Advice would be great: what would you do?

Hi it's my first post, but I've been reading some articles for a few weeks now and I need help! To give you a quick intro as to where I am, I've been lazy with money and I now realise I have to get my act together. June 30 was one of the catalysts to this. I wanted to get your feedback as to what you think I should be doing.

I've read MichaelWhyte's (sp?) post about how he's geared up and pouring 100% of his salary into his investments and living off the income derived from his investments. That sort of strategy fascinates me but wanted to hear from people who use that type of strategy and others given my current financial snapshot.

I'm 30, have a dependent wife with baby on the way, my yearly salary is 300k, I have a house valued at 650k (mortgage of 390k) and I have shares of 60k (loan of 20k). Fortunately I don't have a car loan or other credit due.

I enjoy my work so I'm not looking to replace my job, but I want to have a strategy or a plan to investing. The fact that I pay in excess of 100k in tax bugs me dearly. I'm confident there's a way to improve and be smarter as to how my money is managed.

Can anyone suggest strategies for my situation?

A financial planner mate of mine basically said that I should pay of my mortgage before doing any investing - is this true?

- MiddleClassMonkey

 

Firstly, welcome to the forums Monkey boy

I tend to agree with your mate that you should pay your mortgage off first. At your tax rate, it's a guaranteed 11%-odd return on your money. Earning $300k (wow!) should allow you to drop absolute bombs on that mortgage each month, killing it in 2 years. I'm sure your dependent wife would be comforted to know you've paid off the family home too.

After that, if I were you, I'd set up a line of credit to the value of 80-85% of your PPOR, and draw on some of that.

* Some of it would go towards an investment property or listed property trust,
* Some of it would be for Aussie shares via managed fund or listed investment company,
* Some of it into International shares, again via a managed fund or listed investment company

The remainder left undrawn for rainy days. Whether you do the above with a margin loan to increase your gearing is your choice, I'd go for that too.

I also agree with you that you've been lazy with money given your income but at that income your net worth will be changing significantly over the next few years. Set yourself some goals, like financial freedom by the age of 40 or something - and then work out things like

* how much passive income that would entail
* how much capital would be required to produce that income
* how much of your income you would be able to contribute
* what returns would be required to reach your target etc.

Compounding returns are an amazing thing. Your net worth will increase from $300k to $1.5m before you know it. Although you enjoy your work and have no plans of quitting, your income is your family's financial 'single point of failure' (I'm a network engineer) and the sooner that's fixed via an investment stream the better.

This is all chit-chat over a virtual beer and not financial advice.

 

Paying off your mortgage first means directing your income into that loan to reduce it ASAP.

It does not mean that you should not borrow additional sums at Interest Only to buy more property and/or shares. Don't pay down these deductible loans until your home loan is done.

Now I am going to contradict myself.

The ideal loan on your home is Interest Only with all "repayments" going into an offset account. This lets you virtually pay it down and maintain the flexibility of having a deductible loan if ever you decide to rent it out.

Ask questions if what I have said doesn't make sense.

 

Good suggestions so far.

Can I ask you to give us a budget. Namely what is your current outgoings so that we can gauge how much can be diverted where.

Cheers

 

Simon and Glebe, thanks for your suggestions. How are the two strategies different however? Using an offset account as opposed to establishing a LOC against the home?

So how does this strategy sound?
- Pay off home asap
- Meanwhile, borrow near to maximum borrowing capacity and invest in a diversified portfolio (hopefully through investment only loans)

Are there any other tax-advantaged tips you can offer? (I'm not interested in agri-businesses or superannuation) Or are there any particular managed funds that are tax-effective?


handyandy, unfortunately I've never sat down to do a budget, but basically I'm paying 2800/mth for the home, then living expenses. Realistically I'll have around 100k for investment purposes per year. I suppose I'm concerned about the strategy of investing (issues such as tax effectiveness appeal to me).

Also, what vehicles are recommended for investing in aussie shares and funds, and international shares and funds? Company or trust?

Sorry for sounding all over the place, but it shows how negligent I've been financially.

 

Have you talked to a good accountant about your situation?

If not, then I would suggest chatting to someone like NickM or MattR from this forum, who are both qualified to discuss ways to reduce your taxable income. They can also advise on which entity is best, in your situation, to use for gearing purposes as well.

Welcome to the forum too

 

trusts should certianly be considered... it would have tax advantages for someone in your position...

if your wife is dependant and has a baby, she will not be working and thus from next year could earn up to $180,000 before she is taxed at the same rate as you, alternatively assets could just be held in her straight name...

effectively at the moment, if you redraw your loan to 80% you could borrow 520k, leaving 130k for investment.
Say if you geared this via a margin loan at 50% you could invest $250k in shares,
alternatively if you decide to buy property, you could buy roughly a $500k property (with 30k for initial expenes, buyers agent fees, stamp duty, inital repairs)

(*if this isnt enough money to play with, you could redraw to 95% of the value but extra costs are substantual)

with 100k investment per year, you could invest 8k a month, this could be paid down into your mortgage (via the offset account) and then could be re drawn to invest into shares (and turning non deductable debt into deductable debt, could also be geared at 50% turning it into 16k per month) and any distributions/dividends could be paid out to you and follow the same process...

if i was you i would be paying down the house (at 8k a month + your current repayments) paying only the interst and redrawing the rest of the amount out and then investing via your wife or a trust but personal opinion so seek professional advise...

 

Jacque, thanks for your suggestion to talk to those members. I'll certainly keep those members on my radar. Am I best speaking to accountants or financial planners? Do those accountants also do personal income tax returns?

DaveA, thanks for your suggestions. I've often heard trusts are good vehicles, but I never quite understood them to the level I'd like. If I were to personally leverage into an income paying investment, I'd be taxed at 46.5% (bad) but potential losses and the interest on the loan would be tax deductible (good). I know the benefit of the trust is being able to redirect income to my wife's name, but is there a way of also preserving the deductible component on my marginal tax rate?

If I repay my mortgage and redraw for investment purposes the loan then becomes tax deductible, but is tax deductability preserved if I redraw and place into a trust which will be the investing entity?

 

i know NickM is both, accounts do tax returns, tax planning (something which will be good for u) and general investing decisions

yes and no.... theres a heap of info on trusts but basically theres two types, a discresionary trust (family, DT) and a Hybrid Discresionary trust (HDT), a DT losses cant be distributed but are offset against future income, HDT works a little different but basically yes they can be distributed but all income must go to the person who owns the units (and who would claim the loss), HDT are good for property as there negatively geared, DT are good for shares as more often than not has a positive figure at the end of the year who can be distributed to anyone...

the way you could work this for a DT is borrow the money from your redraw and lend it to the trust, you charge the same interest rate as the bank and thus the effect would be nil to you (borrowing cost=income recieved) but then the trust gets to distrbute the interest back (with nil tax effect for u) to you and this is a deduction for the trusts, although if you gift the money to the trust (asset protection reasons) you will not be able to claim a tax deduction for it...

also maybe the question of what occupation are you in, are you at risk of personal litigation, or will you be in the future (accountants/engineers/doctors/lawyers) this should also be considered by your accountant when making investments to place it in the right entity...

 

I wouldn't invest solely for tax breaks

whew......$300k p/a is a nice wage (what I could do with that I think we're at around 17% of that ), Congratulations you've done well to get there.

Roughly I worked out you have

Loans of $410k and Control of $710k = Equity of $305k and a LVR of 57.7% which gives you some room to play with..i.e taking $100k out and a Margin of 50% gives you $200k for the Market; Or you could look at an Investment Property up to $500k , both options still keep you under 80% LVR

Something to ponder anyhow

PS: Chan and Naylors Chart on the effects of tax on $2 with a 100% return p/a (then taxed at the top tax rate) and the difference over 20 yrs is interesting

 

DaveA, thanks for your comments. So I could potentially invest using an investment loan where the interest component is deductible when holding units in a DT/HDT. Sorry to sound ignorant, but what's the advantage of using a DT/ HDT holding units in my name as compared to personally? eg. I could purchase a negatively geared property through a DT/HDT and purchase all units. I would then have the losses incurred dedutible to my tax. But then what happens when the property becomes positively geared over time? Are there any duties/taxes in transferring or abolishing my units to distribute to then my wife?

That's legal? What benefits does a trust have of having more expenses than income? One of the posts said the trust could lock in the losses for future gains. Is this true?

Thanks to everyone for their comments. I've got so much to think about.

- MiddleClassMonkey

 

Monkey

I strongly urge you to buy the book Trust Magic:

Trust Magic (Powered by CubeCart)

It's author is a Melbourne accountant. Very easy to read.

 

Hi MCM,

Welcome to the forum!

I'll just add my own views to those offered above and try to do so in a semi-structured manner so you can digest it easier.

Legal Structure

I'd say this is less important starting out. In fact NickM would probably agree that for one IP you might as well hold it in your own name and not in a trust. Having said that, you can do basic structuring for tax effectiveness as follows:

Managed Funds (assuming cash flow positive) in your wife's name to take advantage of her lower tax brackets and tax free thresholds.

IPs (assuming negatively geared) in your name to take advantage of your high tax levels and tax deductability.

Portfolio Mix

I personally have adopted a balanced portfolio between shares and properties. Given my personal situation isn't too far removed from your own I'll spell it out so you can see how the cash flow holds together.

1 IP: valued at $700K generating $500pw rental income. Simple figures makes this $50K in interest outgoings and $25K of rental income. Net cash flow of -$25K pa.

1 Managed fund: valued at $800K generating $80K in distribution income and costing $65K in interest. Net cash flow of +$15K pa.

Total net cash flow position is -$10K pa.

In reality, this portfolio has been cash flow positive for me for the last couple of years since my managed fund has done better (in fact double) the 10% return I have assumed above. That has meant an actual surplus cash flow last year of +$70K as well as holding an appreciating property asset.

I have pumped mu surplus investment cash flow in to reducing my PPOR debt. I now owe only $20K on my $850K PPOR.

Borrowing capacity

Banks will lend to your servicability and LVR limits as below:

Servicability is still OK. I have a salaried income of $200K (paltry compared to yours) and my portfolio is currently showing a cash flow positive return of $70K on top of this. The bank uses that "demonstrated" return but discounts it when calculating your servicability. But even discounted the banks look at my servicability and say they'll lend me more as I have a good portfolio mix of +ve and -ve at the moment.

LVR is getting stretched. My assets and liabilities are as follows:

Assets:
PPOR $850K
IP $700K
MF $800K
Land $100K
Super $200K
Cash $150K
TOTAL Assets: $2.8M

Liabilities:
PPOR mortgage $170K (offset by the cash above to be $20K net)
IP mortgage $700K
MF borrowings $800K (mixture of LOC on PPOR and ML)
TOTAL Liabilities: $1.7M

Loan to Valuation Ratio (LVR): 61%

But the problem is that the banks won't lend against some of those assets. I think the land, supoer and the cash in the offset account are no good. My real LVR from the banks perspective is probably over 70% and they only like lending to 80% for properties but will go further in some instances or lo doc.

Your situation

Your servicability isn't an issue and your LVR at 58% looks OK too. You could go to the banks and borrow some bucks against the equity in your PPOR and leverage into either shares or property. Given your cash flow I'd think more growth assets (IPs) at this stage instead of CF+ managed funds. But I'd suggest you talk to a good financial planner about that. Oh, and I'd suggest for you that its more important that you talk to a Financial Planner at this stage than an Accountant. Each have an important role to play, but what to invest and where is more of a Financial Planner question. Leave legal structure for the Accountants down the track. I used Navra Financial Services (NFS) to get me started and can highly recommend them. My planner is Mark Raymond and if you ask for him by name I'm sure he'd take your call and have a no obligations chat up front. I had used other FPs in the past but none had the focus on property as the growth asset of choice that Navra does.

Hope that helps a wee bit.

Cheers,
Michael

 

advantage is the ability to streme income (if held in a DT) or have flexibility of how the future will play out, your example only works in a HDT, a DT you dont by units, let the losses accumulate and they cancel out the gain you make when you sell the profit or it becomes +ive geared...

there are duties (if in HDT) but this is still currently being debated by the ATO, it would be reasonable to believe you would be liable for any Capital gain the property has incurred since ownership, alternatively a way to combate the +ive geared property is to go out and buy another property (which will most probably be negatively geared) and thus may cancel out and you will still make a loss...

It can lock in losses, where as a HDT will distribute those losses so you can use the straight away (think of time value of money), the main benefits are tax deductions, asset structures are something that really need to be thought about so you dont balls it up from the begining...

 

Subject to the terms of issue of the units I don't think that's right. Losses incurred by the trustee stay within the trust. It's just that with a HDT you can borrow in your own name to acquire the units and the interest should be tax deductible.

As always, get specific tax advice for your situation.

Cheers
N.

 

Sorry, i should of been better worded... thanks nigel

Under a HDT you will incure a gain (inside the trust) which can be distributed (which will be a loss once claimed against your interest costs) for an overall tax loss position (outside the trust), with a DT, both the gain and interest loss will be inside the trust and hence the loss will be unable to be distributed to be offset against other income...

disclaimer...

 

Glebe, thanks for your suggestion to read Trust Magic. I'll certainly read that in the next few days.

MichaelWhyte, thanks for your detailed snapshot. You make it sound simple, which I'm sure it's not, but nevertheless encouraging. With all this being so new to me, it'll take me a few days to absorb, but I'm quite excited about it all. Navra are more focused on property when creating financial plans, right? I haven't heard of many planners who focus on property (normally as this doesn't feed a commission), so how does this work? Do they assist in property selection? or is it more just what allocation you should have to property? Also, roughly what are the costs involved in seeing these planners and accountants?

Nigel, any relation to Neville by any chance?

Thanks again

- MiddleClassMonkey

 

How do I get your job?

 

No. But what a good business Neville Ward direct was!

 

Hi,

Although it is sometimes suggested that a DT/HDT is not appropriate if the intention is only to own a single property and/or because one is just starting out I'm not sure this would apply in your situation. High income earners with a dependant wife are often perfect canditates for setting up a DT or HDT. You are young and sound serious about building wealth from now on. So given your very high salary you will build this wealth quickly and hence why not start with the end in mind and establish the most appropriate structure right from the start. Certainly seeking the advise of the likes of NickM would be highly recommended.

This is not advice of course but just geriatric ramblings.

Cheers - Gordon