$80k a year

Tax-ef­fec­tive in­vest­ments that won’t strain your vi­tal cash re­sources should be at the top of the list

Money Magazine Australia - - COVER STORY - JA­SON PETERSEN

A30-year-old earn­ing $80,000 has sim­i­lar chal­lenges to those on other in­comes: a sub­stan­tial tax bill ($20,000pa), a bar­rage of in­for­ma­tion about where to in­vest and, above all else, a de­sire to live life on their own terms. With lit­tle in the way of sur­plus funds – and pos­si­bly a size­able HELP debt – it’s easy to feel fi­nan­cially stuck. And with­out a hefty de­posit or high in­come, get­ting a home loan can be tough, es­pe­cially with banks un­der pres­sure to lend more re­spon­si­bly. This means you need to think about other ways to grow your wealth.

As a young per­son, su­per­an­nu­a­tion is un­likely to be top of mind. Nonethe­less, it’s smart to take con­trol of your su­per early to get it work­ing harder for you sooner. First, with most funds charg­ing 1%-2% in fees, make sure your choice is cost ef­fec­tive, with to­tal costs of not much more than 0.5%. An ex­tra 1% in su­per fees over 30 years re­duces your su­per bal­ance by about $160,000, or $60,000 in present value. There are a few funds (Mac­quarie and Netwealth, for ex­am­ple) that of­fer very low fees and also en­able a key strat­egy to be adopted: the use of self-fund­ing in­stal­ment war­rants (SFIs).

With an as­sumed su­per bal­ance of $30,000, you could take just 20% ($6000) and buy an in­stal­ment war­rant over an ex­change traded fund (ETF) in­vested in the top 200 stocks through the ASX. A good ex­am­ple is the Van­guard Aus­tralian Shares Index Fund (ASX: VAS). Add 20% of your $7600 su­per guar­an­tee (SG) con­tri­bu­tions to this in­stal­ment war­rant ($1500) ev­ery year. From this small com­po­nent of your cur­rent su­per­an­nu­a­tion, you’ve added an ex­tra $295,000 ($120,000 present value) at age 60. More im­por­tantly, you’ve cre­ated an in­come stream of about $19,000pa com­pared with the $ 8000pa you would have achieved with­out the ETF. Of course, the re­main­ing 80% of your su­per­an­nu­a­tion would con­tinue to work in­de­pen­dently of this strat­egy, with your bal­ance at age 60 ex­pected to reach $620,000 in present value. This ig­nores any other su­per strate­gies, such as salary sac­ri­fice, that you can adopt in later years closer to re­tire­ment.

Why the fo­cus on su­per­an­nu­a­tion? With su­per largely taken care of, in a fi­nan­cial sense, you only have to think about the next 30 years, not the next 60.

Go­ing out­side su­per

On a $80,000 in­come, cash flow can be a prob­lem. It’s there­fore im­por­tant to fo­cus on tax-ef­fec­tive strate­gies that don’t place a large strain on your cash re­sources.

Be­cause they also work ef­fec­tively out­side su­per, in­stal­ment war­rants fit the bill. Be­ing self-fund­ing – aside from an ini­tial in­vest­ment – there is no fur­ther com­mit­ment from the in­vestor. All div­i­dends go to­wards pay­ing in­ter­est on the in­stal­ment loan. In­ter­est is tax de­ductible up to the pro­tected bor­row­ing rate of 6.7%, and the frank­ing cred­its are paid di­rectly to you. Even bet­ter, you can add as lit­tle or much as you like de­pend­ing on your cir­cum­stances, as SFIs are sim­ply traded on the ASX. In ad­di­tion, the amount of gear­ing can be set at a level where the in­ter­est is rea­son­able and the div­i­dends work to pay down the in­stal­ment loan over time.

Com­pared with a mar­gin loan, a 75% SFI has a sim­i­lar in­ter­est rate but there are no mar­gin calls, 75% of your in­vest­ment is pro­tected and you don’t need to find the funds to make in­ter­est pay­ments. The ex­am­ple in the ta­ble (top right) shows an in­stal­ment in ac­tion over 10 years, with as­sump­tions of 4.5% div­i­dends, 75% franked, in­stal­ment in­ter­est of 7% and growth of 5%. The mar­ginal tax rate for our $80,000 in­vestor is 34.5% (in­clud­ing Medi­care).

In both cir­cum­stances – su­per or non-su­per in­vest­ments – there are fun­da­men­tal con­sid­er­a­tions and op­por­tu­ni­ties:

Tax bracket. In­stal­ment war­rants en­able you to choose the most ap­pro­pri­ate tax out­come for your sit­u­a­tion, for ex­am­ple, keep­ing you within the lower tax bracket as re­quired.

Dol­lar-cost av­er­ag­ing and re­bal­anc­ing. Reg­u­larly in­vest­ing and en­sur­ing your as­set al­lo­ca­tion re­mains con­sis­tent as­sists in not hav­ing to time the mar­ket, thereby avoid­ing the dan­ger­ous herd men­tal­ity of many in­vestors. Putting ad­di­tional funds into lower-per­form­ing as­sets sys­tem­at­i­cally en­ables your port­fo­lio to have far greater

up­side po­ten­tial when as­set per­for­mance ul­ti­mately turns in the right di­rec­tion.

Di­ver­sify us­ing ex­change traded funds. A key tenet of in­vest­ing is di­ver­si­fi­ca­tion. ETFs en­able you to ac­cess a sig­nif­i­cantly di­ver­si­fied port­fo­lio across and within as­set classes with­out hav­ing to pick win­ners or spend a lot of money on mul­ti­ple trades. In the strate­gies above, two ideal ETFs pay­ing good div­i­dends and of­fer­ing great di­ver­si­fi­ca­tion are the SPDR S&P Global Div­i­dend Fund (WDIV) and the Van­guard index fund men­tioned ear­lier.

Man­ag­ing risk. In­stal­ment war­rants of­fer a level of pro­tec­tion in that they can be set up with lim­ited re­course loans, whereby the in­vestor isn’t at risk of los­ing their in­vest­ment or hav­ing to pay back the funds bor­rowed.

No­vated leas­ing us­ing the em­ployee con­tri­bu­tion method. Aside from buy­ing a home, the other big-ticket item is a car. An ef­fec­tive way to buy is through no­vated leas­ing. This is where a por­tion of the costs of own­ing a car can be paid us­ing pre-tax dol­lars. For ex­am­ple:

Over a five-year term, about $5000 of the costs come from pre-tax dol­lars, sav­ing about $1800pa in tax. In ad­di­tion, for a $19,000 car you only fund the ex-GST price of the ve­hi­cle, sav­ing around $1700 on the up­front cost. Note that GST is paid on the fi­nal resid­ual value – in this case around $525 in GST. Mak­ing the smart de­ci­sion to con­tinue own­ing the car be­yond five years al­lows you to roll over the lease and con­tinue un­til the resid­ual is even lower while re­tain­ing the tax ben­e­fits.

Over the term, tax saved is about $9000, while the GST saved is around $1200, so a ben­e­fit of around $10,000 is gained, com­pared with not salary sac­ri­fic­ing.

No­vated leases are not al­ways plain sail­ing and there are a few con­sid­er­a­tions:

First of all, your em­ployer needs to al­low this ar­range­ment.

Some providers set you up with ad­di­tional costs that negate any tax ben­e­fit. This means it’s es­sen­tial to get qual­ity ad­vice be­fore act­ing.

In­stal­ment war­rants and no­vated leas­ing are use­ful strate­gies across vary­ing in­come brack­ets. They are, how­ever, highly ef­fec­tive for those on $80,000pa. This is be­cause nei­ther re­quires large ex­cess funds, you’re not locked in and you gain tremen­dous op­por­tu­ni­ties while not tak­ing on ex­ces­sive risk. Longterm in na­ture, they do re­quire a de­gree of dis­ci­pline in or­der to en­joy all the ben­e­fits these strate­gies can cre­ate.

Ja­son Petersen is a cer­ti­fied fi­nan­cial plan­ner and head of wealth man­age­ment at 5 Fi­nan­cial.

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