When you start a family, your focus is on financial stability – wealth creation and wealth protection. The big changes in life – a young family, a home, a change at work, windfalls – provide the perfect opportunity to review your financial situation.
When you are in your thirties and forties, debt can play an important role in helping you achieve your lifestyle and financial goals. It must, however, be managed effectively as some debt structures are more efficient than others.
Any debt used to purchase assets that generate an income can result in the interest costs being tax deductible. Where these assets also grow in value, this form of debt is considered to be efficient.
Loans taken out to purchase non-income producing assets or services (for example a car or holiday) do not qualify for a tax deduction in relation to the interest cost. This form of debt is considered to be inefficient from a wealth creation perspective and is often a drain on accelerating your long-term wealth accumulation if not managed properly.
Wherever possible you should try to accelerate the repayment of inefficient debt, and consider replacing it with more efficient debt structures that can be used to create wealth, tax effectively.
Ways to reduce inefficient debt
- manage and understand your cashflow to ensure you are making the maximum possible loan repayments
- choose the loan that has the best structure for you. A lower interest rate does not necessarily mean that you will pay less interest over the life of your loan. Often it is the flexibility and the features offered in a loan that will determine how well various strategies can be put in place to reduce the outstanding loan as quickly as possible (and hence reduce the amount of interest payable)
- making use of the interest free component of your credit card for everyday expenses allows your money to reduce your average daily loan balance and as a result your interest bill and the loan term
Borrowing to Invest
With plenty of years left to retirement, many thirty and forty-something investors borrow funds to build their wealth. The long term view on this strategy allows them to increase their investment portfolio and manage their tax deductible debt in an effective way. Be very mindful, however, that borrowing can also magnify capital losses. Any borrowing strategy should therefore be approached with caution. Understanding the risks involved is very important.
A margin loan lets you borrow money to invest in shares and other financial products, using existing investments as security. Commonly, borrowing limits are set to a certain value or percent depending on the type of asset (eg shares) you are buying, with the difference made up from your own cash or existing investments. This difference is referred to as the 'margin' - hence the name 'margin lending'.
Property investors can choose to invest directly into a property, or via a listed or unlisted property trust. Your Morgans adviser will be able to help select an appropriate strategy for you, depending on your personal circumstances and investment objectives.
Regardless of whether you borrow to invest or not, it is still a good time to think about investing in shares, either directly via the sharemarket, an ETF, or via an unlisted managed fund. Most share prices are at a reasonable value. Your adviser will be able to help select the most appropriate method of investing to suit you.
Companies paying Australian tax keep a record of the amount paid in a franking account. When the company declares a dividend it is able to attach all or some of that franking account to the dividend as a franking credit.
Most companies listed on the Australian Stock Exchange pay dividends to shareholders that include franking credits. The franking credit and resulting tax benefit available from the dividends means the actual return from that particular stock needs to be "grossed up" to reflect its true value.
The following table highlights the grossed-up effect of various dividend yields, as well as the equivalent after tax yield based on flat 15%, 32.5% and 45% tax rates.
Portfolio diversification is an essential element to a successful investment strategy. This applies equally across a portfolio and within asset sectors.
When investing in fixed interest, a spread of investment helps provide both capital certainty and regular income. As part of your planning you will most likely require some component of liquidity i.e. ready access to cash, some longer term investments as well as attractive levels of regular income.
Cash management accounts
Liquidity within a portfolio can be achieved by maintaining an “at-call” cash account which is linked to your investment account for easy settlement. You can also have your dividend payments credited directly back to the account and make regular payments from it.
A term deposit is a deposit held at a financial institution that has a fixed term. Term deposits continue to remain attractive to investors looking to maintain a balanced portfolio with exposure to low risk non-equity investments.
You can use a term deposit to enhance the returns on surplus cash balances or to build a dedicated income portfolio.
Government and corporate bonds
Government and corporate bonds also help reduce portfolio risk while providing a stable income.
The yields on government bonds will generally be lower than most other interest rate investments but provide absolute security when held to maturity.
Hybrid investments generally deliver higher levels of income, paid quarterly, along with benefits of franking. You should discuss with your adviser which securities will suit your risk profile and meet your income needs.
Other investment ideas
If you stick to the basics of investing you will have a much better chance of getting through any period of high volatility and uncertainty.
It's not all about market timing and stock selection as they only play minor roles in the performance of your investment portfolio. It is about asset allocation, active reviews, professional advice, and sticking to your long term strategy.
Take a look at our seven golden rules for smart investing.
Greater financial responsibility – such as mortgages, marriage, and children – means the impact of illness, injury or death is greater.
Protecting your family and assets through insurance has more of a sense of urgency, especially when the family is reliant on your income.
Things you need to consider at this stage in life are:
- the elimination of debt (mortgage, car loans, or even credit cards)
- provision for daily expenses for you and your family in the event you're unable to provide income
- education expenses
- medical costs
Due to the vast range of products on the market, in order to get the right features for your situation, you need specialist advice.
Some things you need to consider:
- the level of insurance
- ownership structures
- funding arrangements
Protecting your wealth in this stage of life is more complex so it is crucial you speak with a financial adviser before committing to a decision.
Life, Trauma and Total and Permanent Disablement (TPD) protection can provide a lump sum payment to cover debts and secure your financial future or that of your loved ones. Trauma insurance will provide a lump sum in the event you're diagnosed with a serious illness, while TPD protection covers you in the event you’re permanently unable to work due to injury.
Income Protection will help continue to meet your financial commitments and daily living expenses.
Business Expense Insurance should be considered if you have a business or are self employed and injury, illness or premature death would cause financial problems. Consider – if you were unable to meet expenses such as electricity, rent, telephones and staff salaries would your business survive?
This is the time to really get serious about your superannuation savings. Laying the groundwork for retirement now will help you reap the rewards when you finally give up work. As they say "failing to plan means planning to fail".
A common strategy for employees is to forego a portion of salary in lieu of increased contributions to superannuation. Contributing pre-tax salary into super not only reduces your income tax, it increases your savings within super. Over the long term, these additional savings can make a significant difference to your account balance for retirement.
Personal Deductible Contributions
Prior to 1 July 2017, only those individuals who were self-employed or substantially self-employed could make personal deductible contributions. From 1 July 2017, anyone who is eligible to contribute to super, and has sufficient taxable income, can claim a tax deduction on contributions made to super. This is irrespective of whether the person is self-employed or an employee.
The following table summarises the contribution limits for concessional contributions and non-concessional contributions:
* indexed by AWOTE at $2,500 increments.
|Concessional Contribution Limits
||$25,000 pa per person (indexed*)
|Non-Concessional Contribution Limits
|Up to age 65
||$100,000 pa per person; or up to $300,000 averaged over a 3 year period
|From age 65#
||$100,000 pa per person (3-year averaging not available)
# if age 65 or over individual must meet a work test.
Regular savings plan
Don't forget the benefits of "dollar cost averaging" via a regular savings plan to help save for future goals such as your children's education costs, or home renovations, for example. Your money will buy more shares or unties when prices are low, and as prices eventually rise your investment will also grow proportionately.
For more information contact an adviser at your nearest Morgans office.
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