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Noels' Money Column

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

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15^th December 2008

There is no doubt that 2008 has been one of the worst years on record. Property prices around the world are tumbling, unemployment is skyrocketing and stock markets are at their lowest level for years. The US car industry is teetering on the brink, steel prices have collapsed, and much of the world is either in recession or entering it.

Fortunately, we in Australia are better off than most. Our banks are tightly regulated and generally do not have exposure to sub-prime loans. Even though unemployment is forecast to rise, the indications are that we will not go into recession. Notwithstanding that, the Australian stock market has fallen by over 40%, and both residential and non-residential property markets have been hammered everywhere. To complicate matters further, the year started in a climate of rising interest rates and finished with rates tumbling. The debt futures markets is now predicting that cash rates will drop to 2.75% by April 2009 – if this happens, Australia will have the lowest interest rates since 1960.

While dropping interest rates may be great news for borrowers, they add to the challenges faced by investors. It is a cardinal principle that your assets should be diversified across cash, property and shares, but the cash returns for the next 12 months are going to be scanty indeed and there is no evidence at date of publication that either the property or share markets are ready for a quick rebound.

Bad news makes big headlines, and it’s easy to become despondent when you are greeted with more bad news every time you buy a newspaper or turn on the television. However, it’s important to understand that the financial system in Australia is inherently sound. Our Federal Budget is in surplus, most of our leading companies are well managed, and the underlying shortage of new housing stock will put a floor under most house prices. Unemployment may rise in 2009 but remember, the eldest baby boomer is now 62, and the next 20 years will see a mass exodus from the workforce as the baby boomers retire. Expect staff shortages, not unemployment, to be one of our major problems in the medium term. 

Our stock market is clearly undervalued, and our compulsory superannuation system guarantees that a flood of money will continue to pour into our superannuation system. Eventually, a large part of that money will end up in shares. Furthermore, as interest rates fall, the dividends from our blue chip companies will look more and more attractive, particularly as franked dividends carry tax concessions that are not available from any other investment. Remember, franked dividends are tax free for anybody earning less than $80,000 a year.

It’s tempting to switch your share-based investments to cash while you wait for the “right time” to re-enter the market, but anyone contemplating this should clearly understand that picking the bottom is just as hard as picking the top. In 1973-74 the market fell 59% and in 1987-88 it fell 49%. The recovery, when it came, was fast and strong. In 1973-74, the rebound was 54%, and in 1987-88, the rebound was 28%. No one can afford to be out of the market when the big bounces happen.

This is my last column for 2008 and I take this opportunity to wish you all a wonderful Christmas and a healthy and prosperous 2009.  Let’s hope we see big recoveries in all markets.

Question:   I am 47 years of age, with a wife and two young children. I own my home valued at $850,000 with no mortgage.  I have $500,000 in super, and about 5,000 Telstra shares.  I also have $70,000 reserve cash due to a recent redundancy.  I am starting my own business, which is knowledge based and therefore has minimal start up costs.  My dilemma, if you can call it that, is I have $300,000 cash sitting in the bank.  Given my position what would you recommend as a sensible use of the money currently sitting in the bank?

Answer:   At your age you can be thinking long term so if you can take a five year view you could talk to an adviser about placing the money progressively into share based investments.  In the meantime, for maximum flexibility, use one of the on-line high interest accounts offered by the major lending institutions.

Question:   My husband is 51, we both work full time, and have a mortgage of $280,000.  Should we change our mortgage to interest only and use the balance of our mortgage payments, including excess payments, to salary sacrifice into superannuation - then when we retire at 60 pay off the balance?

Answer:   That would be a great strategy as it would enable you to take advantage of the difference between the 15% contributions tax to super and your own marginal rate which would be at least 31.5%.  At age 60 you could withdraw the money tax free to pay the house off.

Question:   I bought a property with an investment loan in 1997 for $117,000.  The property was rented out for 12 months after which it then became our primary residence.  I sold it in 2006 for $352,000.  All the proceeds were then used as deposit for my next primary residence.  Am I liable for capital gains tax for the sale of the first property?

Answer:  You have held the property for about nine years and any CGT will be apportioned on a time basis.  As it was only rented for a year it would appear that you will be liable for CGT on 50% of one ninth of any capital gain.  This should be minimal but you should ask your accountant to do the sums for you before you sign any contracts.

Monday, 8 December 2008

Today I’ll continue to talk about break costs on fixed rate loans because the flood of emails that followed last week’s column indicate that it’s a hot topic.  It’s likely to become an even hotter one as we move into 2009, because rates are still tumbling and the cash rate could be as low as 2.5% within six months. 

Bear in mind break costs are separate to the much smaller fees that may be charged for early termination of a variable rate loan.  Typically, a couple may apply for a variable rate loan and the bank may offer them a discount of 0.75% off the standard variable rate in the expectation that those borrowers will remain with the bank for the long term.  If such a loan is paid out within three years there could be a fee of around $1,000. 

One reader emailed me to say that his bank had quoted a break cost of $17,000 even though his current fixed loan rate was lower than the current variable rate, and broadly on par with fixed rates that are now being offered.  He acknowledged that the bank’s loan documentation stated the penalty was calculated on the basis of “our reasonable estimate of what we could earn from reinvesting or re-lending prepaid loan account … for the balance of the fixed interest period”, but was puzzled as to how the penalty was calculated, as the bank was apparently claiming a loss of more than 4% per annum. 

In circumstances like this the appropriate umpire is the Banking Ombudsman who can be contacted through www.fos.org.au.  They have the resources to determine if the fee charged by the bank is a reasonable one. 

Break costs are hard to avoid and but in some situations there are ways to get around them. 

If the reason for breaking the fixed loan is because you are moving from one property to another, you can ask the lender to transfer the loan from the original property to the new one.  You will not save interest as you will be retaining the fixed loan, but in most states you will save on stamp duty as the duty paid on the original mortgage is still valid.  All the lender is doing is substituting the security they held on the first property with similar security over the property you are buying. 

If you are selling a property, but are not replacing it in the near future, it may be possible to avoid break costs by offering the bank alternative security.  This could be by way of a mortgage over other property you own or simply by placing sufficient funds in a term deposit with your lender as replacement security for the original loan. 

In both the above examples there are no break costs to pay because the loan has not been paid out before its contracted term. 

Question:   Is there a system for investing children’s money with parental control (the ability to buy and sell shares or bonds), where funds cannot be withdrawn until the children reach 18 or 21 years? I would like to maximise returns with the money not being able to be withdrawn until the children reach those ages. Can this be done without the parent paying tax on the investments prior to the child turning 18 or 21?

Answer:   A child cannot own shares or managed funds, but the simplest strategy is to invest in share based insurance bonds in the name of the parent.  They can be transferred without capital gains tax to the child when the child is older and at an age deemed appropriate by the parents.

Question:   Can you advise if the law has changed on the taxing of insurance bonds?

Answer:   There were proposals to change the taxing of insurance bonds years ago but they were shelved.  Insurance bond funds pay tax at 30 percent per annum on their earnings, but the effective rate for share based bonds can be as low as 22 percent because of the presence of franking credits in their dividend income.

Question:  I am 51 years old and salary sacrificing $80,000 a year into my SMSF.  In the SMSF I have close to $1 million invested in Australian shares.  I am thinking of diversifying into property by not salary sacrificing and instead investing after-tax money in property.  Is property investment for negative gearing with after-tax money a better strategy than salary sacrifice with about a 10 year period?

Answer:  It sounds like you have ample monies for retirement so you should err on the conservative side.  You can have your cake and eat it to if you take out a home equity loan and buy and investment property on an interest-only basis.  Doing it this way means that you will have no money to outlay for a deposit and the payments will all be tax deductible.  After you reach 60 you could withdraw money tax free to pay out the investment loan.

Question:   I am 30 years old earning $49,000 a year. I own a house and have it rented at the moment and I am living with my family at home. I desperately want to move back into the house, but mortgage payments and the cost of living would make it hard for me to move back in by myself. I receive $1,100 a month in rental payments from the property and my mortgage payments are $1,440 a month.  Can you tell me a way to reduce my mortgage and have enough money to move back into the property?

Answer:   You could accumulate all your surplus funds in an offset account – this would enable you to maximise the tax benefits until you can move back in, but at the same time would allow you to build up a deposit in a tax effective way.  When you do move back an option would be to take in a boarder to help pay part of the outgoings. 

1st December 2008

In early March when all the headlines were about rising rates I wrote “Despite the latest rise, indications are that we are getting close to the top of the interest rate cycle and rates will stay flat or start to reduce over the next year.”  Regrettably my advice fell on deaf ears, because the March to August period saw an unprecedented number of home owners rush to fix their interest rates.

Just nine months later rates are tumbling, creating huge potential problems for those who let themselves be stampeded into a long term fixed rate loan. A recent email is typical.  “We had a fixed rate housing loan, and a few months ago, when we listed our home, we asked the bank about termination fees. They told us a rough estimate was $6,000  - when we finally found a buyer and signed a contract the bank told us the fee had risen to $21,731.  On settlement day when the loan was discharged, we discovered the fee was $29,307.” 

Emails from other readers tell about termination fees, commonly known as break costs, of between $36,000 and $80,000. 

These costs can soak up a hefty chunk of your capital but you need to understand  that insurance always has a cost.  A fixed rate loan is a contract between you and your bank, and the essence of that contract is that the bank promises that your interest rate will not increase no matter what rates in general are doing.  This means your bank could lose heavily if you wish to terminate the contract early.  If you took out a $300,000 five year fixed loan, and rates fell by three percent, the bank would lose $9,000 a year if you terminated the contract before the end of the contract period.  Therefore, a termination in the first year could easily cost the bank $45,000 and they would expect to be compensated.

The purpose of this column is to alert you to the potential cost, because there is no simple way out of the problem.  I have heard suggestions that you could repay the bulk of the loan leaving only a small balance until the end of the contracted period, but this is easier said than done.  For starters most fixed rate loans are paid out early because the borrowers are changing houses, so very few borrowers would be in a position to retain the original home and still buy a second one.  In any event, most fixed rate loans have conditions that penalise early lump sum repayments.

This is just another example of the way problems can be prevented if you take advice first.  You should never contemplate fixing your loan if there is even a remote possibility that you may need to quit early because you will almost certainly be stuck with the break costs.  And don’t think you can take advantage of falling interest rates by converting your present fixed rate loan to a variable rate one - the break costs will cancel out any potential savings in interest.

Question:   We own a property which is our primary residence. Nearly three years ago we moved to the country for my husband’s work, so had to rent our property out and  rent a house ourselves. We have since returned, but have not moved back into our own house and are still renting. If we sell our place now would we be subject to CGT?  Do we need to have moved back in first?

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.  It is not necessary to move back into the house to qualify for the exemption so on the facts provided, it should be free of CGT if you sell it within six years of moving out. 

Question:   What are the implications of purchasing a property, which a person proposes to live in as a main residence, through a trust?  Is there a better method?

Answer:    The problem with buying a property through a trust is that you lose the capital gains tax exemption that is available if you buy in your own name.  Also, if you rent out the property and negatively gear it, you cannot distribute losses from the trust so you may be denying yourself some immediate tax deductions.  Having said that, buying through a trust does offer a degree of asset protection, so you will need to consult with your advisers to decide if you are in the type of occupation where you could lose everything if you are sued. 

Question  :  I am a 44 year old male academic who is taking a voluntary redundancy package of $92,000 (after tax) at the end of this year.  I need advice on how to manage this money.  I have no assets (apart from my car) and no savings.  I have $197,000 in super.  I owe $3,500 on my credit card and have about $10,000 in medical expenses to pay off.  I pay $1085 a month in rent.  I envisage that it may take 6-7 months or more to find another job in academia and in the meantime I will need to live off the package.  I also want to use the package to pay off debts, to top up my super, possibly go on a holiday overseas and to put the remainder towards a home deposit.  Can you offer some advice on the best way to manage this package?

Answer :  By the time you pay off your debts, have an overseas holiday, and put money aside for living expenses there won’t be much over for a house deposit.  As a first step deposit the money in one of the on call online high interest accounts offered by the major financial institutions where there are no fees and your money will be safe from any fluctuations in the market.  Then you should talk to a lender to find out how much you can borrow and what sort of deposit you will need.  This will enable you to decide whether you are in a position to buy a house.  Don’t put money into super until you return to work as you will be losing access to it.

24 November 2008

An unintended effect of the government’s guarantee of bank accounts was a run on mortgage trusts, as people rushed to transfer money to what they saw was a safe haven.  Consequently the mortgage trusts had no option but to freeze withdrawals to protect the interests of all investors in their funds.

The Treasurer, Wayne Swan, suggested that retirees with frozen funds seek help from Centrelink under their ‘hardship’ provisions – this is a process I shall discuss today because it is not as simple as it sounds. 

If your funds are frozen you can ask Centrelink to make an assessment under the Asset Hardship Provisions, but you should keep in mind that the decision will depend on what other assets you have, the liquidity of those assets, and whether you are income tested or asset-tested.

For example, if a couple had financial assets of $900,000, of which $300,000 were frozen, it is most unlikely they would qualify for assistance. As a general rule, available funds of $50,000 or more would disallow access to the Asset Hardship Provisions.

Centrelink advise that in funds where investors’ distributions have permanently ceased, an exemption to the application of the deeming rates may be granted.  These exemptions are granted by the Minister with policy responsibility for the payments to which the exemption will apply.

Where an investment has lost significant value a revaluation of the asset can be conducted.  For market-linked investments, such as share trusts, this can be done at any time simply by contacting Centrelink and requesting a revaluation.

If the investment is not market linked a revaluation is more difficult and Centrelink needs to wait for advice from the fund manager, receiver or administrator about the present value of the investment.  Obviously in the case of collapsed companies this can be a long drawn-out process. 

A problem for retirees is that frozen assets may be treated differently. Think about a couple who were unfortunate enough to have money in Westpoint (gone), MFS -now Octaviar (doubtful) and Perpetual Mortgage Trust (frozen but with very good prospects of repayment in full in due course). 

Deeming exemptions have already been granted for a range of companies in the Westpoint group, but investors need to be aware that many of these had differing deeming exemption start dates and revaluation amounts.

MFS (now Octaviar) entered Voluntary Administration effective from 15 September 2008. As there has been no update from the administrators, deeming will continue to apply to an Octaviar investment. A deeming exemption may be granted when the Administrators advise that the distributions have permanently ceased. For example, Wellington Capital Premium Income Fund (previously belonging to MFS/Octaviar) was listed for trading on the National Stock Exchange from 15 October 2008.  Customers in this fund should contact Centrelink for a revaluation if they have not already done so.

Perpetual Mortgage Trust at this stage has announced their intention to allow quarterly redemptions to investors. This freeze does not affect the distributions paid to investors nor the value of the investment, and the treatment by Centrelink will remain unchanged.

Sadly, it is a complex process but if you believe you may qualify for assistance just go to http://www.centrelink.gov.au/ and type “hardship provisions” in the Search box.   This will lead you to the detailed fact sheets. Alternatively talk to the FIS people at Centrelink or own adviser. As always the first step in solving a problem is to check out the remedies that might be available.

Question  :  My question relates to the ability to claim a tax deduction for non employer sponsored payments made to my super fund. My current income is from income protection insurance due to illness and has no deductions either for tax or super. I am now retired and have reached the age where I might withdraw money from super tax free up to a limit of $140,000. Is it possible to withdraw a sum of money, and if some is surplus to requirements, deposit it back into super and still claim a tax deduction on that sum of money, providing all other eligibility requirements are fulfilled?

Answer :  Provided you have reached preservation age and have retired, you can withdraw money from super whenever you wish and provided you are under 65 you can make contributions to super as long as you stay within the limits.  If no employer is contributing to super for you, which appears to be the case here, you can also claim a tax deduction.  Just be aware that deductible contributions incur a 15 percent contributions tax.

Question  :  I will have approximately $500,000 in my first superannuation fund when I retire at 65.  I will also have access to a second fund of approximately $1 million at age 75.  Both figures are conservative estimates based on average long term growth rates, rather than the recent double digit returns super funds have experienced.  Will I have enough to live on, given that there is considerable longevity in my family

Answer :  The rule of thumb is that you need twelve times your expected expenditure in investment assets when you retire.   The figures you have given suggest your total superannuation would be worth approximately $1 million in total at age 65 so the amount you have should allow you to draw an annual income of around $80,000.  Of course the amount you actually need will depend on a number of variables that include the state of your health, any bequests you may receive and how often your children ask for financial help.  I suggest you ask an adviser to run the numbers in detail for you.

Question:   I have owned a property near the beach for three years - it is worth $800,000 and I owe $460,000. I have just bought another property worth $760,000 that I plan to live in and I used a deposit of only $50,000 and incurred mortgage insurance of $16,000. I was intending to rent my beach property for $600 a week. However, I think that for that return it may be better to sell it and put the money into shares instead.  Is there any compelling reason to keep the two properties or would I be better to sell the beach property and reduce my interest expenses on my principal place of residence and invest some leveraged money into the share market?

Answer:   You could have saved your mortgage insurance by offering the bank security over both properties.  Only you can decide if the property on the beach will outperform the share market but the situation is currently unsuitable for tax minimisation as you are carrying a large non deductible mortgage on your home.  There is certainly no compelling reason to keep the beach property, but you need to take into account capital gains tax if you decide to sell it.

17^th November 2008

Investors face difficult decisions right now.  The three main investment options are cash, property and shares, and it is a fundamental principle that you hold assets in each of these three areas to give yourself diversification.  Each one is challenging right now.    

Unfortunately, while dropping interest rates may be great news for borrowers, they present a serious challenge to retirees.  Yes, it’s a good feeling to think of all the money you have in term deposits right now earning more than 8% but when that deposit matures, and you wish to renew it, you may well find that the best rate you can get is less than 5%.  This could mean a massive drop in your income.

This is why I recommend any spare cash should be placed on fixed deposit until July next year at least, if you are happy to lose access to it for that time.  It will lock in today’s rates and also transfer the earnings to the next tax year – this means you will have an extra 12 months use of the money before you have to pay the tax.

Currently most property appears to be in the doldrums and, if possible, you should avoid putting any property on the market in the current climate.  Auction clearances are way down, and in any event, auctions are usually suitable only for unique properties at a time when the market is booming.  If you do need to sell a property you should carefully research the market so you will know what properties yours is competing with – then you will be able to price it for a quick sale. 

Be extremely careful about signing an unconditional contract to buy a property if the one you own is still for sale.  You could very easily find yourself caught with two properties and be forced to slash the price of the original one. 

The share market is way down at the moment.  This means our blue chip shares are paying franked dividends that are at a much higher rate than you can earn in bank interest, but you do have to accept the risk that their values may fall further before they recover.  At least the benefit of shares is you can invest your money progressively – you don’t have to invest it in one lump as you do with property.

As always, diversification remains the key. 

Question:   My partner and I, aged 40 and 37, have about $450,000 in two term deposits from the sale of a house. We have four young children and we both work part time producing about $35,000 including Family Tax A & B which is enough to support the lifestyle we require. We don't use the $22,000 interest from the term deposit - we simply roll it over and will keep doing so until we need it for the kids’ education in approximately 10 years time.  We realise that when CPI and tax are taken out of the interest earned we are getting very poor returns and it is also reducing our Family Tax A and B by about $80 a week. Is it best to put this money into insurance bonds or some other vehicle like managed funds?

Answer:   You are too young to be tying up money in superannuation.  Therefore insurance bonds are the perfect solution to your problem because the accruing bonuses are not counted for family tax payment purposes.  Also because you are in a relatively low tax bracket, you can cash in the bonds tax-free any time you wish.  For a term of ten years I suggest share-based bonds and, because of franking credits, the effective tax rate should be around 23 percent.

Question:   We bought land as an investment but had to sell before we’d had it a year.  We only made $900 on the sale after expenses but still have interest to claim for two months of this year.  What will we need to pay in tax ?

Answer:    Interest, rates and other outgoings can be added to the base cost when you are calculating CGT so from the information provided, it appears there will be little if any tax to pay.  Of course you should always check with your accountant who can do the sums in detail for you.

Question  :  I am 59 and about to start an allocated pension.  I realise I will still have to lodge a tax return but what will happen if I get a job?  Is this permissible?  Is there an acceptable limit of income allowable on top of the allocated pension that will not be taxed?

Answer :  Once you turn 60, the income from the allocated pension will be tax-free, but until then it will be taxed at your full marginal rate less the 15 percent rebate.  You can earn as much as you wish in addition to your allocated pension because it’s the policy of all political parties that older people should be encouraged to stay in the workforce as long as possible.  Obviously the 15 percent rebate will wipe out any tax on the allocated pension if you stay under $34,000 a year where the 15 percent band ends – your adviser will be able to calculate the total tax payable if you earn a much larger income in a year.

10^th November 2008

 The share market crash and the resultant fall in asset values mean that many retirees are eligible for a larger pension under the assets test.  The reduction in the deeming rates just announced will also mean a larger pension for those assessed under the income test.

 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 current rates for a couple are 3% on the first $68,200, and 5% on the balance. For a single pensioner the first $41,000 is assessed at 3%, and the balance at 4%. 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 $363,800, the income from these would be deemed by Centrelink to be $16,826 made up of 3% on the first $68,200 ($2,046) and 4% on $295,600 ($14,780).

 These rates apply irrespective of the amount actually earned on investments, so pensioners can gain an advantage if they can get safe returns that are higher than the deeming rates. Unfortunately, many pensioners don’t understand this and leave their savings in the “deeming accounts” offered by the major banks.  The problem with these is that all they pay is the rate stated above. This means pensioners are being penalised because the same banks also have online accounts with no fees that offer around 6.5% on the entire balance.

 Cast your minds back to the example above. If the whole $363,800 was placed in an online account paying 6.5%, the pensioner couple would receive $23,647 – even though they are only deemed to be earning $16,826. That’s a difference of $6,821 a year just because they were financially aware. 

Question:   We have accumulated wealth of $300,000 from properties. We are thinking of re-investing this amount of money into managed funds. Would you recommend this?

Answer:    If the money is still tied up in the properties you should take the possibility of capital gains tax into account before making future investment decisions.  However, if the money is now in cash I agree that placing it in managed funds may be a good strategy, but you would need to talk to a financial adviser to ensure that the funds chosen suit your goals and your risk profile.  If you are thinking about managed funds such as share trusts that invest in growth assets, you should also be prepared to leave your money untouched for at least seven years to give the market time to recover if you strike one of the inevitable downturns as we are experiencing now..

Question  :  I am 85 years old and have an extensive share portfolio. I believe that when I die it could be divided equally amongst my four children. I am considering allowing the portfolio to remain intact and form a trust fund from which dividends and credits could be divided between them every six months. Would you please advise if this is my best option or are there better options available that would yield higher benefits for my children?

Answer :  If you transfer the shares to a new entity now you could be liable for a large amount of money in capital gains tax.  A simpler option could be to provide in your will for the shares to be left to a testamentary trust so the children could have the benefit of the asset but would be unable to access the capital.  Your solicitor will be able to assist you.

Question  :  When I turn 55, can I retire and access my super? My plan is to take a holiday, then find another job (perhaps part-time) as I don’t have a large amount of super. Is this possible?

Answer :  Once you reach 55, to access your super as a lump sum, you need to sign a statement that you are permanently retired. However, retirement is a state of mind and you can get tired of fishing, lunching and golfing and then go back to work at a new job. Of course this begs the question as to why anybody would wish to remove their funds from this low tax area – another option is to stay at the same job and access your superannuation by way of a transition to retirement pension.

3^rd November 2008

Unfortunately the action of the government guaranteeing bank deposits has had an unintended side affect – a run on mortgage trusts has forced them to freeze redemptions for an unspecified period.

Now I appreciate there is a lot of worry among investors who have just had their funds frozen so in the hope of alleviating some of that worry I’ll take you through the way mortgage trusts work. Just bear in mind in this context I am talking about the leading ones such as Perpetual, Challenger Howard, AXA, ING, Colonial First State and Australian Unity and not riskier products that have been frozen for months.

A simple analogy is that they are like a one product bank, they accept money from depositors in which they pay interest, and lend that money on first mortgages to borrowers. Those loans are typically for a three to five year term, which means that your money may be safe but it is certainly not repayable on demand because it is mostly lent out. The trusts receive interest on these mortgages which is why they can continue to make the normal monthly interest payments – however they are unable to repay the principal until their loans mature or they sell them off. It will take some time for all the loans to mature, even though the depositors in those trusts will eventually get their capital back, and will also receive interest while they are waiting.

Last Friday, ASIC announced that a deal had been struck to unlock some money from frozen accounts.  It will be done only on a case by case basis where investors can show genuine need – there are limits on the amount that can be withdrawn.

The good news for these investors is that mortgage trusts perform better when interest rates are dropping. This is because the loans with them were taken out when rates were higher and a proportion of the rates are now locked in for three to five years so investors should receive better than bank interest rates while they are waiting for their money to become available.

Let’s all hope that a reasonable solution is reached because the leading mortgage trusts have treated investors well for many years. If they go out of business, Australia will lose more than $30 billion of much needed loan money, retirees will lose access to a valuable investment product, and the banks will have one less area of competition to keep them honest. That’s the last thing we need.

Question :  I am 32 and married. My wife and I earn a combined gross income of $80,000. We recently bought our first home and are about $270,000 in debt. Our monthly mortgage repayments are $1,958. Should we change them to fortnightly and would we save much by doing so?

Answer :   I strongly recommend you change to fortnightly.  Because there are 12 calendar months and 26 fortnights in a year you will pay an extra monthly payment without feeling it.  This will certainly shorten the term of your mortgage and also give you a buffer if interest rates rise or you get into financial strife.  Your current term is 31 years if interest rates are eight percent and you will pay $472,000 in interest.  Just changing to fortnightly will reduce the term to 23 years and save you $140,000 in interest.

Question:   I am 54 and planning a world trip in 2009.  I currently have $25,000 to invest and am wondering what my options are.  Should I invest it into my super and withdraw it after I turn 55, or should I invest elsewhere for a healthy return?

Answer:   Your best decision depends on your total asset and income position because the only reason to put money into super is to save tax.  If you have a high taxable income now, it may be worthwhile to hold the money within super in the cash area so its earnings are taxed at just 15 percent, but if you have a relatively low taxable income, it may be simpler to leave it in a safe online high interest bearing account.  If you don’t need the money until after June 2009 another option is to place it on a 12 month compound deposit in July 2009.  This will move the income from it to the 2009/10 tax year.

 27^th October 2008

Salary sacrifice is a great strategy but many believe it is of little benefit to lower income earners – nothing could be further from the truth.

Think about a common scenario. The house is almost paid off, the kids have left school and the hitherto stay at home mum has the opportunity to take a part time job.  Let’s assume she is 44 and finds one paying $29,000 a year.  If her wages increased by four percent per annum, and compulsory employer superannuation remains at nine percent of gross salary, she would have $209,000 in super at age 65 if the fund averages 10 percent per annum.  That’s not to be sneezed at, but if she salary sacrificed an extra $5000 a year, she would have an additional $296,000 in super –a total of $505,000.

Take it a step further.  Suppose she makes an additional after tax contribution of $1,000 a year and receives the government co contribution of $1500 a year.  That will increase her superannuation by a further $177,000.

The simple act of going back to work in a relatively low paid job has enabled the family to boost their retirement assets by a massive $682,000.  This is a dramatic illustration of the power of compounding – it also shows what low income earners can achieve if they knuckle down and start an investment programme early enough.

One reader wrote “Salary sacrifice might be fine if you’ve got a decent boss, but mine tells me if I increase my own contribution to super by using salary sacrifice, he will simply reduce his compulsory nine percent”.  It’s a sad fact of life that there are unscrupulous bosses around – fortunately a tiny minority – and because it is currently legal for them to act in this fashion, there is little the employee can do about it except to change jobs.  Labour promised to abolish this rort in the run up to the last election, but so far nothing has been done.

The fact that this happens highlights the importance of agreeing on a total salary package, including the employer nine percent, before any salary sacrifice arrangements are agreed to.  Employers who are not yet offering salary sacrifice should wake up to the fact that it’s one of the greatest benefits they can offer their staff, and one that has no cost to them.

In tough market conditions like these, it’s easy to get distracted and worry too much about the performance of your portfolio.  The above examples show that strategy.

Question:   We have a $40,000 inheritance and want to gift $10,000 to each our four nephews and nieces.  As one niece is only 13 what would be the best way to invest her $10,000 so she can access it when she is a suitable age and can make her own financial decisions?

Answer:   I prefer share-based insurance bonds as the tax is paid by the fund and they can be redeemed tax-free by her at any stage if she is in the 30% tax bracket or less.  A minor can buy insurance bonds in their own name but they cannot buy direct shares or managed funds – this is what makes insurance bonds particularly attractive. 

Question:   I am 63 years of age, working full time but hope to retire next year.  My husband is 68 and retired.  In 1992 we bought a commercial property which we sold this month for $515,000.  How is CGT calculated?  What would be the most tax effective way to invest the money?

Answer:   CGT is calculated by taking the net profit after buying and selling costs and capital expenditure and adding that sum, after an allowance for 50% discount, to your taxable income in the year the sales contract is signed.  It may be worthwhile deferring sale until you retire because you could then make a contribution to super, prior to your 65^th birthday, which may substantially reduce the CGT.  Your husband is not eligible to contribute to super unless he goes back to work for a short time.

Question:   I have recently taken out a margin loan.  The plan was to be conservatively geared at 50% to invest in shares along with available savings. Now the house of my dreams has come on the market. Can I use the part of the money in the margin loan account that is still to be invested as a deposit? The margin loan would then be geared at 65%.  Assuming the property will be an investment for the first four or so years, except maybe six months for the first homeowner grant, what impact would this have on my interest rates?

Answer:   I assume you have sufficient funds available for a deposit on the property and if this is the case there should be no problems using some of the undrawn funds in your margin loan account for buying the investment property.  This may even allow you to reduce or eliminate mortgage insurance.  Make sure you keep your accountant closely advised of what is going on to maximise the tax deductibility of what will be an investment loan.

6^th October, 2008

Falling stock markets around the world mean that the share prices are way down.  This means that the value of your superannuation has been going down because most superannuation funds invest a major part of their assets in shares because over time shares have shown to give the highest returns of all.

The diminishing superannuation balances have resulted in a flood of letters to the media asking why the government doesn’t introduce “safe” superannuation accounts where the balances will perform like a bank account and never drop in value.

This shows a complete misunderstanding in the way superannuation works.  It is not an asset like property or shares but merely a vehicle that lets you hold assets in an environment where income tax is just 15% and capital gains tax is just 10%.  Within that environment you can chose any mix of cash, property and shares and the appropriate mix for you will depend on your risk profile.

Also, if you wish to have your superannuation in a bank account type product, you could simply opt for a Retirement Savings Account (RSA) which are available at most banks and building societies.  They are effectively a savings account with tax of 15% deducted before the interest is paid and are subject to the normal preservation rules that apply to any other superannuation account.

There are also those who are claiming they would have done much better to have kept their superannuation in cash and thus saved themselves from the current stock market turbulence.  Unfortunately, these claims don’t stand up to analysis. 

Imagine a person aged 50, who inherited $100,000 in January 2000 and decided to place it into super to take advantage of the low tax rate that super offers.  If they chose to place it in cash inside super, the balance now would be $165,000.  They would never experience a downturn, or a loss of capital, because the money is effectively in a high interest bank account inside the superannuation system.

The outcome would have been vastly different, if they had chosen to place the whole sum in shares within super, and the performance of those shares matched that of the All Ordinaries Accumulation Index which includes both income and growth.  By October 2007, the peak of the last boom, the value would have risen to $295,000. 

Yes, they would have seen it fall in the latest market downturn, but at the end of September 2008, its value would still have been $232,000 – that’s 40% more than they would have had if they had of stayed in cash.

Obviously, in the real world, anybody saving for retirement would have a combination of all assets in their superannuation portfolio.  However, the figures above dramatically demonstrate the high cost of having your entire superannuation portfolio in cash.

Question:   Are the funds invested in superannuation government-guaranteed?  I ask because I understand they are invested in insurance companies and I am thinking of HIH and FAI.  I have asked this question of several financial advisers in newspapers but not one has published my question.

Answer:   You need to understand the superannuation is not an asset class like property and shares but merely a vehicle that lets you hold assets in the low taxed superannuation environment.  Furthermore, you must appreciate that the fund manager is separate from the assets themselves and consequently, money invested through a major institution may be carefully handled but will still drop in value if it is predominantly invested in shares and the market falls.  Australia has many first class institutions that will manage your money for you, but you should also liaise with your adviser to ensure the asset mix within the fund suits your risk profile.

Question:   I bought my property five years ago, lived in it for two years, and then leased it out for three years.  I paid land tax, claimed negative gearing and some depreciation.  I then moved back to live in it for a couple of months before selling it this financial year.   Am I exempt from capital gains tax for the 2008 financial year?

Answer:   You can be absent from your primary residence for up to six years without losing the CGT exemption so from the information supplied it appears you will not have to pay CGT.  Of course you should check with your accountant before you sign any contracts.

Question :  I am 36 years of age, my wife is 41, and we have two young kids.  We are paying off a mortgage of $250,000 at $2,000 a month - the house now is worth $550,000.  We are thinking of selling it, paying off the mortgage, becoming renters and using the sale proceeds to invest.   What are your thoughts?

Answer :   The problem with doing that is you will lose at least $50,000 of your precious capital selling the present property, and then eventually buying another one.  I suggest a better option is to borrow against the equity in your house for investment.  For example if you borrowed $200,000, the only cost would be a tax deductible $16,000 a year.  It would also free you from the hassles of moving and renting, and so ensure your wife and family continue to be happy.

Monday, 29 September 2008

At last there is some good news for pensioners - thanks to the automatic indexation of the aged pension every one of them enjoyed a pay rise on September 20^th.  The maximum rate for couples has been increased by $12.70 a week to $472.40 a week, and for singles by $7.65 a week from $276.30 to $283.95. 

The cut-off point for the assets test for homeowners has also been increased to $873,500 for couples, and $550,500 for singles.  These figures do not include the value of the family home. 

While the increases are welcome, the figures highlight the anomalies in our age pension system.  Relatively wealthy people are the winners – they can live in million dollar mansions, earn $67,000 a year, have over $800,000 in financial assets and still get a part pension and all the goodies that go with it.  

Contrast their situation with the real battlers – the single pensioners who don’t own their own home.  Couples usually cope well because the couple’s pension is much greater than the single pension, and older pensioners with a home can always fall back on a reverse mortgage if they find themselves asset rich and cash poor and have trouble paying for rates, insurance and maintenance.  However, the single non-home owner has to pay at least $150 a week rent, on their own, out of a total pension payment of $283.95 a week plus a little extra for rent assistance. 

The assets test for singles and couples is out of kilter too, and this can cause major hardship for pensioners who lose their partner. 

Think about a couple who own their own home and have assessable assets of $600,000 – they are living well on the income from their investments and a combined age pension of $410.05 a fortnight. They have never taken the time to think seriously about estate planning so have a simple Will that provides for all their assets to be left to the survivor in the event of the death of either of them.

They are not aware that the assets test for a couple is much more generous than the assets test for a single. When he dies suddenly, and all the assets move to her, she finds herself over the limit for the assets test and loses the pension.  At a time in her life when she is trying to cope with the loss of her husband she finds herself suddenly deprived of the pension and the Health Card as well. 

Unfortunately, at this late stage, there is little she can do to rectify the situation.  The best approach would have been to have their Wills made out so that part of their assets were left to their children, or to relatives, or to their favourite charity when one of them died. 

A little knowledge is not always a dangerous thing; sometimes it can mean the difference between retaining the age pension or otherwise. If the couple in this scenario had been familiar with these simple facts and taken them into consideration in their estate planning, they would have both been able to rest easier.   

Question:  Due to ill health I have been off work for 18 months and have no income protection insurance.  Our net income is $1,200 a fortnight and we owe $270,000 to the bank on our home valued at $470,000.  My husband has a super fund of $400,000 and may retire next year; my super fund is around $40,000.  We are undecided as to whether we should sell our home and downsize, particularly with the way interest rates are, or if my husband retires next year,  take some of the lump sum to pay out our existing loan and then he may go back to work part time.   I am finding it very difficult to get back into the workforce, and there is no certainty that I will find another position. 

Answer:   I wouldn’t be hurrying to relocate because of the costs and hassle involved, and you can take comfort in the knowledge that there is ample cash in your husband’s super fund to pay out the loan if your financial situation gets tight.  You have not given your ages but you should also consider getting some financial advice because money in superannuation is not counted by Centrelink until you reach pensionable age and you may find that there will be government benefits available that will help the budget.

Question:   When my wife and I met, we both had our own properties and mortgages.  When we married I moved into her property and rented mine out.  We have since bought another two investment properties but now we have two children we are finding my wife’s property too small.  I have always been told that once you have a property not to sell it but to borrow against it for further properties.  Should we sell everything to acquire our dream home or is there another way?

Answer:    Your best course of action depends on the potential of the properties and your own cash flow.  If they have good potential, and you are not tight financially, I suggest you keep them as there could be hefty costs if you sell them.  But, if you feel you would be more comfortable with less debt, it would be worthwhile getting rid of at least one of them to ease the load.

Question:   Can I claim a tax deduction for personal contributions to superannuation? I am 61 and haven't had a paid job for 25 years. For the last few years I have been receiving a defined benefit pension from Comsuper, and also have interest and dividend income. My gross income for 2006-2007 was about $60,000, of which the pension was $40,000. In that year I contributed $150,000 from a property sale to a super fund. Nobody, including the tax office, seems to be sure of the answer to this, so I hope you can help.

Answer:   As you are under 65 you can contribute to super without passing a work test and as no employer is paying superannuation for you, you can claim a tax deduction of up to $100,000 a year.  I see no reason why you can’t claim a tax deduction but you should bear in mind deductible contributions lose an entry tax of 15% so make sure you talk to your accountant about an appropriate contribution to make the numbers work best for you.

Question:  The home loan for my residence doesn’t have an offset account, but has a redraw facility. The remaining principal is $200,000, and I have put in extra repayments of $40,000 (net principal $160,000).  I plan to move interstate for two to three years and will rent out my home during that time. If I redraw all extra repayments before the rental agreement and don’t make redraws after the start of it, can I claim interest deductions based on the $200,000 remaining loan?

Answer:  Unfortunately you can’t rewrite history.  If you draw down on the loan for a private purpose, part of the loan will be non deductible and you will lose part of the potential tax benefits.  When you rent the house out you could claim interest on money borrowed for renovations and you could also pay a reasonable amount of rates and maintenance out of the deductible portion of the loan. 

Monday, 22 September 2008

We are currently experiencing record volatility on world stock markets as investors try to come to grips with the world financial crisis.  Last Wednesday, Wall Street fell 449 points, the second worst session this year but then bounced back strongly after news of the $700 billion rescue package. 

Of course the shockwaves travelled around the world and it came as no surprise that our  own market dropped more than three percent as rumours continued that some Australian financial institutions still have bad news to report.   It then recovered strongly too. 

We now find ourselves in an interesting situation. The majority of our leading companies have strong balance sheets, are well run and have great prospects - at current prices they are clearly good buying. However, prices will not recover until investors are convinced that all the bad news is out of the way. Consequently the current volatility will stay with us, and buyers will remain wary, until they are convinced our markets has bottomed.

It is natural for investors to be cautious during times like these, but it is still important to realise that the Australia stock market has a lot going for it. The franking system gives shares a unique tax advantage, while compulsory superannuation ensures a continuing and growing of money going into the super system. When this market eventually turns, the upswing will be quick - those who sit on the sidelines are in danger of missing the bounce when it finally occurs. 

Question:  I'm 42, self-employed, earning $68,000 a year and have $50,000 in super.  I own my home worth $400,000, have an investment property worth $320,000, a commercial investment property worth $380,000 and shares worth $200,000.  I am looking for another investment property but wonder if I should start paying off my commercial investment property with my salary.  Could you please advise?

Answer:    You seem to be very much overweight to property and it may be worthwhile diversifying part of your assets into shares.  However, if your preference is for property I suggest you keep the loans on an interest only basis to maximise the tax benefits.  At the same time, you should be putting money away into a separate sinking fund, preferably superannuation, to establish a pool of money to pay off the loans when you retire.

Question:  I am 57 and earn $31,000. My husband and I have a house valued at $300,000 with a mortgage of $65,000 and I have a small credit card debt and $5,000 in savings. I have $50,000 in superannuation as well as a small share portfolio of $20,000. What should I be doing now to set myself up for retirement?  My husband is much younger than I am so I will not be entitled to a pension.

Answer:    If your husband is much younger than you, you may be entitled to at least a part age pension when you reach 65 if he is not a high salary earner and most of your superannuation is in his name where it will not be counted until he turns 65.  At your stage in life you should be talking to an adviser to discuss when you want to retire, and how much money you will need then.  The adviser can then recommend various strategies and I suggest one of these would be salary sacrificing your salary down to $30,000 and then making a non-concessional (undeducted) superannuation contribution of $1,000 to make yourself eligible for the full government co contribution.  Also your $5,000 savings could be used to reduce your home loan as this will give you the highest effective after tax return.

Question:  My partner has been offered a great job and it means we will need to relocate.  Eight weeks ago - not knowing that this job offer was around the corner - we purchased a house and now don’t know whether to keep it and rent it out – the rent would most likely be less than the mortgage repayments - or sell and probably lose any money paid in stamp duty.  What would you suggest?  The market is relatively flat at present.

Answer:   Unless you feel the house has no potential I suggest you keep it.  You will lose a hefty chunk of capital if you sell it and, when you do the sums, you will almost certainly find it will cost you relatively little to hold it when you take into account the benefits of negative gearing and the non cash deductions you can claim because of building allowance and depreciation.

Monday, 15 September 2008

Falling interest rates may be great news for anybody paying off a mortgage, but they present challenges for investors who are now receiving lower returns on their precious savings.  This is why it is time to think about the role of cash as an investment and consider strategies to boost returns. 

A great resource is  www.ratecity.com.au  where all financial products are compared.  According to them, BankWest are still offering the top rate of 8.1% for one year deposits, with the next best rate 7.6% from Macquarie Bank.  If you are prepared to lose access to your money until July next year investing in an interest bearing deposit with all interest and principal repayable in July 2009 is a great strategy as you are fixing today’s rates and also deferring tax until next year when the government has hinted that personal tax rates will be lower.  If you don’t want to tie your money up St George’s DragonDirect and BankWest are offering 8.1% but these will drop as rates continue to go down.

It is critical that you understand the risk/reward trade off of shares and interest bearing securities.  If you invest in a quality diversified portfolio of shares there is huge upside potential with little chance of loss if you can hold for the long haul.  However, if you opt for fixed interest, your earnings are limited to the rate paid by the security, but if the investment goes bad you can lose the entire capital sum.  This is why interest bearing deposits can be a much riskier investment than shares if you don’t stick to the big names.

For those who want enhanced returns it’s hard to go past some of the diversified income funds that are now being offered by leading fund managers.  They invest in a range of assets that include interest bearing securities, high yielding shares and listed property trusts, and can produce highly effective returns because of the franked dividends that come from the shares and the tax concessions that arise from the building allowance and depreciation on the properties.

They do not offer the stability of cash because of the presence of listed investments in the mix, but they do have the potential to give you much better returns after tax than leaving your money in the bank.  Admittedly, the returns for the last 12 months have been negative because shares are down and the listed property trust sector has copped a belting, but there is now a consensus that we are near the bottom and it’s reasonable to expect returns of better than 10% over the next two years. 

Yes, there are opportunities out there ,but please seek professional advice before you invest. There is a huge gap between the best and the worst products and quality research is essential. Good advisers will have this on tap.

Question:  An answer to a question was "if shares were bought by the deceased after December 1985 you would be deemed to have acquired them for the amount paid by the deceased.”  In the ‘Guide to Capital Gains’ issued by the Australian Tax Office, under the heading ‘Cost Base of Asset’ it states "if the deceased acquired the asset after September 1985 the cost base is taken to be the cost of the asset on the day the person died” - therefore CGT liability only commences from date of death for the beneficiary.  I would appreciate hearing your comments on this.

Answer:  There is no conflict between what I wrote and what the Tax Office booklet says.  The cost base is the “cost of the asset on the day the person died”.  This is what they paid for it plus, if a property, any improvements made since acquisition by the deceased.  

Question:  I bought my first property two years ago and have lived in it since then. Now I need to move to a different area for a two to four year period and would like to know how to "turn" my home into an investment property with the best possible tax advantages. I owe $224,000 and have council and body corporate expenses of $3,400 per year. I expect a rental income of $280-$300 per week, minus agent’s fees.

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.  Once the property is available to rent you can claim all outgoings including interest as a tax deduction and will need to declare the rents as taxable income.  I suggest you make a once only tax deductible investment of around $500 to obtain a depreciation schedule report from a quantity surveyor.  This will ensure you maximise the tax deductions.

Question:  I bought my property five years ago and am now planning to buy a smaller unit in the city to move into.  My current property is fully owned and has never been rented out.  Am I liable for CGT on disposal after moving out?   If I do not sell, but lease it for two years then move back into it for a year before disposing of it, what CGT am I liable for then?

Answer:  As long as you sell your original property within six months of buying the unit, you can exempt both properties from CGT for that period (provided that the original property is not income producing); however, this assumes that your original property has always been covered by your main residence exemption to date.  On the other hand, if you rent out your original house, you can only cover one of the properties with your main residence exemption. This choice is available for up to six years after you move out and you are not required to move back in again.  If you choose to cover the unit during the period when you own both, you will be liable for CGT on any increase in value (less selling costs and non-deducted expenses from the date you moved). This applies from the date you move out of the original home, to the date it is sold.

8^th September 2008

Obviously interest rates are now moving downward again which begs the question about what you should do with your housing loan.  This is the time to reflect on one of the great fundamental financial truths – people get paid, pay their commitments, spend what’s left over, and end up broke on payday.  It therefore follows that if you want to be a financial success you should make investing your first expenditure, and not something you try to do on pay day when there is nothing left over.  In July we all received a hefty tax cut, but how many of us used that tax cut for investment or repayment of loans?  Most automatically adjusted their spending to use it up.

The simplest way to invest the rate reduction is to leave your current loan repayments unchanged.  Sure, the banks may give you the opportunity to reduce your monthly payments but don’t fall for it – maintaining your payments at the present level will enable you to pay the loan back faster, and also provide a safety cushion if you have financial problems or rates rise again.

Think about a person with the average housing loan of $300,000 at 9% over 30 years with repayments of $2,414 a month.  They face a potential interest bill of $569,000 which means it would take a staggering $869,000 to pay the loan back when you include the principal.  If rates drop to 8.75%, and the payments are left unchanged, the term will drop to 27 years and they will save $83,000 of interest.  When rates drop to 7.75%, a virtual certainty, repayments of $2,414 will have that loan paid back in just 21 years and will save them $261,000 of interest. 

You can bet that credit card interest rates will still stay high, so make sure you arrange your affairs to pay as little credit card interest as possible.  There are two basic types of credit cards, those that have a high interest rate coupled with an interest free period and those that have a lower interest rate but no free period.  You lose your interest free period if you don’t pay the entire balance before the due date, so choose a card with no interest free period but a lower interest rate if you can’t afford to pay the account in full at the end of the month.

Yes, the downward trend in rates is certainly welcome, but don’t fall into the trap of frittering the extra money away.  Smart choices now can mean tens of thousands of dollars extra in your pocket in the long term.

Question  :  I am 50 years of age and earn approx $36000 per annum. To be eligible for the co contribution scheme, am I better off to make personal super contributions after tax, or before tax in the form of salary sacrifice?

Answer : To get the maximum co contribution, you cannot be earning anymore than $30 342  a year. Therefore, if you can afford it, salary sacrifice your salary down to $30 342, but also be aware you need to make a separate undeducted contribution of $1000 to be eligible for the $1500 co contribution. Unfortunately from July next year salary sacrificed contributions will be taken into account when calculating your total income for co-contribution eligibility purposes.  This means you will get the full co-contribution this year, but a slightly reduced one next year.

Question  :  I have $16,000 owing on three credit cards, and a overdue amount on my bank overdraft of $1,190.  My weekly salary is $5400 after tax.  Can you please tell me what is the best way to pay off these debts. 

Answer : Pour all your resources into paying off the smallest debt. Then, when that is out of the way, use the payments no longer needed for it to attack the next smallest debt. If you keep doing this, you will soon be back on track.

Question :  I am 58 and have $470,000 in superannuation. I own my home worth about $700,000 and have a weekender worth $200,000.   I do not draw a pension from my superannuation and don’t intend to until I’m 65 – my husband is a TPI pensioner through Department of Veterans Affairs and I receive the partner pension.   I work eight hours a week and wish to draw $20,000 from my super for a holiday.  When I attempted to do so I was advised by the fund that I cannot do this as my employer pays superannuation to them on my behalf and therefore I’m not retired.  I understand from your articles that if you are over 55 and work less than 10 hours a week, you are considered retired for the purposes of accessing superannuation.  Is this correct?

Answer :  You have misunderstood the situation.  A person aged between 55 and 60 has to sign a statement that they are permanently retired in order to access their super; of course, retirement is a state of mind and a person can retire, have a change of heart, and return to the workforce without penalty.  One option is to retire, and eventually return to the workforce but I appreciate that this may not be possible for you.  You could start a transition to retirement pension with part of your super, leaving the rest of your super intact, but the problem with doing this is that part of your super will lose the 100 percent exemption from Centrelink, that it now enjoys.  The simplest way out may be to borrow for holidays. 

Monday, 1 September 2008

It’s disturbing, but not surprising, to read that contributions to superannuation are dropping because people are frightened to make extra contributions while the market is down.  Unfortunately, Australians are a strange lot, they love to invest when the boom is on, but stay away from the market in droves when it’s cheap. 

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

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

Let’s see how it works in practice. We’ll assume you started investing $1000 a month in January 2000 - and kept it up faithfully despite all the ups and downs of the market. Provided you reinvested all your dividends, and the performance of your investment matched the All Ordinaries Accumulation Index, you would now have $173,000 for a total investment of $102,000. That’s a return of 11.76%p.a. compound.

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

Question  :  I am 62 and intend to retire at the end of 2009.  I am salary sacrificing $100,000 a year and intend to sell our rental property in 2009.  If we receive $350,000 for it, can I put the whole lot in as a non concessional super contribution in the 2009/10 financial year, bearing in mind I’m not working from 1^st January 2010 as I will be fully retired, but still 64 years of age until my birthday in September 2010.  I assume I can, even if there is a delay in the sale as long as it occurs before my 65^th birthday?

Answer :  A person under 65 can bring forward three years undeducted (non-concessional) contributions and so contribute $450,000 in one lump, therefore I see no problem with what you propose.  You do not have to pass a work test to make a contribution prior to age 65 and if the sale was delayed you could always consider borrowing for the contribution if the sale was a definite one. 

Question:   I'm 23, living at home, and have managed to save $41,000 since I graduated from university early 2006. I have the money in an online savings account paying 6.0% pa. My goal is to save $160,000 over the next five years so I earn $800 per month interest which should cover virtually all day to day living expenses. I don't know if this is a good plan though - any advice about what I could do with my money would be appreciated.

Answer:     Congratulations on a wonderful effort.  Your goal is commendable but you should understand that inflation erodes the purchasing power of money on deposit and tax can take a big chunk of your earnings because bank interest does not carry any tax benefits.  For a relatively long period such as five years, I suggest you are better contributing your spare cash to a quality Australian share trust.  The income will be franked so it will be lightly taxed and each year your capital should grow, and with it, the income that it pays.  Of course you should be prepared to hang in there when the market has one of its inevitable slumps.

Question  :  My term allocated pension fund has $218,000 invested in a conservative growth fund . The fund is to continue for another 15 years when I will be 87.  At present, my monthly pension is drawn only from the conservative fund.  Would it be wiser to draw from the other investments at present?  While they are earning a much higher rate I understand they are also subject to wider fluctuations, and may fall in the future, in which case I will lose more. 

Answer :  If you have a 15 year timeframe in mind you certainly need a fair proportion of your portfolio in growth, and I agree that you should be drawing from the conservative fund.  Just make sure you keep at least four years planned expenditure in the conservative area to protect yourself against market downturns.

Monday, 25 August 2008

The current tough economic conditions have led to an increase in the number of people who simply can’t pay their bills.  To assist them most banks are now having marketing campaigns whereby they offer clients personal overdrafts – usually around $5,000.  The benefits of these are claimed to be that they avoid the embarrassment of having cheques bounced and also provide an avenue of credit for people who would otherwise be forced into the arms of payday lenders where the interest rate might be 50% or more. 

Personal overdrafts are offering interest rates of around 18% which are in line with most credit card rates.  While I accept they may be a useful tool in emergencies if used properly there is still a risk that they will encourage cash strapped families to get even further into debt.  The problem with living on credit is that the situation simply gets worse and worse. 

Families use credit because they can’t make ends meet but once they get into debt they have to find more money for the interest – usually very high rates of interest.

A much better way is to cut back on all non essential spending and embark on a campaign of getting rid of credit card debt.  If you have several debts use all your resources to attack the smallest one first – when that is paid off use the money no longer needed for it to attack the next smallest debt.  Once that is paid off keep repeating the process until all those high interest debts are out of the way and you only have your home loan left. 

Remember, it’s better to forgo non essential items today than to be in debt for years.

Question  :  My wife 55, works part time with a taxable income of $23,000.  She has a super balance of $110,000 and contributes $100 per fortnight after tax.  Would she gain any benefit from adopting a transition to retirement strategy?

Answer :  As she is 55 she could start a TTR if you were short of income but in view of the relatively small amount she has in super I think a better option would be for her to focus on building up her super, not running it down.  Make sure she claims the government co-contribution.

Question :  I am considering a loan to buy an investment property but am unsure about something - why does everyone recommend interest-only loans? What benefit is there to this apart from slightly lower repayments? Wouldn't you be better off to try and repay some principal and build up equity?

Answer : The name of the game is to maximise your deductible debt, and with it your tax benefits. Interest-only loans do this, and also give you a built in safety buffer as the repayments are the lowest available. Be aware that I recommend you combine an interest only-loan with a sinking fund that is based around insurance bonds or superannuation.

Question  :  I have read your comments regarding saving capital gains tax through the strategy of placing proceeds into superannuation and claiming tax deductions.  However, isn’t this strategy relatively useless once the $50,000 ceiling for deductible contributions has come into being?

Answer :  If you are over 50 you  can make deductible contributions up to $100,000 until June 2012, and if you are under 50 a tax deduction of $50,000 will go a long way to reduce a capital gain -  also take into account the 50% discount for ownership over a year and the fact that tax rates generally are dropping.

18^th August 2008

Share markets are down, so of course superannuation fund returns for the last year, have been in the red.  This has prompted a flood of questions from worried investors like “What if my superannuation keeps falling until there is nothing left?” 

Anybody who has superannuation needs to get one fundamental principle crystal clear – superannuation is not an asset class like property or shares, but simply a vehicle that lets you hold assets in a low or zero tax environment.  If the balance of your superannuation fund is falling, it is because all or part of your fund’s money is invested in shares.  The situation would be no different if you held shares outside superannuation because their values would be down too.

When you buy shares you buy an interest in a business.  Therefore, if your superannuation is invested in shares, you are a part owner of businesses like BHP, Woolworths, Harvey Norman, Mirvac, Telstra and the major banks and share in their profits by way of dividends.  For your superannuation to fall to nothing, all these companies would have to fail. If that happened we would all be finished, because nobody would have a job.

If the share-based portion of your superannuation is down, you are in a similar position to a farming family whose property is drought stricken.  They know if they hang in long enough, the drought will eventually break -  riding it out and having faith is a much better option than quitting the farm at a fire sale price at the worst possible time.

Another question is “Can I still afford to retire?”  OK, you mightn’t have as much money today as you had a year ago, but remember rising life expectancies mean it is highly likely you will live to 85 or more, probably at least 20 years away, so you can afford to keep a fair chunk of your super in growth assets. 

If you’ve got a 20 year timeframe, you want to make sure that you don’t put yourself in a situation where you are forced to dump assets at the wrong time, and so turn a paper loss into a real one.  This is why we have always recommended that retirees or people nearing retirement, keep at least three years planned expenditure in cash, which can be done through a combination of asset allocation inside superannuation and high interest bank accounts.  If you do this, there will always be money available to meet planned expenditure, and it provides a safety cushion to give the market time to recover so that you are never forced to dump quality assets when the market is down.

In times like this, when the markets are all over the place, it’s important to remember that investors tend to overreact on both optimistic and pessimistic news.  There will always be factors like the sub prime crisis, inflation, interest rates and the fluctuations of the oil price to cloud your decisions, but no matter what happens, life will go on and people will need the goods and services that are the necessities of life.  The secret is to stay focussed on the long term and not get spooked by the inevitable day to day gyrations of markets everywhere.

Question  :  I am 55, work full time and earn $41,000 a year before tax . I have recently inherited $94,000 and have had it in a bank account getting 6.05% interest – around $440 a month.  I just received a letter from the ATO stating I now have to start PAYG and pay $395 per quarter.  I have a super fund with $17,000 in it.  Is there a minimum amount I can have in the interest bearing account that would avoid PAYG?

Answer :  As you are 55 the best strategy is to place it into super as a non-concessional contribution as the income on the earnings will then be just 15%, not the present 31.5% and as the money will be quarantined in the superannuation environment, it will not give rise to any additional income tax.  Once you’ve done that you can prepare the variation request to the Tax Office and should not have to pay any additional tax.

Question :  I am a 56 year old single female with DIY super fund assets of $1.1 million, $465,000 of which is in shares and $680,000 in commercial property.  I own $80,000 worth of shares in my own name.  Having held these shares for about 10 years, I’ll have a substantial capital gains tax liability on their sale.  My home is valued at around $450,000 on which there is a mortgage of $23,000.  My before-tax income from part time employment is around $30,000 p.a.  Despite being a low income earner, I love my occupation and don’t want to retire until I’m 60.  I’d be grateful for any suggestions about how I might fund a better lifestyle over the next four years than my meagre income allows.

Answer :  As you have reached the age of 55 you are perfectly placed to start a transition to retirement pension whereby all or part of your superannuation fund becomes a tax-free allocated pension fund, and you can withdraw an income from it that will enjoy a rebate of 15%.  If you drew the minimum pension of four percent of the account balance, you would substantially improve your standard of living and may even have enough to pay out your home loan and so rid yourself of the loan repayments.  You should liaise with your adviser to ensure that you do not take out any more money from your super fund than you need.  The situation will change once you reach 60 because then the income from the TRP will be tax-free.

Question  :  I am an active 85 year old widow.  I have about $1.5 million worth of shares, two commercial properties which return $50,000 net per year and $60,000 in cash.  I pay approximately $18,000 a year in tax.  I have no super or trust.  My two children will inherit my estate.  Should I sell shares and convert into cash to balance my portfolio and will this mean more tax?  Should I keep on buying shares or save more money?  Naturally I would like to reduce my tax.

Answer :  Obviously you do not receive any age pension so there is no restriction on your giving money to your children now if you feel it is appropriate.  It would certainly reduce your tax and it may be more beneficial to them now then when you die.  The franked dividends are certainly helping your tax position because on my calculations you should be earning approximately $110,000 a year and yet are paying tax at an average rate of just 16%.  Have you had depreciation reports prepared by a quantity surveyor to ensure that you are maximising deductions available from your commercial properties? 

11^th August 2008

As I have been predicting for months, interest rates have appeared to have topped and it is now almost inevitable that the Reserve Bank will start to lower them next month.  That’s good news for homebuyers and anybody with a mortgage, but it’s bad news for anybody who is presently enjoying the high rates that are currently available. 

If you’ve got a home loan this is obviously the time to be staying with the variable rate, and if you’ve got a fixed rate, you are almost certainly going to find it will be expensive if you tried to change out of it.  Of course, if you are lucky enough to have a fixed rate that’s lower than the ongoing variable rate, you wouldn’t want to change out of it.  Just make sure you take all the fees and charges into account, when you are comparing one home loan against another.

Anybody with cash to spare should ask themselves whether they are prepared to lose access to it until July next year.  If so, ask your bank about a fixed rate term deposit with all interest paid on maturity in July.  This will enable you to lock in the current high interest rates and defer tax for another year. 

That’s fine as far as it goes, but the challenge will come when the deposits come up for renewal in 10 months time.  It’s highly unlikely that you will get the same high rate and it’s also possible that the stock market will have moved up by then, and the yields on listed shares will be lower than they are today.

You also need to consider what is called “the doctrine of relative attractiveness” which simply refers to how attractive is one investment when compared to another.  It’s easy to prefer cash when rates are very high, but as interest rates fall, shares get relatively more attractive as the gap between interest rates and dividends yields narrows. 

When you take all these factors into account, it’s hard to resist the conclusion that now is a good time to be moving at least part of your portfolio from interest bearing accounts to shares.

Question  :  I am 49, single and earn about $56,000 a year.  I have $118,000 in super, $7500 in cash and my home is worth about $530,000.  My mortgage is $34,000 at a fixed rate of 6.65% until April 2009.  I repay $670 a month and contribute after tax $280 per month towards my super.  My employer pays 9% super based on a base pay of $38,000 a year.  I would like to retire at 55 or at the latest 58 and would like to know if this is achievable with an annual income of between $30,000 and $40,000.  I am undecided if salary sacrificing is my correct course of action or whether I should increase my mortgage repayments.

Answer :  A good rule of thumb is that you need retirement assets of 12 times your expected annual expenditure.  Therefore, if you need an annual income of $35,000 when you retire you should be aiming to accumulate at least $420,000 in superannuation.  That is only a rough guide because the amount needed by an individual depends on a wide range of variables which includes how long they will live and the state of their health.  Provided you do not mind losing access to your money, you are far better off to salary sacrifice into super in lieu of increasing your mortgage payments.  This is because you lose at least 31.5 percent of all monies taken in hand but only 15 percent of monies salary sacrificed to super.  It will take only $530 a month to have your mortgage paid off in seven years, so it would be a good strategy to reduce your payments to this amount which would enable you to increase the amount that is being salary sacrificed to super.

Question  :  I have a Get Set Loan of $40,000 (debt is $38,000) on which interest is 13.45% pa. I also have a line of credit against my own home (to buy another investment property) which is worth around $650,000. The current outstanding debt is $54,000. Should I pay out the Get Set Loan from my line of credit which has an interest rate of 8.8% and get rid of the Get Set Loan altogether and just operate my income and outgoings from my line of credit.

Answer :  The Get Set loan is an unsecured personal loan that offers high flexibility but the price you pay for this is the high interest rate you mention.  You should be trying to minimise your interest expenditure and I agree it would be wise to amalgamate all your loans under the line of credit umbrella where the interest rate is lower.  Just make sure that you keep your deductible and non deductible loans strictly separate.

Question  :  I am interested in your recent article "Catch a Golden Egg."   The article refers to the situation where a couple could "... earn $60,000, have other assets worth $800,000" and "still get a small part aged pension and all the goodies that go with it."  It then draws attention to the deeming rules.  Would the couple’s assets of $800,000 add so much "deemed" income to their $60,000 p.a. income that they would become ineligible for even a small part pension?

Answer :  It would depend on the nature of their assets because only financial assets are deemed; for example they could own an expensive motor car, boat and caravan as well as a beach house and none of these would be subject to deeming.  But despite the relaxation of the assets test, it is still a harsher test than the income test.  If a homeowner couple have deemed assets of $770,000 and personal effects of $30,000 their combined age pension would be $84 a fortnight under the assets test and $310 a fortnight under the income test.

Monday, 28 July 2008

Death and taxes have always been regarded as inevitable, but all it takes is a bit of forward planning to substantially reduce the latter.

Let’s start with superannuation.  The taxable component of your superannuation is subject to a death tax of 16.5 percent unless it is left to a dependant – a spouse is always a dependant – but by the time most of the ageing baby boomers leave this world, it’s highly likely their kids will be aged 40 or more and with a bit of luck, will have found a job.  If you are over 60 and still eligible to contribute to super, an easy way to reduce the death tax is to make tax-free lump sum withdrawals and then re-contribute them as non concessional contributions.  This will dramatically reduce the taxable component. 

Another strategy is to withdraw all your superannuation tax-free before you die.  Now I appreciate that the date of one’s death is a hard one to pick but remember that superannuation is nothing more than an investment structure that lets you hold assets in a low tax, or zero tax environment.  For most people, there will come a time when the potential 16.5 percent tax on death is much greater than any tax savings that could be generated by holding the money inside super. 

Think about Janet, aged 80, a widow and whose main asset is $300,000 in super.  If she   died there would almost certainly be a death tax of $49,500 deducted from the superannuation proceeds.  However, if she withdrew the entire $300,000 and invested it outside the superannuation system, the tax on the income from it would be minimal as she would qualify for tax concessions such as a seniors’ tax offset and the low income tax offset.  Just taking action at the right time, has saved the estate almost $50,000.

Question:   I have inherited a fully owned property in regional Victoria, valued at $300,000 which I am currently living in. I wish to move back to Melbourne and buy there. Should I borrow against the equity of this property to use as a deposit and rent this home out? If so, can I then claim my new Melbourne property as my primary residence and use this one as an investment?  Or would it be best to sell this property and use that money towards a deposit, then buy another investment property down the track?  I don’t believe any CGT applies as the home was bought pre 1985.

Answer:   The problem with borrowing against the investment property is that you will be paying tax at your top marginal rate on the rents, but will not be able to claim a deduction for the interest as the purpose of the borrowing was to buy your own residence.  Unless you see very good growth potential in the inherited property you may be better off to sell it and use the proceeds for your own home.  Your accountant will be able to confirm the situation regarding CGT but on the face of it, the inherited property would appear to be exempt.

Question  :  You recently advised a 56 year old pensioner who does casual work to salary sacrifice as much of her/his casual earnings into super in order to minimise income for Centrelink purposes.  You also stated that as a further benefit they may qualify for the government co-contribution. It is my understanding that salary sacrificed contributions do not qualify towards the co-contribution. Could you please clarify this for me?

Answer :  To qualify for the full superannuation co-contribution you need to contribute at least $1000 as an undeducted (non concessional) contribution.  A salary sacrificed contribution does not qualify-  so I agree with you.  In the question you mention, my advice was to make an undeducted contribution in addition to the salary sacrificed contributions.

Question:   My spouse, who currently does not have any taxable income other than managed fund distributions, but may return to work during the next financial year, has been accumulating capital gains, which may be up to $100,000 if the funds were redeemed in full . Would it be sensible to realise the capital gains over a few years starting before June 30 next year, while she is being taxed at a lower marginal rate? As the fund has no entry fees and she is happy with it, could she just redeem funds and immediately re-buy to achieve this?

Answer:   It would certainly be a good strategy to redeem and re-buy the managed funds, but if she is returning to work, it may be appropriate to talk to your adviser with the aim of putting a long term strategy in place to avoid excess and unnecessary tax in the future.  This could be done by investing the proceeds in share-based insurance bonds if she is relatively young or placing the money directly into super if she is older and lack of access is not an issue.

Monday, 21 July 2008

People complain about taxes, but if you had to choose which tax to pay, your preference would have to be capital gains tax (CGT).  It is not triggered until you dispose of the asset, which may be many years from when you bought it, and provided you have owned it for over a year, you get a 50 percent discount. 

Furthermore, even death does not trigger CGT – it merely transfers any CGT liability to the beneficiaries. If the asset is disposed of they may be liable for CGT, but if the asset is kept for their lifetime, any CGT applicable would be passed on, in turn, to their beneficiaries. If the assets are kept indefinitely it could be deferred for generations

To help you understand how it works, let's imagine that you have been left an investment property by your mother who has recently died.

If she bought it before 20 September 1985 it would be CGT free and you will be deemed to have acquired it on the date of her death at its market value then. Suppose she paid $90 000 for it in August 1985 and its value was $400 000 when she died on 1 April 2008. For tax purposes you are deemed to have bought it for $400 000 on 1 April 2008 - you receive the property with no CGT liability because the original owner had none.

If she acquired the property after 20 September 1985 it is subject to CGT and any capital gain is effectively transferred to you. For example, if she bought it for $90,000 on 1 October 1985 the Tax Office will assume that you acquired it for just $90,000.

The same principles apply to the family home. Usually it will be exempt from CGT and in most cases will be deemed to pass to the beneficiaries at it market value at date of death. However, it  must be disposed of within two years of the deceased’s death for it to retain its tax free status. Be aware that special rules apply if the deceased rented out the property at any time, or if the deceased was absent from the property for six consecutive years as may happen if they spent a long time in a nursing home.

As you can see, it’s simple but the examples do highlight the importance of seeking advice before you sell any assets that you have received through a will as you may find yourself facing an unexpected CGT bill.

Question  :   Can you tell me the best way to pay off a home mortgage efficiently?

Answer :  The interest on a home mortgage is not tax deductible so you should be trying to get rid of the loan as soon as possible.  My preference is to pay back $12 a thousand a month, $2400 a month on a $240,000 mortgage, as this will pay off the loan in around 10 years if interest rates stay in their present range.  Once the term drops to 10 years there is little to be gained by increasing the payments any more – you are better off to invest any spare money into an investment borrowing programme.  If you can’t afford $12 a thousand a month, try to pay at least $8.

Question:   A reader asked about withdrawing from the taxed portion of a superannuation fund to reduce tax payable on money left in an estate. You suggested they could make a tax-free withdrawal and re-contribute it as an undeducted contribution. Can you withdraw a  portion of the money in the fund and reinvest it, or would you have to withdraw your entire balance and reinvest? 

Answer:  All withdrawals are tax-free once you reach 60 and there is no restriction on the sum you can take out.  However, the amount you can contribute as an undeducted contribution is limited to $150,000 a year so it would be pointless to take out more than that in any one year, unless you intended to bring forward three years contributions and invest $450,000 in one lump.

Question:   I bought a house five years ago for $100,000. I lived in it for one and a half years then rented it out. In the last two months I have now made it my principal place of residence again and will keep it that way until I sell it in the next couple of months.  I have spent over $30,000 on painting and renovations and have a loan of $107,000 - I borrowed money to renovate.  I am planning to sell at $350,000.  What would be the capital gains tax in this scenario?