by the card owner.  Therefore the credit card would remain in force until I instructed World Vision to cancel the authority.  They did this without question and I transferred the debit to a different credit card. 

If I had been unable to stop the debit it may have gone forever, and the bank would have charged me interest had I not paid the balance by the due date.  I asked the bank what would have happened if I had reported the card stolen and they assured me that doing that would have stopped all debits for good.  Of course this was impossible in this case because the card was ‘cancelled” and therefore couldn’t be classed as stolen. 

It does seem a bizarre situation, but anyone cancelling a credit card may well think the best option would be to simply report it lost or stolen.  According to my bank sources that would have the effect of nullifying any periodical debits. 

Monday, 6 June 2011

Do you want to make a guaranteed 100% on your money between now and June 30^th?  Then rush off to your financial adviser and make n non-concessional contribution of $1,000 to superannuation.  Provided you meet the eligibility guidelines, the Government will give you a tax-free bonus of $1,000, which will see your $1,000 miraculously turned into $2,000.

The maximum government co-contribution is $1 for every $1 of eligible personal super contributions made in a financial year and is subject to an income test.  The maximum co-contribution of $1,000 is reduced by 3.333 cents for every dollar that the taxpayer’s total income exceeds $31,920.

As income rises the co-contribution reduces by $33.33 for each $1,000 of additional income, until it cuts out at $61,920 a year.

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

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

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

Monday, 30 May 2011

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

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

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

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

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

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

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

Monday, 23 May 2011

Changes to children’s tax announced in this month’s budget mean anybody investing for their children or grandchildren will need to consider new strategies.

Until now, thanks to the Low Income Tax Offset (LITO), a minor could earn $3335 a year tax free – this is equivalent to having about $55,000 in the bank.  From July the amount that can be earned tax free by a minor will reduce to $416 a year – about $6,500 in the bank.  Once this limit is exceeded, penalty tax at the top marginal rate is applied. 

This creates a dilemma for parents and grandchildren.  If you invest in your own name it may reduce your family tax benefits or put you into a higher tax bracket, if you invest in the child’s name as trustee the penalty tax will still be payable. 

This is why I believe insurance bonds will become the preferred investment for anyone investing for minors.  The bond funds pay tax at 30% on their earnings, but as the profits accrue in the form of bonuses, there is nothing to declare on your tax return each year. 

This means you can’t fall foul of the dreaded children’s tax.  

After ten years the bonds can be cashed in tax free, but if they are cashed in earlier, the accrued profits enjoy a 30% rebate which makes them tax free for most people anyway. 

They can also be transferred CGT free at any time you deem appropriate. 

There are a wide range of insurance bonds so make sure you take advice as to which one is most appropriate for your own situation. 

Monday, 16 May 2011

Last week’s Budget relaxes the penalties for those who exceed their superannuation contribution cap, but the changes are way short of what is necessary. They are applicable only for contributions made after 1 July 2011 and are limited to excess concessional contributions of up to $10,000.  First time offenders will be allowed to withdraw excess contributions up to $10,000 without penalty - such refunded contributions will be assessable personally to the fund member and taxed at the marginal tax rate.   

This does nothing to help the 80,000 people who are presently subject to punitive penalties, but in any event the $10,000 limit is unrealistic.  A case in point is the 76 year old man who used internet banking to withdraw $100,000 from his self managed super fund and as a result of hitting the wrong button, banked the money back into the super fund’s account instead of his own.  The penalty for this honest and simple mistake was $46,500.

It’s easy to inadvertently go over your cap.  One of the most common traps is when a contribution made by an employer ends up in a different tax year.  I know of many cases where people made salary sacrificed contributions late in June but because of tardiness, or bad administration on the employer’s behalf, the contributions were not received by the fund until after June 30.  When this happens the person has under-contributed in the year prior to June 30 and is now in danger of exceeding their cap in the following year unless they watch all superannuation contributions for that year carefully.

People with multiple jobs are also at risk because they may have several employers all making compulsory contributions for them.  Other traps are changing from one job to another and not keeping an exact record of the super from the previous employer, or receiving a pay rise or a bonus late in the financial year that attracts a 9% contribution from the employer. 

Monday, 9 May 2011

Despite years of financial education, it is still a sad reality that heavy losses incurred by investors are still making headlines.  Therefore, as the financial year draws to a close, let’s revisit the basic investment principles.

The first is diversification -  don’t have all your eggs in the one basket.  Usually the people who have suffered the heaviest losses are those who have chosen to put their entire life savings in one product.  Remember, a savvy investor has their portfolio spread in a mix of cash, property and shares.

The next is to understand that higher potential returns mean higher risk. These days you can obtain a safe 6% in government-guaranteed bank deposits – what is the point of investing in risky areas just for the sake of an extra 1% or 2%.

In some ways debentures and other interest producing investments carry an especially high risk – if your investment goes bad, you usually lose your entire capital.  In contrast, if you invest in property or shares you are more likely to risk only part of your capital and you often get that back if you can stay in there until the next uptrend comes.

Make sure you take inflation into account when deciding where to invest. It is certainly comforting to get a safe 6% in the bank, but over the long term inflation will erode your precious capital.  Haven’t you noticed how much prices have risen in the last five years?

Don’t be frightened of shares. There are now some great managed funds out there with a good track record and who invest in a range of quality shares. You can start with just $1,000 and the assets in which they invest give you automatic diversification.

Finally seek advice. Often those who lost it all responded to newspaper ads or cold canvass techniques. Good advice doesn’t cost, it pays.

2 May 2011

June 30^th is fast approaching which means the focus will be on saving tax by making contributions to super.

There are two types of contributions – those for which somebody claims a tax deduction, and those for which nobody claims a tax deduction. The latter were originally called “undeducted contributions” but are now known as “non concessional contributions”. 

There are limits to the amount of concessional contributions that can be contributed each financial year – they depend on your age.

Suppose you work for XYZ Limited and they pay $4,000 a year in superannuation for you.  This is a tax deduction for them.  You voluntarily add $2,000 to their contribution so the total contribution made on your behalf for the year is $6,000.  Unfortunately, the regulations prohibit you from claiming a tax deduction for your own superannuation contributions if your employer is contributing for you, so your $2,000 becomes a non concessional contribution.

You cannot claim a tax deduction for your own super contributions if an employer is making contributions for you, but there are many people, such as the self-employed or retired, who do not have employers paying superannuation for them and are allowed to claim a tax deduction for their own contributions.  The amount of the deductible contribution (concessional) is limited to $25,000 a year per person, but those aged 50 and over can make total concessional contributions of $50,000 until June 2012. 

There is a limit of $150,000 on the amount that can be contributed in any year but a person aged less than 65 can bring forward three years contributions and contribute $450,000 in one contribution.  Of course, having done that, they cannot make any further non concessional contributions for three years. 

Keep in mind there are severe penalties for exceeding the contributions limits.  We will talk about that next week.

25 April 2011

June 30th is just a few short weeks away – a wake up call to think about ways to reduce your tax.  

Keep in mind that a basic principle of tax planning is to try to defer income to future years while, bringing forward expenses to the current financial year.  Therefore, if you have money sitting in the bank and are prepared to lose access to it for a few weeks place it on a term deposit with all interest maturing after June 30^th.  The interest will then be taxed next year.

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

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

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

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

As always take advice but don’t delay - when the clock strikes midnight on  30^th June it will be too late.

18 April 2011

As their superannuation grows many Australians are wondering whether they should start their own self managed superannuation fund (SMSF) and “take control” of their finances.

There is no easy answer because running your own fund is not as simple as it sounds. It involves three major jobs - administration (doing the paperwork), investment (deciding where to place the money) and arranging insurance where appropriate. 

If you can handle these tasks with ease, you are well on your way, but you also need to take into account the assets the fund will hold.  If these are not at least $300,000, the setting up costs and the annual expenses are probably not worth the exercise. 

Far too many people start their own fund after a market crash because they think “I could do better myself”.  If this is your attitude, you need to ask what is your track record in handling growth assets like property and shares before you take the plunge and decide to forsake the experts and do it yourself. 

Having said that, I admit that there are good reasons for having your own SMSF in certain circumstances.  These include the ability to hold specific investments such as business property that are not available through a retail fund, or if you enjoy and are successful at trading shares or if you have complex estate planning issues. 

Also, the government is less likely to come to your aid if you are a DIY investor.  Just last week the Gillard government announced a bailout of $55m for superannuation fund members who invested in the failed Trio Capital.  Members of self managed superannuation funds were not allowed to participate on the grounds that trustees of SMSFs “have the benefit of direct control over where their money is invested”.  In other words, if you choose to do your own thing don’t expect any help from the government. 

Monday, 11 April 2011

March has been an exceptionally challenging month with tragedies on a grand scale in Japan and the Middle East. 

Nevertheless stock markets around the world showed remarkable resilience and the ASX300 accumulation index finished March up 0.7%.  One reason for this is because Japan is still the world’s third largest economy, and even though it accounts for around 9% of world GDP, the affected regions make up around 7% of Japan’s economy – this translates to less than 1% of the global economy.

If you invest in shares you need to understand that you are becoming a part owner of a business.  Even though share prices will bounce around when bad news happens, as it always does, the bad news is often isolated and may not affect the company in which you hold shares.  In fact, natural disasters may be very positive for a company because of the rebuilding that inevitably follows. 

The Brisbane floods are a good example – the economy was initially flat when the floods came but now the building trade is heating up as flood affected victims start to rebuild and refurnish their houses. 

One of the benefits of the present hiccups that are occurring around the world is that the Reserve Bank is showing no inclination to put up interest rates right now, even though business lending is up and confidence is growing.  I still believe we will see a small rise before the end of the year, but all the signals for the next few months are “steady she goes”. 

This means you formulate strategies to save tax and build wealth and then stick with them, irrespective of what markets are doing.

4 April 2011

Household expenses seem to just keep on going up, so it is important to look at every avenue to trim your costs and save your personal budget from going into the red. 

 One of the best ways to do this is to pay your life insurance from superannuation using salary sacrifice.  Life insurance is essential for most families but the premiums cannot be claimed as a tax deduction.  Therefore, they must come from after tax dollars. 

Think about somebody who earns $95,000 a year and who is paying $2,000 a year for their life insurance.  Because they are in the 38.5% tax bracket the cost to their salary package of that $2000 premium is actually $3300 when expressed in pre-tax dollars. 

A better option would be to increase their salary sacrificed contributions to super by $2,000 a year and then pay the insurance premium out of the super fund.  This strategy would cut the cost of their salary package to just $2,000 a year and save them $1,300 in pre-tax dollars. 

Take advice before using this strategy - there are heavy penalties for exceeding your superannuation caps and it is also important to have your new life insurance in place before cancelling an existing policy. 

28 March 2011

As a general rule, you should never dump quality shares and managed funds when the market is going through one of its normal negative periods  However, in certain cases it can be a clever thing ESIto do if you wish to move assets from outside super to inside super and stay in the same asset class.

Suppose you had shares worth $50,000 and had seen their value drop to $45,000 in the last downturn.  Because the value is reduced, there is less capital gains tax to pay when you cash them in, and because you are moving to the same investment inside super, you are not losing the asset.

A person is 42, earns $80,000 a year and has accumulated $50,000 in quality share trusts.  If they make no further contributions and the funds average 7.5 percent a year after tax, they will be worth $280,000 at age 65.  Unfortunately, capital gains tax could take a hefty chunk of that if they cash them in. 

A better strategy may be to bite the bullet now, cash the investment in, and place the proceeds into super as a non-concessional (undeducted) contribution.  Sure, CGT will take $4,000 leaving them with $46,000 to invest but the funds will produce a much better after tax return because they are now in the low taxed superannuation environment.  At age 65, they should be worth $360,000.

Because withdrawals from super are tax free after 60, the entire proceeds should be CGT free if an account-based (allocated) pension has been started.  That small decision to move those investments inside super at age 42, has boosted retirement savings by around $100,000.

As always it is important to consult your financial adviser before cashing in any investments or moving money to super.  There can be harsh penalties if you get it wrong, particularly if you exceed the amount you are allowed to contribute in any one year.

21 March 2011  

An innovative product from Austock Life - ChildBuilder Bonds - has all the advantages of ordinary investment bonds but have some extra bells and whistles as they are offered under a master trust system.  This enables the investor to spread their funds across a range of wholesale managed funds, but best of all also allow switching between the funds at any stage with no capital gains tax. 

The bonds are initially held in the name of the investor, usually the parent or grandparent, with a provision that the proceeds will vest in the nominated child at a set age that can be between 10 and 25. 

David and Kate are determined that their one year old son, Nicholas, will go to a private secondary school.  They make an initial investment of $2,500 in a ChildBuilder Bond and then make a commitment to invest $200 a month into the bond.  The outcome is very important to them, so they take advantage of the 125% add on feature and increase their contributions by 25% each year. 

If the fund earns a net 7% a year there will be $137,000 there when Nicholas turns 12.  As this will more than meet their target they would then stop contributing and start making regular withdrawals.  After allowing for inflation they calculate that the school fees will average $20,000 a year over the next six years. 

If all goes to plan there should be $55,000 left in the bond when Nicholas finishes school - this will enable the parents to spend $25,000 on a well earned second honeymoon.  The $30,000 remaining in the bond could be worth $42,000 when Nicholas turned 23 and would be a great help to him then as a house deposit. 

Because these bonds are a tax paid investment there is nothing to declare on anybody’s tax return each year, nor is there any tax on withdrawal or transfer to Nicholas. 

14 March 2011

Superannuation is the perfect savings and tax minimisation vehicle.  Nothing else offers you the ability to invest with pre-tax dollars, enjoy tax on the earnings of 15% and then make tax free withdrawals once you reach 60.  It’s about the only tax break a PAYG employee can get these days, and is ideal for anybody in business as it’s one of the few assets that cannot be touched if you go broke. 

Sadly there are still a large number of Australians who fail to understand that superannuation is not an asset like property or shares, but merely a structure that owns those assets.  As a result, when share markets fall,  superannuation always get the blame. 

The result of this misunderstanding is a general distrust of super which is not helped by some of the ridiculous statements that get air time.  The latest is a claim that within fifteen years superannuation funds may be forced to freeze assets and ban withdrawals, because the retired baby boomers will be taking out more than the rest of the workforce are contributing. 

This is clearly impossible – the superannuation industry can only run out of money when there is no cash, property or shares left in the world.  Remember, it is merely a vehicle that owns them. 

The big problem is that too many would-be investors focus on the illogical scary snippets that make the headlines, and consequently never get to focus on the real problems. 

Think about this. Even though the superannuation industry can never run out of money because it is merely a receptacle for assets- governments are a different animal entirely. 

Unable to create wealth of their own, they are merely conduits that raise taxes and redistribute them.  Within twenty years the eldest baby boomers will be in their mid-80s which is usually when most of them will be thinking about entering aged care.  The big worry for them is that there will be insufficient places, and carers available at the same time as aged pensions will be under pressure.  That is the real crisis facing this country. 

28 February 2011 

“How much do I need to retire?” is the question everybody asks. Unfortunately there is no simple answer, for it  depends on many factors that include how long you will live and the state of you health.

A simple rule of thumb is 12 times your expected annual expenditure.  Therefore, if you believed you could spend $50,000 a year when you retire you should be aiming for total financial assets of $600,000. 

The sum you need to invest along the way depends on how soon you start and the rate of return you achieve.  For example, if a  21 year old wanted to retire at  65 with an income of $3 500 a week in today’s dollars, they would have to invest only $235 a month if the contributions were increased in line with inflation.   It’s a different matter for a person aged 40 as they don’t have time for compound interest to work its magic.  They would have to invest an indexed amount of $880 a month. 

That’s the effect of time; now consider the rate of return.  The calculations above assume an inflation rate of 3% and a net earning rate of 9%, which gives a real rate of 6%.  If the investor managed to achieve only inflation plus 4%, the figures change dramatically. The 21 year old would have to invest an indexed $523 a month while the 40 year old would have to invest $1471 a month. .

Fortunately, we still have a generous aged pension system.  If a couple had only $300,000 in financial assets in retirement they would be eligible for a combined aged pension of $26,416 a year.  This should be enough to make up the gap.

21 February 2011

This is the time of the year when the bills come pouring in. Of course some lenders are trying to take advantage of the situation by running advertisements urging us to take out a new personal loan to consolidate all our small debts. It certainly sounds attractive because you’ll enjoy a lower interest rate and possibly even lower payments.

Don’t fall for it! If you have accumulated a pile of consumer debt now, it’s almost certainly because of bad money management. Of course consolidating your debts will ease the pain in the short term but unless you change your spending habits you’ll quickly accumulate a pile of new debt and be in an even worse situation than before.

Be aware that the interest rate doesn’t matter much if the term is relatively short. For example, if you had $10 000 of personal debt at 15% and re-paid it at $500 a month, you will pay the loan off in 1.9 years paying $1579 in interest. If the interest rate is reduced to 10%, the term will only decrease by one month and you’ll save just $594 in interest.

Instead of getting yourself in more strife by consolidating your debts, you are better off to do a budget and try to find the areas where you can make savings. A simple way to start is to total all your fixed expenses such as loan repayments, rates, insurance and school fees and each pay day deposit a sum into a separate bank account just to pay them. For example, if you are paid fortnightly and they come to $52 000 a year, make sure you bank $2000 out of each pay into that account. This will provide the funds to pay these bills when they come due.

Monday, 14 February 2011

Even though Capital Gains Tax has been with us for over a quarter of a century, there is still much confusion about the way it works. 

If you have to pay tax, CGT is the best one to pay because it is not triggered until the asset is sold and, provided you have kept it for over a year, you pay tax on just 50% of the net profit.

This means that the maximum rate of CGT for the highest income tax payer in the land is just 23.25% for assets that have been held for over a year.

There is no set rate of CGT.  In the year the asset is disposed of, the net proceeds are simply added to your taxable income with a resulting increase in the amount of tax you have to pay.

Obviously if you can lower your income in the year of sale you may pay less CGT because you will be in a lower tax bracket.  This is why it is often a good strategy to make a tax deductible contribution to super if you are in a position to do it.

Keep in mind that the relevant date is the date the sales contract is signed and not the date of settlement.  If you signed a contract to sell a house on June 15^th 2011 and received the proceeds on July 30^th 2011, you would pay CGT for the financial year ending June 2011. 

As always, make sure you talk to your accountant before signing any documents.  It is too late to re-write history once the deed is done.

7 February 2011

A major question for anybody installing solar panels should be how the Tax Office will treat householders who generate solar power and sell the excess back to the grid. 

A recent private ruling an accountant friend received is worth thinking about . It assumes “you have a solar electric system on the roof of your principal residence… you are not registered for GST… and your purpose for installing the system was to offset the cost of your electricity and to contribute to greenhouse emission reductions”. 

If you are seen to be carrying on a business the income will be taxable income but you will also be allowed to deduct expenses such as depreciation, and even interest on funds borrowed to install the equipment. 

The private ruling I have states the taxpayer who applied for the ruling will not be carrying on a business, and consequently will not be entitled to any relevant deductions in respect of the equipment. 

Factors taken into account include “the solar panel system will be attached to your home rather than located at a dedicated business facility… although large for a home system it is designed for domestic rather than commercial use… there is no prospect of profit in the short or medium term and the likelihood of profit in the long term is also questionable as it is dependant both on the length of time the panels will remain effective before requiring replacement”.  They also point out that the moment you move house you will lose the benefit of the cheaper electricity. 

Bear in mind that a private ruling is applicable only to the person who applies for it, but it does give a good indication of the way the ATO will treat the average householder.  However, many acreage owners are now spending $100,000 or more on solar panels with the main intention of selling it at a profit.  At some stage they may cross the line and find they are carrying on a business instead of pursuing a hobby.  This is why it is imperative that anyone thinking of moving into solar energy on a larger scale seek their own private ruling. 

Monday, 31 January 2011

There is still a lot of confusion about the difference between holding assets as tenants in common and holding them as joint tenants. In this context the term "tenants" doesn't have a thing to do with landlord and tenant, it refers to ownership of assets such as property and shares. For example, if you buy a house in partnership with another, usually your spouse, you normally have the ownership registered as "joint tenants". This means that, if either party dies, the entire property is then owned by the co-owner, irrespective of the terms of the will.

However, if the property is held as "tenants in common" the share of the deceased is transferred in terms of the will of the deceased.

Which one do you choose? It depends on who you want to receive the asset if you die first. Usually couples buy the family home as joint tenants to give each other the security of knowing that it can't be bequeathed to a third party if there are family arguments and the will is changed.

There are three situations the occur regularly where it is probably best to hold an asset as "tenants in common". The first is where you are buying a property in partnership with one or more friends. In most cases you would both expect your share to go to your family if you died, not the friend.

The second is when you, and other family members, are left property through your parent's will.  This is similar to buying property with a friend. Almost certainly you would want your share of the estate to go to your own estate if you died, not to your siblings.

Last, but certainly not least, is when re-marriage occurs. Both parties may have children from a previous marriage, and usually prefer to keep their assets separate so they can be willed to their children from that previous marriage. Possibly the assets should be divided between those children and any that arise from the new marriage. If the house was held as joint tenants it would go straight to the co-owner and the children may miss out.

The above examples show how important it is to get advice from your solicitor and your accountant before you sign a contract to buy property or shares. It can be very costly to change things about after the money has changed hands.

Monday, 24 January 2011

Many retirees are having increasing difficulty making ends meet as bills rise.  One way out is to downsize to a cheaper home but agents’ fees coupled and stamp duty mean anybody doing this is almost certain to lose close to $50,000 of their precious capital. 

Another option is to take out a reverse mortgage - is a loan where there may be no repayments of principal or interest. They are not particularly popular with older people because the debt is likely to double every nine years because of the effect of compound interest, but they can be a great tool in the right circumstances.

The beauty of them is they can enable seniors 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, refit their kitchen with new appliances and even go on a decent holiday. 

There is another option – a loan from Centrelink under their Pensions Loan Scheme where the interest rate is currently 5.25 %, considerably lower than the normal reverse mortgage rate

This enables people of pensionable age who cannot get a pension because of their income or assets (but not both), or those who are only receiving a part pension, to access part of the equity in their home. 

Suppose a couple owned their own home, had a block of land worth $600,000, personal effects worth $40,000 and just $10,000 in the bank.  Because of the level of their assets they are entitled to a combined aged pension of just $12,781.60 a year ($491.60 a fortnight). 

Under the Pension Loans Scheme they could offer Centrelink a mortgage over one of their properties and receive payments of up to $15,288 a year ($588 a fortnight) which would give them the same level of “income” as a couple on the full aged pension.  These loan payments are not subject to tax nor are they assessed under the Centrelink income test. 

It’s not the perfect solution but the couple have at least given themselves some protection against rising costs.  Of course, the loan will continually increase and will need to be paid back when the house is sold or from their estate after they die.  As always there is no such thing as a free lunch, but it is better than starvation.

10 January 2011

The financial challenges of having a new baby have become a little easier now that the government’s new paid parental leave has started.  But, like all government schemes, it’s far from simple and intending recipients will have to choose between the new parental leave payment (PPL) or the existing baby bonus payment.  They cannot both be paid for the same child except in cases of multiple births.  

The two payments are vastly different, so it would be worthwhile to take the time to understand the differences.

PPL will pay up to $10,258 over 18 weeks but the payments are treated as income. Therefore they will be subject to tax and you will also lose Family Tax Benefit part B and Spouse Dependant Tax Offset - other benefits such as Family Tax Benefit Part A and the Low Income Tax Offset may be reduced.

The primary carer must have worked for at least 10 months in the 13 months up to the date of the baby’s birth and they are not allowed any more than 8 weeks off in a row before the actual date of birth.    This period can be extended by paid annual, sick or long service leave or pregnancy difficulties.  The legislation takes into account part time and casual work so it is only necessary to have worked 330 hours during that 10 month period.  If the parent worked part time before the birth they can still get the full $569.90 per week.

The PPL payments will stop if the carer returns to work before the end of the 18 week period.  The primary carer must have had an ATI (Adjusted Taxable Income) of no more than $150,000 for the financial year PRIOR to the birth. There is no limit on the partner’s income.

In contrast the baby bonus of $5294 is tax free, there are no work test requirements nor restrictions on returning to work. Total family income cannot exceed $75,000 for the SIX MONTH period AFTER the birth.

Despite the income tests, PPL may be better for lower income and part-time workers, while the combination of the Baby Bonus and Part B may be better for higher income earners.

Income can be reduced for eligibility purposes by pre-paying interest on investment loans if appropriate, or by salary sacrificing to super.

As always advice should be taken – this is a minefield!!

3 January 2011

Welcome to another New Year.  Unfortunately, even though our stock market produced overall returns of better than 40% in 2009, all it could do in 2010 was tread water. 

Anybody who watches the stock market knows that good years often follow bad so the obvious question is “is this a good time to invest?” Unfortunately, nobody knows when the perfect time to invest is, but you can still enter the market safely using a technique called “dollar cost averaging”. It consists of investing a set sum every month into the same investment, and forgetting about what the market is doing.

Share trusts are a perfect investment to use, because the price of their units fluctuates in line with the stock market, and most funds will accept monthly investments from as little as $100. Think of it as akin to buying apples. If you spend $100 on apples, and they are 50 cents each, you get 200 apples for $100. A price drop to 40 cents an apple means that $100 buys 250 apples. Obviously you can’t go wrong as long as the price of the apples eventually recovers to more than your buying price. Based on history the share market has always recovered to exceed its previous high point.

Let’s see how it works in practice. We’ll assume you started investing $1000 a month in January 2000 - and kept it up faithfully despite all the ups and downs of the market. Provided you reinvested all your dividends, and the performance of your investment matched the All Ordinaries Accumulation Index, you would now have $202,026 for a total investment of $131,000. That’s a return of almost 8% per annum compound.

The good news doesn't stop there. Because of the imputation system, all or most of the dividends may have been tax free and there no capital gains tax is payable until you sell – hopefully that will not be until after you retire.

Monday, 27 December 2010

Welcome to another new year.  This is the time when we make many resolutions about getting our life and our finances on track but unfortunately, the intentions get lost in the daily grind.  An effective solution is to prepare a “net worth statement” which is just a sheet that lists your financial assets and liabilities.  This becomes the base for your future strategy.   

On one side, write down assets such as your real estate, shares, and superannuation but don’t include items such as cars and furniture as they have no long-term value.  On the other side, list all your loans and include the interest rate, the monthly repayments and whether the interest is tax deductible.  You now have a working document.   

Next, think about each asset in turn and decide if it should be sold.  Also, if you have investment property, try to figure out if it still has potential or whether it’s time to get rid of it and upgrade to something better.   

If you have loans on which the interest is tax deductible make sure they are on an interest only basis.  This ensures you maximise your tax benefits, and also frees up money to speed up the payments on the non-deductible loans.  Next arrange your budget so that you pay back the smallest non-deductible loan as quickly as possible.  Once the smallest loan is paid off you can use the money that is no longer needed for its payments to attack the next smallest loan. 

Remember the name of the game is to increase your net worth – the difference between your assets and your liabilities.  Adopting the above strategy will enable you to maximise capital growth while quickly reducing your debts

Monday, 13 December 2010

The proposed changes to the way banks operate have created a lot of media attention but unfortunately it is not possible to simply ban all exit fees.    Basically these so called “exit fees” fall into three separate categories - first are the fees for breaking a fixed rate loan, which can be over $50,000 in some cases, depending on the size of the loan and the rate that was locked in.  These are not going to change. 

Then there are “exit fees” which are, in reality, deferred application fees.  Banks will sometimes offer to waive application fees, and even provide a cheaper interest rate, if the borrower contracts to stay with that bank for a three or four year period to enable the bank to recover these costs.  If these are abolished new borrowers will be faced with higher upfront fees and possibly higher ongoing interest. 

Finally, there are mortgage discharge fees which the banks claim are their costs for finalising a normal mortgage when the borrowers have paid it out, or have taken the loan elsewhere.  These are currently around $700.  ANZ has already flagged its intention to reduce them but, let’s face it, $700 is small bikkies in the scheme of things.  Remember, the interest on a 30 year loan of $300,000 could be over $450,000. 

The secret is to become an informed consumer and, thanks to the internet, there is now a wealth of information available for anyone who is concerned about the interest rate they are being charged.  At www.ratecity.com.au there are hundreds of loan products on display and there is even a ratings system which even includes “Today’s Best Buys”.  At date of writing there were variable rate loans as low as 6.74% and three year fixed rates at 7.14%. 

Even though these loans may not be appropriate for you, who knows what may be hiding in the fine print, they are certainly a great starting point for further investigation, and possibly a robust discussion with your present lender. 

This is my last column for the year so please let me take the opportunity to wish you all a happy Christmas and healthy and prosperous 2011. 

6 December 2010

Christmas is coming so lets think about credit cards. They are certainly convenient, but the problem is that they can lure you  into debt - it is a big deal to extract $100 note from your wallet and hand it over in exchange for goods and services, but it’s an entirely different experience when the retailer processes your credit card.  When this happens, the pain is deferred to the end of the month when the credit card statement arrives.

People often ask if it’s a good strategy  to solve their credit card worries by consolidating their credit card debts with their housing loans.  In most cases, it will cause more harm than good because almost certainly they are in trouble because of bad money management.  Sure, consolidating their loans may give them some short term relief, but in a few months the credit card debts will have ballooned again and they will have the additional problem of a higher housing loan.

A better solution is to list all your personal debts and then use all your resources to attack the smallest one.  When that is paid off, use the money no longer needed for it to attack the next smallest one.  Keep doing this and you will be back on track in no time.

It is certainly possible to save some interest by moving to a lower interest credit card but you should still be aiming to pay 5% of today’s outstanding balance.  For example, if you had a debt of $5,000 you should cut up the card and then make repayments at the rate of $250 per month.  If the interest rate was 12% you would pay it back in 1.87 years with total interest of $607.  If the rate was 15% the term would still be less than 2 years and total interest would be just $790.

29 November 2010

The major assets most Australians have when they retire are their house and their superannuation.  Everybody likes to receive a big lump sum but one benefit that is almost unknown is the ability of some superannuation funds to refund a lump sum to the member’s estate on death, in compensation for the 15% contributions tax that was deducted from their contributions during their working life. 

This is known as an anti-detriment payment and can be made only to a spouse or former spouse of the deceased, a child of any age, or to the estate provided the ultimate beneficiaries are the spouse, former spouse or a child.  It can only be made when an accumulation death benefit is paid as a lump sum, or when a pension is commuted to a lump sum on the death of a pensioner (or reversionary pensioner) within the prescribed period.

The calculation of the payment is a complex one, but in many cases the fund may use a simple formula.  This is between 13.68% and 17.65% of the taxable component (excluding insurance) if the eligible service period commenced before 1 July 1988, and 17.65% for service that commenced after that date. 

Case Study: Jack’s eligible service period started in 1989 - when he died in 2010 his superannuation was paid to his widow as a lump sum.  The taxable component was $600,000 so the estate was able to claim an anti-detriment payment of $105,900.

Unfortunately, space restrictions allow me to only touch the surface today, and the topic is such a complicated one that expert advice is essential if it is relevant for you.  The main thing is to be aware of it, and also to take note that many funds do not offer it.  Accordingly, being in the wrong fund could cost your estate tens of thousands of dollars.

Monday, 22 November 2010

The rise in interest rates have brought housing loans back into the spotlight and many borrowers are even considering changing lenders to take advantage of what may seem to be a cheaper rate.  Unfortunately it is not as simple as it sounds and sorting through them is just as tricky as working out which phone plan is best for you. 

A useful guide is the comparison rate sheet which all lenders are required by government legislation to display, but keep in mind that it is only a starting point.  Even though it includes the basic loan costs such as set up fees, interest rates and ongoing charges it does not include bank fees that are only charged in certain circumstances. These include fixed loan early termination fees and redraw fees. 

But there is more to a loan than the interest rate and the fees and charges. One of the most important things to consider is flexibility.  Now you might believe that a no frills loan with low fees is perfect for you right now because your affairs are simple and your present intentions are to stay in the one house for many years, but keep in mind that change is always with us, and your present loan may not be appropriate if things change.

What happens if you decide to move house, or borrow some money for renovations or investment, or need to reduce your repayments as the kids are at high school.  If you have one of the no frill loans it generally won’t have a redraw facility and you may be required to take out a second mortgage for the extra money.  Naturally the bank will be looking for a higher interest rate on the second mortgage and the extra fees could wipe out all your initial savings..

Monday, 15 November 2010

Buying that first home can be an exciting experience but it’s important to understand that the First Home Owner’s Grant (FHOG) and the First Home Transfer Stamp Duty Concession have different requirements.  If you fail to understand them you could face penalties and also may be required to pay back all or part of the money you received from the government. 

For FHOG purposes you must move into the property as your principal residence within a year of the title registration date (established homes) or within one year of the final inspection date (new homes).  For stamp duty purposes you must move in within one year of the transfer date. 

You must live in the house for a continuous period of six months for FHOG purposes but for stamp duty purposes you are required to live in it for a continuous period of 12 months after moving in. 

For FHOG purposes you can rent out the property before moving in provided you comply with the occupancy requirements.  This is not allowed for stamp duty purposes, however the vendor or the vendor’s existing tenant may remain in possession for up to six months after the transfer date. 

To qualify for the stamp duty concession you may not rent out the property after moving in.  The FHOG rules do allow you to rent out one or more rooms provided the home remains your principal place of residence. 

As you can see, different rules apply to both schemes which is why it is important to take advice if you intend to delay moving in or rent the property out.  More information is available at the Office of State Revenue website, www.osr.qld.gov.au.

Monday, 8 November 2010

Have you ever tried to work out the effect of inflation on your savings? Use the Rule of 72. Do you wonder how long it will take for your home to double in value? Use the Rule of 72. Would you like to know an easy way to do compound interest calculations in your head? Yes, you've guessed it. Use the Rule of 72. The best part is that you don't have to be a mathematician to use the Rule of 72? It's simple, but once you understand how to use it, you'll wonder how you got by without it. It goes like this:

Divide the number 72 by the expected rate of return - the answer is the number of years it will take for a given sum to double at the expected compound rate of return:

Suppose your home is worth $400 000 today and you predict it will increase by 7% per annum. Divide 72/7% and the answer is close to 10. If your prediction is correct, your house will be worth around $800 000 in 10 years time, and $1.6 million in 20 years time. .

Are the figures correct? Yes the figures are correct, but nobody knows if the house values will perform as you have just predicted. If that house is worth less than $1.6 million in 20 years, the capital gain will have been less than 7% per annum.

You can use your own judgment but I have grave doubts that a home worth $400,000 today will be worth $1.6 million in 20 years.

Notice compounding coming into play.. Every time an asset doubles in value there is more growth in the last double than all the previous doubles combined. For the figures to be true the value has to rise by $800,000 in the last 10 years, but only $400,000  in the previous 10 years

Imagine where inflation would be, and interest rates, if that happened.

Monday, 1 November 2010

At a recent seminar, I was astounded to hear the speaker claim that the mathematical skills of over 50% of the population were limited to the ability to add and subtract.  It was in the context that “complicated” financial terms like compound interest were far beyond the comprehension of the average person.

This paints a sorry picture because knowledge of compounding is essential if you are going to build wealth and it’s really quite simple.  When you leave the earnings of an investment to compound, you leave them to grow instead of withdrawing them. 

For example, if you had $100 000 in the bank and you earned $5000 in interest, you could withdraw the $5000 or else leave it in the account.  If you leave it in the account, you now have $105 000 working for you – this is called compounding.

Provided the interest rate stayed the same and you left the account alone, you would earn $5250 interest in the following year and your account balance would be $110 250.  If that was left to compound, the interest the next year would be $5513 and your new balance $115 763. 

Notice how both the interest and the principal are growing every year because every year you’ve got more money working for you.

If you have property, the growth automatically compounds because you can’t hack off the back patio and sell it, and if you have shares, you can join the dividend reinvestment plan whereby dividends are used to buy more shares and not paid to you directly.  Not all companies offer this.  Of course if you’ve got managed funds, it’s only a matter of ticking the reinvestment box.

Compounding is really that simple.  If the interest is paid to you, you will find that it will be spent and lost forever.  If you reinvest it, you will find yourself the proud owner of a portfolio that grows faster and faster every year.

Monday, 25 October 2010

The much publicised First Home Saver Account Scheme opened for deposit taking on 1 October 2008, but its reception by the public was lukewarm. 

However, these accounts can be a useful wealth building tool in some circumstances  Even though there is an apparent four year lack of access period, the regulations merely require that a saver deposit at least $1,000 in their First Home Saver Account (FHSA) in each of four financial years.

If an account holder is purchasing a property jointly with another account holder, only one person needs to meet the four year requirement.  The other party can withdraw their funds irrespective of their saving period. 

These accounts certainly enable young people to boost their house deposit because the government is contributing 17% on the first $5,000 of funds deposited each year until the balance reaches $75,000, at which point no further contributions can be made. This is equivalent to a capital guaranteed tax free return of 17% per annum on top of the interest that will be paid by the bank. 

 A further benefit is that interest on these accounts will be taxed at just 15%, the same as superannuation.  If a first home saver in the 30% tax bracket deposited $5,000, and received $250 interest for the financial year, tax would take just $37.50, leaving them with $212.50 in addition to their $850 from the government.  This is a total after tax return of 21.25%. 

The May Federal Budget acknowledged the possibility that a first home buyer may buy a home using a mortgage before they access the money in their FHSA. Accordingly the scheme was changed to enable them to roll the balance of the account into their mortgage once they have satisfied the access condition. 

18 October 2010

Unfortunately there is a general misconception about the relationship between capital gains tax and superannuation.  There is still a common belief that you can minimise capital gains tax by rolling the proceeds of the sale of an asset into super. 

This is a half truth, and getting it wrong could be very costly. 

There is no special rate of capital gains tax – when you sell an asset the CGT is calculated by simply adding the net proceeds after adjustment to your taxable income.  Obviously, if you can reduce the extent of your taxable income it may be possible to pay CGT at a lower marginal tax rate. 

Think about a couple who are aged 62 and retired.  As they are both under 65 they are eligible to contribute to superannuation without a work test.   Because no employer is paying superannuation for them they are also entitled to claim a tax deduction for their superannuation contributions.  However this is limited to $50,000 in a financial year for people aged 50 and over and $25,000 a year for younger people. 

The couple sell jointly owned shares for $300,000 and so trigger a CGT bill of $100,000 after the 50% discount has been taken into account.  As the shares are held in joint names this means that $50,000 will be added to the taxable incomes of both of them in the year the shares were sold.  If they contributed $150,000 each to super and apportioned the contribution so that $100,000 was non concessional and $50,000 was concessional (tax deductible) they could claim a tax deduction of $50,000 each.  This would have the effect of wiping out the CGT bill. 

It is important to take advice and do the numbers before adopting this strategy because concessional contributions to super lose 15%.  This means in the above example it would have cost them $15,000 in contributions tax to eliminate the capital gains tax.  The amount of CGT they would have paid depends on their other incomes – if these were small the exercise might not be worth doing. 

Monday, 11 October 2010

The expected interest rate rise didn’t happen last week but you can bet that more rises are on the cards.  As a result many people are asking "Is it the right time to lock into a fixed rate?"

Unless you are terrified of rates rising, my inclination is to stay with a variable rate to give yourself flexibility. Remember, insurance always has a cost - if rates start to fall you will be locked into the higher rate and may leave yourself open to a hefty penalty if you try to get out of your fixed rate loan before the term ends. Often the penalty will be equal to what you would save by re-financing the loan to a variable rate.

Whenever you make financial decisions you have factor in some assumptions. Right now the variable rate is about 7% and most five year fixed rates are around 8%. Rates tend to rise in .25% increments so it would take four rate rises before your current variable rate went up to the current five year fixed rate.

A disadvantage of fixing rates is that you can lose flexibility if you wish to make lump sum payments, or need to pay the loan out because you’ve sold your house. I suggest you stay with variable if selling in on the cards, but if you are sure you will be staying put, and think you will be able to make extra repayments, you could consider converting your loan to a “cocktail”, where part of the rate is fixed and part is variable.  Then you could pay any surplus funds into the variable portion of the loan without penalty.

Finally, always check out what fees are involved if you wish to refinance. There is no point in refinancing if the costs outweigh the benefits.

Monday, 4 October 2010

Aged care is a growing worry.  The older baby boomers are now approaching 65 and many are helping parents move into aged care. It’s a difficult time emotionally and the plethora of rules and regulations that confront their every move makes the process much harder.  So complex is it that, some financial planning groups are training specialist advisors in this field. 

A couple moving into aged care will often undergo an asset assessment in order to calculate the maximum amount payable for an accommodation bond or charge.  Unfortunately, most people do not understand that the timing of this assessment can create very different outcomes. 

Case Study: William is in high care and Ethel in low care.  They have a house worth $700,000 with cash and contents worth $55,000.  If they both complete the asset assessment while they are still living at home (or while one is in respite), William will not be liable to pay an accommodation charge and Ethel cannot be asked to pay an accommodation bond.  Therefore their total assessable assets will be $27,500 each –  less than the minimum asset amount of $37,500 each.  The aged care facility will receive a fully supported resident supplement for William and Ethel.  But, if they both entered care on the same day and completed the assessment after entry, each would be considered to have $340,000 of assessable assets.  Ethel could be asked to pay a bond of up to $340,000 and William would be liable to pay the accommodation charge of $26.88 a day. If William and Ethel enter on separate days with the asset assessment completed after entry, the first person will not pay an accommodation bond or charge while the second would.

The huge difference in outcome is solely attributable to the timing of the assets assessment. 

While it may seem attractive to have both William and Ethel enter care with no bond or charge payable, under this scenario they would not meet the criteria to keep and rent their former home with the pension and aged care exemptions that can apply. So any financial planning strategy for aged care needs to consider; the ability to access care, the impact on pension entitlement, the effects on the cost of care and the ability to afford care in the short and long term

I cannot stress too highly the importance of seeking expert advice if you or your family are considering moving into aged care. 

27 September 2010 

In last week’s column I used out of date figures for pension eligibility.  Today I am taking opportunity to provide you with the updated figures and also talk about ways to increase your pension by using funeral bonds. 

From 20 September 2010 a couple who own their own home can have $978,000 of assets before losing access to the aged pension.  For a single homeowner this is $659,250. 

The figures for the income test are $62,795.20 for couples and $41,033.20 for a single.  For example, a couple could own their own home, have $900,000 of assessable assets and still receive a combined pension of $116.60 a fortnight. 

Pensioners prize the part pension, even though it is small, because in most cases it gives them access to a range of discounts as well as the pensioner concession card. 

One way to reduce assets to make yourself eligible for a part pension is to arrange for  payment of your funeral while you are still alive.   You can do this by pre-purchasing a burial plot and also by pre-paying funeral expenses or by investing in funeral bonds.

The amount of money spent on the burial plot is exempt from the assets test and the income test regardless of the value of the plot - Centrelink will not take into account any money you pay to a funeral director provided you have a contract that sets out the services to be undertaken

Funeral bonds are a more flexible alternative because they give the investor the option of appointing a specific funeral director to receive the proceeds or leaving the bond open so the proceeds can be paid directly to the family.  We recommend the latter option because there can be problems if the bond is assigned to a funeral director and the funeral costs less than the value of the bond.  If the family are the beneficiaries, any surplus funds can be used for any purpose they see fit.

The relaxation of the rules mean that retirees who are just above the assets test cut off point, will be able to qualify for a part pension.  For example, a couple with $998,000 of assets as well as the family home, would be ineligible for the age pension because they have too many assessable assets.  However, if they gifted $10,000 to their children or a charity and invested $10,000 each in funeral bonds, their assessable assets would drop by $30,000 and they would qualify for an age pension of around $1200 a year plus most of the fringe benefits.  The benefits alone are thought to be worth at least $1500 a year.

Monday, 20 September 2010 

The revised aged pension rates have just been released and are now even more generous than ever. 

Now a single pensioner can have assets of up to $638,000 plus their own home and still receive a part pension and most of the fringe benefits that go with it.  For a couple the figure is $947,000.

The figures for the income test are $39,421 and $60,361 respectively.  This means a couple could have their own home, plus $825,000 of assessable assets and still be eligible for a combined pension of $229.10 a fortnight. 

If you have a reduced pension because of the level of your assets, or are not eligible for a pension because your assets are over the cut off points, you could consider making gifts to family members or to your favourite charity.  A pensioner can make a gift of up to $10,000 a year without penalty as long as they do not gift more than $30,000 over five years. 

If you intend to gift more than $10 000 a year, you are better off to treat the balance over $10 000 as an interest free loan, because excess gifts are held as an asset for five years. 

CASE STUDY

A pensioner couple wished to give $30 000 to their children.  If they gift it in one lump $10 000 will be regarded as a gift and the balance of $20 000 will be deemed for five years.  However, if they gift $10 000 immediately and treat the remaining $20 000 as an interest free loan they could progressively forgive $10 000 for each of the next two years.  Then they would not be caught by the five year rule. 

Another way for pensioners to reduce their assets in order to increase their pension entitlements is to put part of their funds into a funeral bond – we’ll talk about that in a future column.

Monday, 13 September 2010

These are confusing times for investors.  Interest rates are on the rise, house prices in many places have plateaued, and the share market has gone quiet after starting the year strongly. 

In a climate like this, the best way to approach investing is to go back to basics and understand that investing is an art and not a science.  This is why smart investors take the time to learn what advice is factual, and what is at best an educated guess.  For example, I can tell you without doubt that you can’t claim a tax deduction for interest on money borrowed to buy your own home but you can claim interest on money borrowed for investment.  However, if you ask me where the stock market will be in a years time, or whether shares in XYZ limited are a good buy, the best I could do would be to offer an opinion that may be right or wrong. 

For most people, the simple way to wealth is to buy a house in a good location and pay it off over a 10 year term.  Surplus income could then be used for a borrowing plan to invest in quality share trusts.  The house gives you a good lifestyle and an asset that is free of capital gains tax.  Because the share trusts diversify over a wide range of companies, they protect you from the disaster that may happen if you invest heavily in just one share and the company goes belly up.

We all know that cash in the bank might appear to be safe, but it offers no tax benefits and will lose its purchasing power to inflation over the long haul.  This is why we recommend a diversified portfolio with money spread over cash, property and shares.  Just keep in mind that growth assets like property and shares should be looked at over a ten year period.  This will give you time to ride out the inevitable flat spots.

Monday, 6 September 2010

One of the best ways to speed up your journey on the road to wealth is to eliminate costly bank interest.  However, there are only two ways to pay a loan back faster – find a lower interest rate or increase your payments. 

A recent query from a reader shows how a clever use of both those strategies can make a major difference to your financial situation. 

The question went “I am married with two teenage children, with a single income of $165,000.  We have $220,000 left to pay off our house which is valued at $600,000.  We would like to buy a new car for $45,000, and upgrade our kitchen at a cost of $20,000.  Should I redraw from my home loan for the car and kitchen to ensure the lowest interest rate?  We currently pay $3,000 off our home loan per month.”

They are already in a good position because their current repayments will have the loan paid off in just eight years.  My advice was to pretend that the $65,000 was being paid on a personal loan over five years at 10%.  This would require repayments of $1,381 a month. 

Having done these calculations, they could fund the car purchase and the renovations by drawing down on their existing home loan which would increase it to $285,000.  If they then increased their present repayments by $1,381 a month to $4381 a month, and kept them up, they would be debt free in less than seven years. 

This example is in stark contrast to those who consolidate their personal loans with their housing loan just to save monthly payments.  They may enjoy short term relief but the price is a huge increase in the interest they pay as they extend their personal loans to 20 years or more. 

Monday, 30 August 2010

The global financial crisis has hit the superannuation of most retirees, and consequently they are looking at ways to restore their finances.  Unfortunately as many of them have suffered heavy losses by forgetting investment fundamentals, I will today revisit some basic principles. 

Let’s start with our old favourite “the higher the return the higher the risk”.  A reasonable long term average for the stock market should be inflation plus a maximum of 6% - this puts 9-10% as a reasonable estimate of what the market might do in the long term.  Anybody who is promising returns higher than this should be treated with caution. 

The next one is “if it sounds too good to be true it probably is”.  ASIC are currently taking action against an American con-man who promised Gold Coast investors 12% a month.  Of course, it was never going to happen and a lot of people lost their money.  In another case, more than 600 people lost a total of $10 million in a sports betting scam based on the Gold Coast. 

Think about it, if a person had finally found a guaranteed way to make money betting on horses or trading shares, why would they share it with anybody else?

Be very wary of buying a business just to give yourself an income.  Most owner operated businesses don’t do well under a manager and, even if you run it yourself, there is always the danger that the books may be “cooked”.  A great way to test this is to look past the financial statements and ask for the tax returns.  If they show a different picture run a mile. 

Remember, the three main places to invest are cash, property and shares and a savvy investor will diversify their portfolio across all three asset classes.  If you stick with interest bearing accounts in the bank, well located property and blue chip shares you should do well over the long haul.

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Monday, 23 August 2010

Recently I received a question from a reader which is highly relevant to anyone who is trying to maximise their returns from superannuation.  The question read:  “Can you please give us some general information about DIY superannuation including ways to set it up and the costs.

We are 63 yrs and retiring in 2 years, and only have $68,000 in a Super Term Deposit  earning 4.90%. This matures soon.  We thought if we were to put it into a DIY Super term deposit we might be able to earn more  as there are rates  at the moment  around 6.50%.  My husband is working and earns $52,000 pa.   I earn around $8,000.”

It’s a simple matter to start your own super fund and any accountant or financial advisor would be able to refer you to a firm that specialises in handling the paperwork such as preparation of the Trust Deed.  Usually the costs to run your own fund are around $3,000 a year so you would need to have at least $200,000 to make it viable. 

Of course, when you start your own fund you still have to make a decision about investing directly or whether you opt for managed funds and let the experts make the decisions.  If you prefer the second option it may be simpler to just use one of the master trusts that will almost certainly be offered by your advisor.  Most master trusts include term deposits so it is possible to stay in the superannuation area and still access some of the high interest rates that are currently around.

The questioner can certainly benefit by salary sacrificing part of his income to super and the spouse could pick up a free $1,000 a year from the government by making a non concessional contribution to super and then claiming a co-contribution. 

However, the main purpose of superannuation is to save tax, and when they retire, they may find that holding the money outside super will be more tax effective than holding it inside super.  This is because of the Senior Australian Tax Offset which allows a couple of pensionable age to earn $26,680 a year each and pay no tax.  As always, ongoing advice is crucial. 

16 August 2010

Credit cards are back in the news with promises by the Labor party that pre-approved increases in limits on credit cards will be made illegal by mid 2012 if they are returned to power.  They are also flagging changes to the regulations so that credit card holders will be made aware of the high cost of paying the minimum amount only. 

That is all very well, but surely it is better to take action now to get in control of your credit cards, and not wait for changes that may or may not occur in two years time. 

The most important thing to know about credit cards is the way they lead you into debt.  This is because paying with a credit card is a very different emotional experience to paying with cash.  On the rare occasion that I find myself in the possession of a $100 note I find it almost traumatic to take it out of my wallet and hand it over, but I can run up a $150 charge on a credit card with hardly a thought.  

This is why we invariably get such a shock when the dreaded statement arrives, and the balance is far more than we expected.

The interest charged on most credit cards is now around 19% per annum, and the minimum requirement is usually about 4% of the outstanding balance.

Now think about a person who owes $4,000 on their credit card and who can only make the minimum payment of $160 a month.  Paying the minimum payment is a reasonable strategy if they stop using the credit card, because the minimum payment will have the loan paid off in less than three years with total interest totalling $1,132.  However, the problem for most people is that they continue to spend on their credit card and often find themselves with a growing debt on which they are paying 19% interest. 

As always, the solution is to take charge of your finances and spend to a budget so you can get out of debt and start living within your means.  If you don’t, it is easy to continue to overspend and get further into debt every month. 

9 August 2010

Increasing property prices over the last 10 years means many people now have a large equity in their home. However, this does not mean that they should automatically borrow against it. The term “using the equity in your home” usually means to mortgage it to borrow for investment which can be a useful strategy in some cases, but remember all the equity in the world is useless unless you have the cash flow to fund your borrowings. The extreme example is the single pensioner living in a million dollar home in the best suburb. 

You also need to be aware that borrowing always involves some degree of risk, even if its only a slight one, and you should not be borrowing if you do not need to do it. 

Sure, you may be inundated with offers from lenders who will try to talk you in to borrowing against your equity but all they are doing is filling their sales quotas.  If you are thinking about borrowing to invest, your first step should be sit down with a financial adviser and work out whether your present assets are sufficient for retirement. If they are not the adviser can help you work out a strategy to help you get there. This may well involve salary sacrifice to superannuation and diversifying into share based investments.

It also may be necessary to borrow for investment as part of this strategy,  but part of the financial planning process includes preparing a budget so you can see what is a safe amount to borrow.  

Usually it is best to have your investment loan on an interest only basis while you contribute an additional sum each month into insurance bonds or superannuation. This minimises your commitment while giving you a safety buffer. 

2 August 2010

As part of its election manifesto Labour has promised to introduce a no frills default fund (MySuper) to which employer contributions would automatically be directed if the employee did not make a choice of their own.  There will not be one single fund, and the major superannuation providers now will be encouraged to introduce their own version of MySuper. 

This was one of the key recommendations of the recently released Cooper report, but take heed of these key phrases from that report. “MySuper… recognises that direct engagement in superannuation is not a priority for a large proportion of the population.  A touchstone of MySuper is that its members defer to the trustee generally in relation to all aspects of their superannuation”. 

In short, Cooper is saying that the control of most Australians’ superannuation should be taken from them because they are too disinterested to take care of it themselves. 

Even though a no frills fund might suit some people it is important to understand that your superannuation fund may well be your major asset apart from your home when you retire.  This is why it is important to seek advice to ensure that the fund you choose is appropriate for your goals and your personal situation. 

Issues to be addressed include the need for life insurance, the appropriate mix of assets, flexibility, customer service the ability to make binding nominations.

Rising life expectancies mean that a major danger for most Australians is living longer than their money.  I have stressed repeatedly the importance of looking upon super as a tool to save tax while building wealth, and at the same time making sure it meshes with the other assets that you hold, such as your own home, investment properties and your share portfolio. 

Fortunately we live in a country that encourages freedom of choice and where good financial advice is readily available.  The ones who exercise that choice and who seek and use good advice will be the winners in the long run.

Monday, 26 July 2010

People's attitude to money is amazing. They'll spend most of their lives working hard for it, worrying about it, and fighting over it, yet many won't give more than a passing thought to what will happen to it when they die.

Nearly 60% of people die without a will, and most of the remainder seem content to use a "do it yourself" job from the local stationery shop, or grab the first free offer they can find.

This is an unfortunate attitude because the cost of having no will, or a badly drawn will, is far higher than the legal fees to get it right in the first place.  One of the most common mistakes is for a couple receiving Centrelink benefits to leave all their assets to the survivor in the event of the death of one of them.  This is because the Centrelink income and assets tests are different for couples and singles. 

CASE STUDY.  A couple have their own home as well as a car and personal effects worth $50,000.  They also have superannuation, bank accounts and other investments worth $650,000.  As a couple they are entitled to a pension of approximately $394 a fortnight.  If one of them dies, and all assets are left to the survivor, that person will be over the limit for the single pensioner assets test and will lose their pension entirely.  That’s the ultimate double whammy – losing your partner and your pension simultaneously.  If the will had left part of the financial assets to their children the survivor would have retained a part pension.

Almost everybody you know will have some story about hassles caused by a badly drawn will, or worse still no will at all.  That’s a pity because it doesn’t take much preparation to stop these types of problems before they arise.  Just make sure you involve your solicitor, your financial advisor and your accountant when drawing up or reviewing a will – each is a specialist in a different but very important area. 

Monday, 19 July 2010

The long awaited Cooper Review into superannuation was released last week and predictably its contents dominated the headlines of most newspapers the next day.  As a result I spent most of the week on various radio programs talking about what the changes would mean to the average person.  The most common question was “Why is superannuation so complicated?”

Yet, if you look at it step by step there is really nothing too difficult about it. 

Your employer is required to contribute 9% of your gross salary into a superannuation fund and the government takes a 15% tax from that contribution.  While your money is accumulating within your fund, the tax on its income is just 15% per annum which is almost certainly less than your own marginal tax rate.  This means the money can grow faster inside super, than if held in your own name, as the after tax returns should be higher. 

Because the government is giving you tax concessions to encourage you to save for your retirement, the money in your superannuation fund is inaccessible until you retire after reaching your preservation age. This is at least 55, but higher if you were born after 1 July 1960. All withdrawals from super are tax free once you reach 60 and when you start an account based pension from your fund, as most people do, the fund itself becomes a tax free fund. 

For retirees it is a money paradise.  You are allowed to hold your money in a tax free fund, while drawing a tax free income from it. 

Unfortunately, the average Aussie does not understand that superannuation is not an asset like property or shares, but merely a vehicle which lets you hold assets in a low tax area.  That’s why they love super when the market is booming, but hate it when the market is down. 

To make the most of your superannuation you need to understand the workings of our old friend compound interest.  Think about a person aged 25 who currently has $10,000 in super and who earns $35,000 a year.  If inflation is 3% per annum and their salary increases by inflation they will have $1.626m at age 65 if their fund returns 9%.  However, if the best they can do is 7% they will only have $961,000.  That is a difference of $665,000 - just because of a better mix of assets inside the fund. 

Monday 12 July 2010

Leverage, or gearing as it is sometimes called, can be one of the fastest wealth-building tools around.  This is because it magnifies the amount of assets you can have working for you.  If you were left $300,000 you would normally do much better long term if you borrowed another $300,000 and bought property or shares worth $600,000, than if you simply invested the $300,000 on its own.  .

That’s fine if everything goes well, but the multiplier effect works against you if the market falls.  The person who has borrowed $300,000 is looking at a loss of $120,000 if the market falls 20% - a loss of 40% of their initial capital.

Gearing is fine, if all goes well, but there are now derivative products around that offer you super gearing – the ability to make huge profits, but at the same time huge losses.  Unfortunately, they can also lure the unwary investor into losing far more than their original stake.  The most popular of these are contracts for difference (CFDs) which are now being heavily advertised.

A CFD is a contract between two parties to exchange the difference in the price of a security between when the contract opens and closes.  To put it simply, CFDs allow you to trade shares without having to physically own them, and the result is that you are borrowing money to bet on whether a share price or an index will go up or down.

The companies issuing them may permit you to borrow up to 95% of the value of your debt (or even more in some cases).  That means with $5,000 you could buy a contract for $100,000 worth of shares – for $100,000 you could in theory buy a $2 million contract.  With 95% borrowing just a 0.5% or 1% change in the price of a share can turn into a 10% or 20% gain or loss.”

As ASIC points out  “Because of this borrowing, it's much riskier than a flutter on the horses or a night at the casino. Your losses are potentially unlimited and can far exceed the money you've wagered. You could wipe yourself out in a single day.”

Be warned - as always, the higher the return the higher the risk.

Monday, 5 July 2010

Account based pensions, formerly known as an allocated pensions, can be great tax savers because they allow a retiree to hold money in a tax free area while drawing a tax free income once they have reached 60.  The disadvantage of them is that a minimum amount must be withdrawn each year. 

Early last year when markets had slumped because of the global financial crisis submissions were made to the Commonwealth government pointing out the difficulties faced by retirees who were forced to withdraw capital from their pension funds at a time when asset values had slumped. 

The government responded promptly and in February 2009 announced changes which halved the minimum amount that must be drawn from an account based pension.  For example, for those aged between 65 and 74 the minimum withdrawal was reduced from 5% to 2.5%.  The changes were a temporary measure in response to the global financial crisis and it was expected that the normal drawdown rates would apply from July 2010. 

On June 30^th 2010 the government announced that the reduced drawdown minimum requirement would remain until 30 June 2011. 

This will be good news for some retirees but there are other options available as well. 

For example, you could commute your account based pension fund back into superannuation.  There should be minimal cost in doing this, and you could then make withdrawals as required - there is now no compulsion to withdraw money from your superannuation.  The downside of this is that you would be moving from the tax free account based pension area, to the superannuation area where earnings are taxed at 15%.  This may not be a problem if part of your fund income includes franking credits as they could easily wipe out any tax that was payable. 

A further option is to quit the superannuation system altogether.  After all, if you are retired, the main purposes of holding money in superannuation is to minimise tax.  However, the latest increases in the amount of tax offsets available to retirees mean that a single person who is eligible for the Senior Australian Tax Offset (SATO) pays no tax if their annual taxable income is under $29,867 and for couples $25,680 each.  Withdrawals from superannuation for these people are now tax free, so if you have a relatively small amount of assets outside of super, and not a huge balance inside it, it may well be viable to withdraw all the money you have in super and invest it in your own name.  You could still hold it in bank accounts, managed funds or shares but there would be no requirement to spend a minimum amount each year. 

Naturally any changes should be done with advice because there may be Centrelink implications, but the above examples highlight the fact that expert guidance can improve a person’s situation. 

Monday, 28 June 2010

Tax cuts of around $15 will be with us from July 1 so you are going to find more money in your pay packet. That’s great, but human nature being what it is, you will almost certainly fritter it away if you don't put a plan immediately in place to save it.

If you have a housing loan contact your lender and arrange for your loan repayments to be increased by the amount of the tax cut. You will be able to handle the increased payment easily and it will enable you to save a handy chunk of money over time. Suppose your loan is $200,000 and your present repayments are $1331 a month over 30 years. Increasing the payments by just $15 a week would reduce the term of the loan to 25 years and save you a staggering $47,000 in interest.

Other options are to salary sacrifice the pay rise into superannuation or to use it to start an investment plan. You could talk to your adviser about a regular gearing plan whereby you could contribute $100 a month, that’s just $23 a week, which is matched by $200 a month in borrowed money to make a total investment of $300 a month.

This mightn’t sound like much but if you had started doing this in January 1990, and your fund matched the All Ordinaries Accumulation Index, your portfolio would now be worth $207,000. The debt would be $49,000 and your contributions would total $24.500 plus the tax deductible interest on the loan. All this for just $23 a week.

Obviously you must take advice to ensure that the strategy that you adopt is suitable for your personal situation, but it's a certainty that you'd need to take action immediately. If you don't, the tax cuts will vanish and you'll never have the benefit of them..

Monday, 21 June 2010

June 30^th is fast approaching and this column is a reminder of things you should do before the financial year ends. 

First, check your superannuation contributions and where possible increase them to the maximum.  Just be aware that you lose access to money placed in superannuation until your preservation age which is at least 55 and also that there are heavy penalties for making excess contributions. 

If you have investment properties do your best to make arrangements for repairs and maintenance prior to June 30^th.  The work does not have to be physically done and you can claim a tax deduction in the current financial year as long as you have signed a binding contract. 

By all means talk to a quantity surveyor about having a depreciation report done for each investment property you own.  The cost will be around $500 per property which is tax deductible and will almost certainly pay for itself in the first year as it will almost certainly uncover quite a few deductions you would not have thought of yourself.  This is a once only fee so once you have paid it you won’t have to worry about doing it next year. 

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

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

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

Just make sure you take advice before adopting any of these strategies as getting it wrong can be very costly.  Also be aware that once July 1^st arrives you have lost almost all of your tax saving options. 

14 June 2010

Today we will continue discussing the best way for first home buyers to pay off their home loan. My preference is for repayments of at least $8 per thousand per month – that’s $2400 a month on a mortgage of $300,000.  This will cut the term to 19 years if rates are 7% but also provide a very useful safety buffer if rates rise. 

Once the term is down to this level, the mortgage should be well under control and they  can choose between shortening the term even more, or investing elsewhere.  The problem with increasing the repayments to shorten the term is that a larger and larger sum is needed as the term shortens. 

If there is a good equity in the home, a better option may be to stick with the 19 year term and use the surplus funds for a home equity loan on an interest only basis to buy quality share trusts.  The only repayments would be interest, and as it is tax deductible, would come from pre-tax dollars.  For a medium rate taxpayer, this means that $1000 a month of after tax dollars is equivalent to $1650 a month of pre-tax dollars – this could fund the interest on an investment loan of $250,000. 

A whole new world would then open up for them.  They would be controlling an extra $250,000 of assets which, if returns averaged 10% per annum, could be worth $1.8m in 20 years time and $5m in 30 years time. At the same time they are getting valuable practical experience in the ups and downs of the stock market.  Furthermore, because the loan is secured by a mortgage over the house, there is little possibility of a margin call. 

This example vividly illustrates the benefits of managing your finances properly and making it a priority to get that housing loan under control.  Not only does this save a fortune in interest, it also opens your mind to the wide array of options that diversification provides and does wonders to boost your finances when you finally decide to stop work.  As always, the key is to start early and take good advice. 

7 June 2010

Most Australians begin their journey to wealth by buying their first home.  It’s a simple strategy, but can give rise to a whole host of dilemmas such as what sort of loan to take, how fast should the house be paid off, and is it wise to diversify and invest elsewhere before your loan is paid off?

Keep in mind two fundamental principals.  For tax purposes you should try to minimise your non-deductible debt and maximise your deductible debt - for wealth creation purposes you should be trying to control as many assets as you can afford in order to maximise your chances of capital gain. 

Now let’s explore the options available to a couple who have just bought their first home and have taken out the average mortgage of $360,000.  It may well be a struggle in the early years and to ease the pressure they may start their repayments on a 30 year term which would be $2396 a month if rates are 7%. 

The problem with these low repayments is that they will be paying back $502,000 in interest if they don’t increase them as time goes by.  Because of the long loan term they will have compound interest working against them, instead of for them, and after ten long years of repayments of $2396 a month will have reduced their debt by just $51,000 to $309,000.  Shocking isn’t it?  They will have paid $287,000 in payments but the bulk of the money, $236,000, has gone to the bank for interest. 

An easy way to reduce this horrendous sum is to pay half the monthly loan repayment on a fortnightly basis.  They won’t feel any extra strain if they pay back $1198 a fortnight, especially if they are paid fortnightly, but because there are 26 fortnights and 12 calendar months, they will be making the equivalent of an extra payment which will go straight to reducing the principal.  Just this one simple act will reduce the term to 24 years and save them $123,000 in interest. 

Next week we will explore their next step.

31 May 2010

Salary sacrifice is highly effective for older employees but younger employees are much better off to build assets outside the superannuation system and, at that stage in their lives, rely on the compulsory employer superannuation. 

Think about two people we will call Tom and Ella, aged 30, who understand the power of compound interest and who want to put a wealth building program in place as soon as possible.  They decide they can spare $6,000 a year from their gross salary.  Tom decides to salary sacrifice $6,000 a year to super which means he will be investing $5,100 a year after the 15% contribution tax has been deducted.  If his superannuation fund earns 9%, he will have an additional $1.25m in his superannuation fund at age 65. 

That’s not to be sneezed at but, after taking advice, Ella chooses a different course and borrows $85,000 to invest in a quality share trust.  If the trust earns 9% per annum she will have $1.96m at age 65 – an extra $710,000. 

The reason for the difference is that Ella has got $85,000 working for her at age 30 – it will be almost 17 years before Tom has $85,000 of his own capital working for him because he is only investing a net $5,100 a year.  Also, because Ella is investing outside the superannuation system, she is not losing access to her money for the next 30 years. 

Ideally, at age 30, Ella would have a reasonable equity in her own home and be able to borrow for shares with a home equity loan.  However, if she had meagre assets she could start small with an initial borrowing of just $2,000 through a regular gearing plan.  This loan would then be progressively increased as years passed and her equity in that plan grew.

Remember, investing is like a game of Monopoly – the winner is the one who controls the most assets around the board.  Borrowing for investment is still the best way for people to create wealth because the interest is tax deductible and there is no tax on capital gains until the asset is disposed of.  This may be many years after they retire.  A further benefit is that the capital gains tax is payable on just half of any gain once the asset has been held for 12 months. 

24 May 2010

Transferring the debt on your credit card to a low interest card is good in theory, but there are some big dangers when you try to do it.

Think about a person with a credit card debt of $7,000.  The rate is 18% and he doesn’t get an interest free period because he never pays the balance in full.  He simply makes the minimum payment of $140  each month, which barely covers the monthly interest.

Naturally he is intrigued when he sees advertisements offering to take over his credit card balance with an initial rate of about 2%.  He applies, and soon finds himself the proud owner of a credit card with a low interest rate and 55 days free credit on purchases. 

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

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

As a result he will be hit with interest of 18% on the $3,000 of goods - and it will be back dated to when he bought them. 

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

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

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

Monday, 17 May 2010

Do you want to make a guaranteed 100% on your money between now and June 30^th?  Then rush off to your financial adviser and make an non-concessional contribution of $1,000 to superannuation.  Provided you meet the eligibility guidelines, the Government will give you a tax-free bonus of $1,000, which will see your $1,000 miraculously turned into $2,000.

The maximum government co-contribution is $1 for every $1 of eligible personal super contributions made in a financial year and is subject to an income test.  The maximum co-contribution of $1,000 is reduced by 3.333 cents for every dollar that the taxpayer’s total income exceeds $31,920.

As income rises the co-contribution reduces by $33.33 for each $1,000 of additional income, until it cuts out at $61,920 a year.

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

Until 1 July 2007 self employed people were unable to claim a co-contribution.  The rules have been changed and now the self-employed may be able to claim a co-contribution if they meet the other eligibility criteria. 

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

It is also possible to make a quick capital guaranteed 18% on your money.  Think about a spouse superannuation contribution.  Provided the spouse’s assessable income is less than $10,800, the contributor will be entitled to a tax rebate of 18% of the contribution with a maximum of $540.  The amount of rebate reduces progressively once the spouse earns over $10,800 and cuts out at $13,800.    It’s a simple way to turn $3,000 into $3,540. 

Monday, 10 May 2010

Cigarettes are up in price again – time to think about quitting.

Do your children smoke?. Then ask them to think about two people aged 20. Assume that one chooses to smoke, and the other chooses to invest the price of a large packet of cigarettes a day ($20 a day or $608 a month) into a managed fund that invests her money into a range of blue chip shares. The price of cigarettes rises at least as fast as inflation, so it we assume inflation runs at 4 per cent  per annum, the price of cigarettes will rise by 4 per cent  per annum..

If the non-smoker increases their investment by 4 per cent per annum too, the amount invested, or spent on cigarettes, by age 65 will be $818,000. If the share trust returns 10per cent per annum, (a realistic return if inflation is 4%) the sum accumulated by the investor will be $8.2 million at age 65. The smoker’s return on their investment is ongoing health problems, the non-smoker has become seriously wealthy.

You may argue that $8.2 million won’t be a huge sum in 45 years time after inflation is taken into account, but it is equivalent to about $1.6 million in today's dollars.

Put it another way. If a person who is young now wants to retire at age 65 with the equivalent of nearly $2 million in today's dollars all they have to do is invest the equivalent of a packet of cigarettes a day from the day they start work. 

What if you are older and have a mortgage.

CASE STUDY You are age 35 and have a home loan of $400,000 over 30 years which you are repaying it at $2661 a month. If you quit smoking and use the $608 a month saved to increase your payments to $3269 a month you will pay off the loan in 18 years.. You will be debt free at 53 instead of 65 and save huge $255,000 in interest. Home loan interest is not tax deductible so saving $255,000 is equivalent to your  earning nearly $420,000 from your job.  Just giving up smoking gives you the equivalent of  $420,000 in extra salary.

If you give up smoking make sure you commit the money that you are going to save, otherwise, it’ll be quickly frittered away like your last pay rise. If you have a home loan immediately increase the repayments by the amount you no longer spend on cigarettes, f you don’t have a loan, talk to an adviser about a regular savings plan. Above all get serious – as my GP says “they all stop after the first heart attack”.

Question: It has been my understanding that a person’s tax return is to record income that has been received, during the financial year of that return and after 30 June, any new receipts are part of one’s income for the following financial year.

A number of companies when forwarding dividends , and associated cover notes, after the end of a financial year, state that these earnings were made in the preceding financial year , and should be shown on the recipient’s tax return for that year.

If a person, in early July, has already submitted a tax return , based on the amounts actually received, during the preceding financial year , will the ATO accept that these late received dividends become income for the year in which they are actually received?

Answer:  You are correct in your assumption about dividends from direct shares – they should be included as income in the financial year that you receive the payment.  But it's a different matter with some managed funds because they have transactions throughout the financial year but the book keeping is not completed until well after June 30^th.  This is why they forward you a statement which will detail the numbers that are to be included in your tax return for the financial year that is passed. 

Question: My wife has earned less than $6,000 per annum for a number of years.  We have about $60,000 worth of shares in her name.  When we bought them three years ago they were worth $20,000.  If we cash them in now how much CGT will she pay?

Answer: The capital gain will be approximately $40,000 but as she has owned the shares for more than a year she will be entitled to the 50% discount.  Therefore $20,000 will be added to her taxable income in the year of sale.  If she earns no more than $6,000 in addition to this, the total CGT will be about $3,000. 

Question: We are in our forties and have small children.  We have paid off the mortgage but are now saving and planning on renovating in about a year.  In the meantime we are paying tax on interest on our savings.  Can we put our savings - $30,000 - in the names of our children to save on tax?

Answer: If you transfer the money to your children and then transfer it back to yourselves the ATO will almost certainly take the view that it was your money at all times and assess the interest to you.  While you are waiting to renovate the best option would be to hold this in the name of the lowest income earning spouse. 

3 May 2010

The long awaited Henry Review contained 138 recommendations, most of which have ignored by the Rudd Government. And, as I predicted, there has been no attack on negative gearing.

Cast your mind back to 1985 when Treasurer, Paul Keating, watered down negative gearing by introducing a system that quarantined any net losses from property investment, and required them to be offset only against future profits.  It was a disaster - investment in property fell dramatically, rents went sky high, and in October 1987 Keating backed off and reversed his original decision. 

Despite the misinformation that is often bandied around, negative gearing doesn’t save much tax.  If you bought an investment property for $400,000, and borrowed the entire purchase price, the interest would be about $30,000 and the net rents would be around $16,000.  This would give you a cash shortfall of $14,000 which would only save you $5,530 in tax if you earned between $80,000 and $180,000. 

Who in their right mind would get themselves into hock for $400,000 just to save $5,530 a year in tax?  Sure,  I admit that certain properties can give tax breaks due to depreciation allowances but these are often illusory as any tax saved is clawed back when you eventually sell.  

The essence of negative gearing is that it speeds up whatever is going to happen – poverty or wealth.  Buy a property for $400,000 on $20,000 deposit and you will have doubled your money if the price rises to $440,000, however if it falls in value you could lose your deposit unless you are prepared to wait out the cycle.  The problem for property buyers now is not that negative gearing may be abolished, but that they will be lured into buying over priced properties which could devastate their finances if prices fall as interest rates rise 

Question: I have inherited a portfolio of shares in mostly blue chip companies - current value around $80,000.  I have never owned shares before and want to know how best to manage them.  The inheritance has also included $200,000 cash.  Can you suggest the best way to manage and grow this money?

Answer: You should form an association with a stockbroker who can help you put together a portfolio that will suit your goals and risk profile.  This may involve selling some of the inherited shares and buying others, but check out possible capital gains tax before you make any sales.  Remember when you inherit shares you takeover the CGT liability of the deceased and this is not triggered until the shares are sold.  You will need to take advice about investing $200,000 but my advice is to take it slowly.  If you find you are comfortable with shares you may decide to progressively move part of the $200,000 into more shares. 

Question: I am a 58 year old single earning $80,000 per annum (indexed to CPI) with $310,000 in Super (defined benefit contributing $130 per fortnight). I pay rent of $350 per week and otherwise have no debt. I would like the security of owning  my own home to a value of $420,000 in today’s value and so far have saved a 25% deposit in a term deposit. I anticipate working until I am 65 year of age.

Would it be recommended to salary sacrifice into my super now and buy a house on retirement or buy the property now?

Answer:  Provided you can afford the repayments on the house you wish to buy I suggest you jump in and get it as soon as possible.  Yes, it is possible that prices may fall but it is my belief that the rising population will hold house prices up.  If you opt for an interest only loan you may well have sufficient spare income to salary sacrifice part of your income to super with the intention of providing a fund paying out part of the loan when you retire.  The danger of waiting to buy is that you could be locked out of the market if prices take off. 

Question: I will be 64 years old this year, caring for a terminally ill husband, receiving carer’s allowance from Centrelink, and scared that I might not be able to live on the $50,000 I have in Super, if and when anything happened to my husband.

I would like to transfer the money into a Term Deposit account which will add capital instead of leaving the money in Super.

Can you please advise me what to do with my small amount of superannuation.

Answer:  The only purpose of holding money in superannuation is to save tax.  If your total financial assets are $50,000 you are most unlikely to be paying tax and would save fees by withdrawing the money from super and investing it in an area with which you feel comfortable. 

26 April 2010

June 30th is just a few short weeks away – a wake up call to think about ways to reduce your tax.  

Tax cuts are in the offing with the upper limit for the 15% personal income tax band rising from $35,000 to $37,000 on July 1, and the rate for the $80,001 to $180,000 band dropping from 38% to 37%. 

Even though these are relatively small tax cuts, keep in mind that a basic principle of tax planning is to try to defer income to future years while, bringing forward expenses to the current financial year.  Therefore, if you have money sitting in the bank and are prepared to lose access to it for a few weeks place it on a term deposit with all interest maturing after June 30^th.  The interest will then be taxed next year when your marginal rate may be lower. 

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

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

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

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

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

As always take advice but don’t delay - when the clock strikes midnight on Wednesday  30^th June it will be too late.

Question: My wife and I are both aged 65.  We are retired with about $1.5m in two account based pensions, we own our home worth about $650,000, and have no other significant assets and no debt.  We do not receive any government benefits.   If we were to sell our home and use the sale proceeds plus most of our super to buy a new fantastic home worth about $1.75m, and then each couple of years thereafter downgrade to a slightly less valuable home, we would receive a full age pension and associated benefits - but would the transaction costs be more than the government benefits generated by this "gradual downsizing" strategy?

Answer: You would have to do the sums because costs of buying a home vary from state to state but I would imagine the overall costs of what you are thinking of could be in excess of $100,000.  A better option may be to seek advice about a Commonwealth Seniors Health Card.  Eligibility is based on taxable income which should be very small if you have most of your money in account based pensions.  This should give you the benefits you are seeking without the cost. 

Question: At present I am a pensioner who earns around $300 in interest. My husband died in October last year and previously I disclosed the interest in his tax return. Will I have to do an income tax return myself now?

Also, next month I am to get $100,000 from my husband’s estate. I will have to contact Centrelink. Can I give my two sons $20,000 each to help them as they have a large mortgage each?

Answer:  Thanks to the Senior Australian Tax Offset (SATO), a single person of pensionable age does not have to pay tax if their income is less than $29,867 a year.  Therefore there would be no need for you to prepare a tax return if your income is relatively small.  You are required to advise Centrelink of any material changes in your circumstances but I recommend that you do not make gifts of more than $10,000 a year in total because the money will be held as a deprived asset for five years.  A further complication is that you cannot give away more than $30,000 over five years.  Your best strategy might be to give your sons $5,000 each every year for the next three years. 

19 April 2010

Despite the changes to superannuation, in some circumstances, it may be  worthwhile to split your super with your spouse. 

It  works like this.  Once a year you can instruct your fund to transfer, to your spouse, up to 100% of your superannuation contributions made in that year.  Both undeducted and deductible contributions can be transferred, but the 15% contributions tax on the concessional (deductible) contributions will have to be taken into account when the transfer is made.  This effectively limits the amount of concessional contributions that can be split to 85%.

Think about Peter, aged 52. He earns $125,000 a year and is contributing $50,000 a year to superannuation due to a combination of the compulsory employer superannuation and his own voluntary sacrificed contributions.

He already has over $600,000 in superannuation but his wife Clare, who does not work, has none. His deductible contribution of $50,000 will still be liable for the 15 per cent contributions tax but he can ask his fund to put $42,500 of it into her superannuation account. If he keeps up this strategy until he is 65 she may well have over $900,000 in her own superannuation account then if her fund earned 9% per annum.

Super splitting doesn’t get Peter out of the 15% contributions tax but it still has advantages. First it enables them to maximise the amount that can be withdrawn tax free if Clare wants to make withdrawals before age 60 – remember withdrawals are only tax free for those aged 60 or more. Those aged between 55 and 60 can withdraw the first $150,000 of the taxable component tax free but, for them, the exit tax of 16.5% remains on the balance. If deemed appropriate, he could even work until age 75 and keep up the salary sacrifice/spouse split strategy going.  This would keep him in a lower marginal tax bracket while funding a major part of the household expenses through tax free withdrawals from her super.

The strategy can be especially useful if there is a significant age difference.  If Clare was older than Peter she would reach age 55 or 60 before him and so be able to enjoy the tax and access benefits that come at either of those ages.  If she was younger than him, their Centrelink benefits could be maximised as money in superannuation is not counted until the owner reaches pensionable age. Suppose Peter turned 65 when she was 58. He could cash out a large chunk of his super tax free and put up to $450,000 into super in her name as an undeducted contribution and, subject to other assets, get a substantial aged pension and all the benefits that go with it.  

A potential benefit in moving superannuation to your spouse’s account is protection against  rule changes in the future that may restrict lump sum withdrawals.  Personally I don’t think it’s on, but it is obvious from the many emails I receive that a lot of you are worried about it.  In the unlikely event of it happening two separate accounts would enable a couple to have two lots of accessible lump sum withdrawals. 

Question: I am 65 years of age and recently retired.  My wife is 63 and still working part time. We own our home currently valued at $700,000 and have between us $350,000 in superannuation which remains untouched at present.  After the sale of a property and combined with savings we have $650,000 in a cash management account - however the returns are not so attractive at present.  What would you suggest we invest all or part of the $650,000 into to gain a more interesting return?

Answer: My preference would be for the money to be invested in super in your wife's name as this would enable her to start an allocated pension when she stops work.  The fund would pay tax at 15% while in the accumulation phase but once you start the allocated pension the fund will be a tax free fund with all withdrawals tax free.  How much better can it get!  Just bear in mind there are limits on contributions but she could put $150,000 in this financial year and $450,000 in the next financial year.  Once the money is in super you could take advice on an asset allocation that suits your needs and risk profile. 

Question: I read that insurance bonds and super were the only vehicles that would not give taxable income. What about dividends from fully franked shares? 

Answer: Franked dividends may be tax free in the hands of an investor who earns less than $80,000 a year, but they still give rise to taxable income.  In fact the taxable income they create is larger than the actual dividend received because you need to include the franking credits in your income for that year as well as the dividend itself.  

Question: My wife and I are both potential first-home buyers.  We have $150,000 in the bank and are stumped as to what we should do.  Our combined income is $250,000 a year, but with parenthood approximately 12 months away we are hesitant to borrow a large amount.  Can you recommend a strategy that would help us?  We are torn between buying an investment property or a family residence.  We have also been offered a nice place to rent for $500 per week if we were to take on an investment property.

Answer: I suggest you do a budget based on a single income.  Buying a well located investment property while you rent elsewhere is a good strategy but make sure you occupy it before you rent it out.  Then when you move to the rental property the capital gains tax exemption will be in place for six years which means you should be able to enjoy the tax advantages of having an investment property while not losing your CGT free status. 

Monday, 12 April 2010

Last week the Reserve Bank of Australia continued their policy of returning interest rates to normal.  How far up they will go is anybody’s guess but keep in mind that the current cash rate of 4.25% is still 3% less than the 7.25% they were in April 2008.  This means it is conceivable that home loan rates could go to 9% or even a little more. 

Obviously, the extent of any rate rises will depend on the extent of the recovery in the Australian economy but, in the current circumstances, it would make sense to put yourself in a position of strength so you will not be forced out of your home due to increases in your loan repayments. 

A great strategy is to make sure you repay at least $800 a month for every $100,000 you borrow.  For example, if you had a loan of $300,000, you would make payments of at least $2,400 a month.  This will keep the loan term under 30 years if rates are 9% and will give you a great safety buffer if rates stay down.  Even if rates held at 8%, repayments of $2,400 on that loan of $300,000, the term would be 22 years. 

I also urge you to make your payments fortnightly.  Instead of paying back $2,400 a month, pay back $1,200 a fortnight.  Because there are 12 calendar months and 26 fortnights you will be paying an extra month’s payment every year without feeling it. 

Above all, keep in mind that most mortgage stress is not caused by the home loan repayments themselves, but by extra commitments such as credit card debt and personal loans.   Make sure you focus your energies on getting rid of these as soon as possible – this will give you a further safety buffer. 

Question:   We have two properties – our principal place of residence and an investment property.  Our current house is in both names and has about $150,000 owing against a total value of $350,000; the second, in my wife's name, has $140,000 owing against a total value of $300,000 (my wife has had the investment property for five years).  We are thinking of selling the investment property and using the money to pay off our current home and then mid next year buying another larger property.  What scenarios can we consider with regards to capital gains tax, the interest on the loans we are paying - she is not planning to go back to work for six months?  We currently earn $90,000 a year each.

Answer: Your wife will be liable for capital gains tax on the sale of the investment property but if she lived in it at any stage before renting it out there will be an adjustment made to reflect the period of residence.  As she has had the property for longer than a year she will be entitled to the 50% discount so you may find, after doing the sums, that there is not a large amount of CGT to be paid if she sells the property in a year when she has no income.  Just bear in mind that CGT is calculated on the date the sales contract is signed, not the date of settlement.  Talk to your accountant before you sign any contracts

Question: I am researching companies with the view of investing $500 at a time.  I am more interested in keeping the shares over a long period of time for the dividends.  Am I being too conservative buying in $500 allotments?  I am actually saving to buy so I don't miss the money - or is there some other investment you would suggest?

Answer: I believe that shares are a great buy over the long term but the way to maximise your returns is to have as much money working for you as soon as possible.  If your income is secure, you could take advice about conservative borrowing for investment in shares.  For example, you could build a portfolio of say $5,000 in quality share trusts and then commence a regular gearing plan whereby you invested a set sum, say $250 a month, which was matched by borrowed funds of up to double that.  This means the total investment was $750 a month of which $250 comes from your own funds and $500 is borrowed.  As the portfolio builds you could refine your strategy and even possibly move to a home equity loan.

Question: How do I build on my super if I choose to reduce/quit my job due to lifestyle choices i.e. offspring or looking after parents?  Would I need to invest my partner’s money from his job or even borrow money to increase the amount of money needed for our retirement?

Answer: The key to building wealth is to invest using funds you have generated from surplus income, or create a pool of investment by using excess income to borrow.  Unfortunately if you are reducing your income the wealth building process becomes much more difficult as you are reducing the amount of resources available.  In your situation I think you should start from scratch and consult a financial advisor to discuss exactly when you would like to retire and how much you believe you will need then.  The advisor can then help you design some strategies that are appropriate for your goals and these could include borrowing for investment or salary sacrifice

5 April 2010

Last week I talked about tax deductibility of interest.  Today we will take it a step further and think about strategies for borrowers who are using line of credit loans. 

There is confusion about home loan accounts with a redraw facility and offset accounts.  It’s worth taking the time to understand them because they are vastly different animals and getting it wrong can be very costly.  An offset account is simply a savings account with the interest being deducted from your loan interest instead of being paid to you as taxable income.  At any stage, funds can be withdrawn from the offset account without tax implications.  In contrast, every time you make a withdrawal from a line of credit account, you are establishing a new loan.

Suppose a couple have a $400,000 loan on their home and have the goal of eventually upgrading to another home and renting the original out.  Over the years they have accumulated $350,000 in their offset account, which means they effectively owe only $50,000 on their property.  When they make the move they simply withdraw the $350,000 from the offset account and use that as a deposit on the new home.  This leaves them with a $400,000 debt on the now tenanted original property and they can claim all the interest on it as a tax deduction.

Their neighbours once had a $400,000 loan but have worked hard to reduce the debt to $50,000.  If they move out, the debt on the now rented property will be stuck at $50,000.  Certainly they could redraw funds from the original loan to buy their dream home but the interest will not be tax deductible. They will have a huge non-deductible debt on their new residence, and will be paying tax on the rents from the original property.

An investment line of credit loan can be a particular trap if the borrowers do not keep their business and private expenses strictly separate.  Unfortunately far too many borrowers deposit their salary into the investment loan account and then withdraw funds each month for normal living expenses.  They do not realise that the deposit of the salary is treated by the tax office as a permanent reduction of the debt, and each redraw is a new loan.  Because the redraws are used for a private purpose such as paying for groceries, the loan very quickly loses its tax deductibility.

The lesson in all this is that you should keep your investment and private borrowings separate and always use an offset account if you intend to rent out a property that is presently used as your own residence.

Question: My wife and I are in our mid 50's and have about $500 a week spare for making money.  Neither of us has much super - we are both reluctant to pour money into super.  What can we sink our money into that will give us the best return over the next ten years - super, an investment property, a property trust or syndicate, managed funds, blue chip shares, anything?

Answer: There are two important factors to consider - the type of investment to hold and the best entity to hold it.  For a person in their mid 50s earning more than $35,000 a year the perfect investment is super because you can usually invest in pre-tax dollars using salary sacrifice.  Because salary sacrificed contributions lose just 15% and money taken in hand loses at least 31.5% you are making big tax savings immediately.  Once the money is inside super you and your advisor can decide what sort of asset mix is appropriate for you.

Question: I am unable to work and am supported by my 61 year old husband.  We owe $39,000 on our mortgage.  I will soon turn 55 and wish to use my super to pay off the mortgage, before any changes to access may occur.  Are there any disadvantages you can see to this course of action?  I have not made any prior withdrawals.  Would I be liable for tax on the payment?

Answer: I am not concerned about changes to the access rules for people of your age but under the existing rules once a person reaches 55 and retires they can access their super and withdraw  up to $150,000 of the taxable component tax free.  But, while your proposed strategy is feasible there are other factors to consider.  For example, if you had more than $150,000 in super you would pay 31.5% on any monies you withdraw prior to age 60 and if your husband is seeking any Centrelink benefits money withdrawn from super and invested could disadvantage you both because money in super is not counted by Centrelink until the member reaches pensionable age.  In your case this is 65.  Just make sure you take advice before you make any withdrawals.

Monday, 29 March 2010

If the volume of emails is any guide, borrowing for investment is a hot topic with readers.  And so it should be.  After all, we have a tax system that is biased against saving because the tax office takes up to 46.5% of the interest you earn on money in the bank.  On the other hand, if you take out a loan to buy property or shares, the tax office subsidises up to 46.5% of the interest; yet provided you keep the asset for at least a year, you pay capital gains tax at a maximum rate of 23.25%.

On the face of it, the tax treatment is simple.  Provided the purpose of the loan is to buy income-producing assets, the interest will be tax deductible.  The most common question I am asked is “suppose I upgrade from my existing home to another home, and rent out the original one, can I take a loan against the original home for the mortgage on the new one and claim the interest as a tax deduction.”  The answer is an unequivocal no, because the PURPOSE of the loan is for private use - to buy a new home to live in - and that has nothing to do with the property being used as security for the loan.

However, a loan can change character.  The interest on your home loan will not be tax deductible while you are living in it, but if you vacate the property and rent it out, you can then claim interest and other outgoings as a tax deduction and at the same time will have to declare the rental income as taxable income.  The cream on the cake is that you can then be absent from that home for up to six years without losing the capital gains tax exemption provided you don’t claim any other property as your principal residence in that time.

There can also be traps if you are using line of credit loans.  I will discuss these in detail next week. 

Question: My son missed paying $262.03 out of a total of $16,456.21 on his credit card in January and we didn't realize it until the February statement came.  We thought he would get charged interest on the late payment of $262.03 only, but he was charged on the full amount for that month.  Is that is the usual way that it is done?

Answer: Unfortunately a missed payment of only a few dollars can result in heavy interest penalties and the unfairness of this has been the topic of many articles in recent years.  If he has been a good payer in the past, I suggest he contact his bank and ask them to waive the payment in this case.  They will usually come to the party.

Question: After 1 July 2009 if I withdraw money from super is it assessed as income to qualify for the super co-contribution?

Answer:  To qualify for the co-contribution you must have income from personal exertion.  Obviously, withdrawals from super do not qualify. 

Question: I am 24 years of age.  I live in a unit valued at $300,000 on which I owe about $60,000.  I have $15,000 in a managed fund - CFS Geared Australian shares.  I have $8,000 in savings and I earn $53,000 a year. I was thinking I might put the $8,000 in the managed fund.. What do you think?

Answer: The basic idea is sound as long as you are aware you should not be placing money into share based investments unless you have at least a five to ten year timeframe in mind.  The other issue is to try to maximise your deductible debt while minimising your non deductible debt.  This is why a better option may be to pay the $8,000 off your home loan and then borrow for investment.  If you do this by way of a home equity loan you should never have to worry about margin calls.

Monday, 22 March 2010

It has been a mixed month for most pensioners.  On the one hand they received a welcome increase in their pension, but at the same time the government increased the deeming rates.  This had the effect of reducing the pension for those who are assessed under the income test, and many pensioners found their net benefit hardly changed as the increase in one hand was cancelled out by a reduction in pension on the other.    

This means it is time to refresh our knowledge of the deeming rules that determine the income that Centrelink applies to pensioners’ financial assets. The new rates for a couple are 3% on the first $70,000, and 4.5% on the balance. For a single pensioner the first $42,000 is assessed at 3%, and the balance at 4.5%. The assets that are subject to deeming include bank accounts, shares and managed funds, debentures, superannuation when the owner has reached pensionable age, and deprived assets such as excess gifts.

For example, if a couple of pensionable age had financial assets totalling $350,000, the income from these would be deemed by Centrelink to be $14,700 made up of 3% on the first $70,000 ($2,100) and 4.5% on $280,000 ($12,600).

These rates apply irrespective of the amount actually earned on investments, so pensioners can gain an advantage if they can get safe returns that are higher than the deeming rates. Unfortunately, many pensioners don’t understand this and leave their savings in the “deeming accounts”.  The problem with many of these is that they may pay interest rates that are lower than what can be obtained safely elsewhere.

Right now, there are major banks offering up to 5% on online savings, and over 6% for term deposits.  Pensioners and their families should check these rates out because the purpose of the deeming rates is to encourage pensioners to become interest rate savvy.  As always, take advice and stick with safe institutions. 

Question: A friend earns around $67,000 a year.  She salary packages through her employer which reduces her taxable income.  She has a rental property leased at $360 per week, and rents a property for herself at $300 per week.  Would she be better off financially if she continued renting and negatively gearing rather than living in her own property and paying off a mortgage; or does it come down to personal preference?  Should she return to living in her own property how does this affect capital gains tax when she sells?  The property has been rented for one year and she lived in it one year prior to that.

Answer: Your friend is the only one who can decide what is the best option for herself, but by owning an investment property and living in rental accommodation she is in a position where she is enjoying the tax benefits of owning investment property and at the same time living in an area where she want to be.  As she initially lived in the property, and then rented it out, she is entitled to take advantage of the six year rule and so can be absent from that property for up to six years without losing the CGT exemption as long as she does not claim any other property as her residence in that time.  Based on the information supplied, I believe she has her affairs pretty well under control. 

Question: We bought a new property in July 2007 and shifted into it in December 2007, renting out our previous home of 17 years.  We are paying off the loan with rental income and some wages.  We refinanced the loan through a different lending institute in October 2008, but nothing else has changed.  In a recent column, concerning a similar situation, I interpret from your answer that the interest would be a tax deduction once we rented out our previous house.  When we had our tax done our accountant said it wasn't a tax deduction because the original loan was for another rental property we sold to buy our new residence. Will our refinancing for our previous home (now rented) make a difference to tax deductibility?

Answer: The fundamental principal is that you can only claim a tax deduction for interest on a loan if that loan was used to buy income producing assets such as property and shares.  However, a loan can change character so that an existing loan on a non income producing property can become a deductible loan if the property starts to be used to produce income.  If the loan was solely to buy the property you now live in, the interest will not be tax deductible.  But if there was a residual loan on the older property before you bought the new one, the interest on the balance of that loan before buying the new property will be tax deductible. 

Monday, 15 March 2010

Recently I received a question about the merits of salary sacrificing to super, as opposed to taking the money in your pay packet.  The questioner and her husband were both in their mid fifties and were having a difference of opinion about strategy.  He felt it was better to take the money in hand to provide certainty, but she felt it would be more effective to use salary sacrifice.  They both earned around $55,000 a year.  

I am a strong believer in salary sacrifice for people in that age bracket because they could access their superannuation if they retired, and also have a fairly low risk of being affected by any law changes. 

Also, money taken in hand tends to be spent whereas money contributed to super is locked away. 

The maths work well because of the difference in the 15% entry tax on super, and the employee’s marginal tax rate.  For example, if the couple in question took $5,000 in hand they would lose $1575 in tax and have $3425 over.  However, if that $5,000 was salary sacrificed to super they would lose just $750 tax and have $4250 over.  Furthermore, the tax on the earnings on money within super is 15% whereas, in their case, earnings would be taxed at 31.5% if the money was invested outside super. 

A word of caution – before entering into a salary sacrifice arrangement make sure your employer will not use this as an opportunity to reduce the compulsory 9%.  True, it doesn’t happen very often, but it does happen enough for people to be wary of it.

Question: With the Budget changes to salary sacrificing, I am wondering if there is any merit in continuing with my transition to retirement pension.  I am 57 years old and earn $120,000.  For the 2009/2010 year I was planning to salary sacrifice $80,000 and take out a TTR of $25,000 a year – but am wondering if there is now any tax advantage in doing this.  If I put any non-concessional contributions into super, is there any advantage in putting it into my spouse’s account?  She has just turned 60, does not work and has minimum super.

Answer: From July 1, 2009 your maximum deductible contribution to super from all sources is limited to $50,000.  Therefore, if your employer is contributing $10,800 (9% of $120,000) your additional salary sacrificed contributions will be limited to $39,200.  There is still a significant tax saving to be made but it will not be as much as it would have been under the original rules. 

Question: We sold two investment properties last year (2008), one unit sold in May 2009 with a profit of $65,000 for which we paid capital gains tax in last tax return  We sold the second property in July 2009 at a loss of $140,000.  As it was deemed to be sold in the next financial year the loss could not be offset against the gain

Is there any way of offsetting this loss?

Answer:  Unfortunately you cannot rewrite history but your question illustrates the importance of taking advice before buying or selling assets.  I assume you are aware that it is the contract date that is the relevant one and not the date of settlement.  Depending on your circumstances it may be possible to reduce CGT by making a tax deductible contribution to super before 30 June 

Question: I note that the amount you can contribute to super changed from $100,000 to $50,000 from July of last year.  What happened to the previous governments ruling that you could contribute to super at $100,000 each year till 2012?  I had made plans for retirement according to that, now I stand to loose that benefit.

Answer:  Unfortunately it is a sad fact of life that the rules regarding superannuation are continually changing and legislation put in place by one government is not binding on another.  Fortunately, people aged 50 and over are still able to contribute $50,000 a year to super until June 2012 so there are still some worthwhile tax benefits to be enjoyed.

8 March 2010

Recently my son James Whittaker and I launched our latest book “The Beginner’s Guide to Wealth” which has been written to help young people take control of their life and their finances at an early age.  It is a sad fact of life that many people do not excel at school, even though they may have a wealth of talent, and so develop the feeling that success is destined for other people, but out of their grasp.  In our new book we explain that life is a long journey and, irrespective of high school marks, it will still serve up many challenges and disappointments. 

In our experience, the qualities that make for success in life are a good attitude, a pleasant disposition, an eagerness to build positive habits, and a commitment to ongoing learning and development.  None of these require a high IQ. 

Most young people I meet tell me they are unsure about what they want to do in life.  This should not be a problem because many jobs that exist today were unheard of 20 years ago.  The best way to handle uncertainty is to experience as many different types of jobs as possible – this will enhance your skills and widen your circle of contacts. 

Once you get a job, resolve to be the one person that the boss can trust absolutely.  Then, you’ll be the one given the challenging tasks that nobody else wants and you are also most likely to be asked to relieve your supervisor when he or she is away.

The person who keeps learning and who is always prepared to give 110% will find opportunities everywhere. 

We have been very humbled by the overwhelming feedback since the book launched earlier this year and we are continuing our mission to make it available to as many people as possible.

Question: I believe I was told by a financial services person in Centrelink that they have received notification that the Rudd Government has advised they will be discontinuing salary sacrifice at the end of this financial year.  Is this correct?

Answer: There is nothing in the pipeline as far as I know regarding discontinuance of salary sacrifice but it is possible that you misunderstood what the people at Centrelink told you.  There have been changes to the way eligibility for certain Centrelink benefits are assessed and it is no longer possible to use salary sacrifice to reduce your salary for Centrelink eligibility. 

Question: My husband and I have been running our own small business for six years.  Sadly, we have been forced to close, but have $50,000 put aside.   We currently rent, and both are now in the position of finding jobs.  Can you provide us with some advice on the best way to use this money to secure our future?  I am 34 years of age, my husband is 40, and we have a nine month old baby daughter.  We have a $3,000 personal loan debt.  What is our best move?

Answer: I think it is important to put your money in a place where you cannot get easy access to it otherwise you will almost certainly find that it will start to be frittered away.  In view of your relatively young age I would stay away from super but a good option might be a three month term deposit offered by one of the major banks.  At the end of that time you may have jobs and could then start saving for a house.  You could investigate paying off the personal loan but you may find that you do not save any interest by doing so.  I assume there are no outstanding tax liabilities in regard to the sale of the business.

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?

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, 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.

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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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