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Noels' Money Column

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

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.

Monday, 7 December 2009

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

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

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

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

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

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

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

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

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

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

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

Monday, 30 November 2009

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

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

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

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

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

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

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

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

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

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

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

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

Monday, 16 November 2009

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

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

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

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

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

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

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

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

9 November 2009 

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

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

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

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

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

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

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

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

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

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

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

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

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

Monday, 2 November 2009

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

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

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

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

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

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

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

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

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

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

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

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

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

Monday, 26 October 2009

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

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

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

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

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

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

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

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

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

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

Monday, 12 October 2009

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

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

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

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

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

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

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

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

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

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

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

Monday, 5 October 2009

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

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

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

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

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

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

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

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

Monday, 28 September 2009

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

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

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

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

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

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

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

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

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

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

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

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

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

Monday, 21 September 2009

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

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

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

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

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

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

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

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

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

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

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

Monday, 14 September 2009

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

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

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

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

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

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

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

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

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

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

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

7 September 2009

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

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

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

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

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

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

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

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

Monday, 31 August 2009

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

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

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

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

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

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

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

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

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

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

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

24 August 2009

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

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

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

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

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

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

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

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

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

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

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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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