Create a financial roadmap
I was honoured recently by the Institute of Chartered Accountants for 25 years service as a Chartered Accountant in practice. Having passed this milestone and grown our advisory firm over that time from a handful of clients to over 2,000 across Australia,
Senior executives and business owner operators have complicated lives pressured by the demands of growing their businesses, advancing their careers and being keenly involved in family activities. Working to accelerate their personal financial success and gaining clarity and simplicity to their financial life usually becomes an after thought.
From my experience there are five key pillars for creating and maintaining a successful financial roadmap.
1. Taxation is your biggest expense
Cost control is a critical component of business hygiene and it should be no different on a personal level. Two people in almost identical circumstances can generate substantially different wealth, simply through small incremental tax wise decisions, they make or fail to make over their careers.
I do not advocate flouting the tax laws. While there are few legal large scale tax minimisation opportunities these days, there are a range of avenues available to boost after tax income. Personal deductions have been reduced to a minimum however reasonable salary packaging savings are still available predominantly through the packaging of motor vehicles that may produce a better after tax result of around $5 to $10k per annum. Using an ‘associate lease’ to package a vehicle for a spouse or family member can potentially double the benefit.
Optimise your investment structure
A major thrust of tax planning is to ensure that income is earned by the lowest tax paying individual or entity in a family group. There is little opportunity to divert employment or ‘personal exertion income’ for these purposes, however structuring your wealth producing assets to provide asset protection and estate planning benefits through the use of family, unit or hybrid trusts, sometimes including corporate beneficiaries should be considered. In the last 15 years, Government legislation and ambiguous court decisions have progressively marginalised the effectiveness of traditional structures to invest and protect passive wealth at an appropriate tax rate. Traditional structures are increasingly ineffective in the 21st century and a review may facilitate more tax effective outcomes and establish next generation investment structures.
Understand the tax benefits of capital gains
The second big-ticket taxation item is to look for opportunities to build capital appreciating assets as opposed to generating income. The benefits of capital gains tax (CGT) discounting effectively halves the tax rate applicable to top marginal rate income and can be reduced further in certain circumstances. The CGT is also only paid when the asset is realised rather than each year as it is in respect of ordinary income.
The assets you choose to generate your capital gain are more important than minimising the tax on sale, however refer point three below.
2. Good debt vs bad debt
Careful management of your borrowings can result in very significant tax savings over a long period of time. Savvy wealth creators work hard to reduce non tax-deductible debt as quickly as possible while building a tax- deductible line of credit. The line of credit, assuming a top marginal tax rate effectively halves the interest cost, a significant saving over a 10- or 20-year period.
The biggest trap for the unwary is that once you repay a debt established to acquire an income-producing asset, a redraw will not be classed as tax deductible borrowings unless it is used for income producing purposes. Many people erroneously believe they can ‘redraw’ the loan against a rental property for example and retain its tax-deductible character. Paying down a loan for an investment property while you still have a home loan is a good example of missing an ideal opportunity.
A further useful strategy for your own home is to rather than pay down the non tax deductible mortgage, build up funds in an ‘offset’ account. This reduces the non tax-deductible debt while it is your principal base of residence. If you choose to move out to a new principal residence as the debt has not been paid down but offset you can remove the offset funds clearing the way for the original mortgage to now become tax deductible.
3. Understand risk vs return
You don’t need to have qualifications in free market theory to appreciate the maxim that the greater the return the greater the risk of an investment.
This is the balance between seeking to enhance wealth and preserving it. It is often a feature of bull runs or rising markets; and exuberance and over confidence can result in some pain when markets correct.
Low return, whilst normally meaning there is less likelihood of a loss of capital, may instead mean there are lazy assets that need to be more effectively put to work.
As you succeed in generating wealth a portfolio approach to investment provides a level of protection from factors that may affect certain asset classes.
Concentration of your assets in one
‘big project’ subjects you to the risk of loss if the project or investment fails for whatever reason. A financial adviser can professionally profile your risk tolerance so that you properly understand your likely attitude to various forms of investment and market cycles.
Your major asset that is often overlooked is your ability to earn income. Whatever asset position you are in your circumstances can change dramatically and the compounding effect of inadequately insured loss of income though illness or accident could be devastating. Opportunity assets While staying true to my comments about risk management and the importance of understanding your risk profile, to the right person there can be an opportunity to boost outcomes from your investment choices. While avoiding the temptation to ‘bet the farm’ there can be some contrarian investments that might give a higher return for acceptable risk. Whether it’s an investment manager that looks for ‘empty rooms’ or unloved stocks that haven’t yet been discovered or that investment property that is something different in size, location or alternate uses, there may be an opportunity to outperform.
4. Super strategies
Smart wealth creators maximise their super every year and stay abreast of the tactical opportunities that present themselves as their age profile changes and successive Governments fine-tune the area. Salary sacrificing to the aged based limits is a must. The compounding impact of effectively getting a tax deduction to invest your income in a low tax environment is enormous. The ability to gain CGT exemption when your fund is in pension mode is another substantial benefit.
Further strategies around ‘transition to retirement’ (TTRs) involving the creation of concessional income streams and ‘contribution splitting’ with your spouse are also potentially available.
Self-managed super funds are a growing and popular alternative to traditional super funds. They are now the favoured choice for around one million Australians, advantages include greater control, flexibility to acquire certain assets like direct property, tax deductions for life insurance premiums and estate planning flexibility.
5. Get the right advice
There is no area where it is more important to concede that you ‘don’t know what you don’t know’ than financial advice.
The strategies outlined above whilst important are high level only and are representative of the multitude of tactics that are available to minimise taxation, invest wisely and grow your wealth.
Harmonising these opportunities in a fashion that gives you a 360 degree view of your financial landscape will not only assist with your understanding of the concepts but will increase the likelihood that you will take the important steps necessary to improve your own personal financial position while you focus on succeeding in corporate and family life.
Allan McKeown is the CEO and Founder of Prosperity Advisers and has over 25 years experience providing taxation and wealth advice to a range of executive and high net wealth clients. Prosperity Advisers is a Chartered Accounting and Financial Planning Advisory firm with 120 staff and offices in Sydney, Newcastle and Brisbane. www.prosperityadvisers.com.au