Spring clean your finances
Taking advantage of smart strategies to grow your wealth and reduce tax can make a real difference to your finances.
We’ve identified four strategies to get you thinking about the various options available. And this is just the tip of the iceberg! Yourfinancial planner can help you with other strategies that may be suitable to improve your financial position.
Use debt to grow your wealth
While most of us have some degree of debt, we tend to see this as a burden. But by harnessing the power of ‘good’ debt, such as borrowed capital used to invest in assets like shares, you can grow wealth and generate an income. What’s more, unlike your home loan, the interest on an investment loan is generally tax deductible.
One example of this is drawing on the equity in your home to establish an investment loan, and investing this money in shares. By doing this you’re building an income producing asset apart from your home and you can use the income from this additional investment (and any tax advantages) to reduce the outstanding mortgage.
Make your insurance more cost-effective
There are ways of setting up personal insurance so it’s more affordable and tax-effective. The most common strategy is to purchase life and total and permanent disability (TPD) insurance through your super fund.
Insurance premiums can be paid from your existing account balance, your employer contributions (such as superannuation guarantee) or you can salary sacrifice an amount to super, giving you a cashflow advantage.
In some cases, you may be eligible for a discount if you pay your premiums annually rather than monthly and holding all your personal insurances in the one policy can reduce fees. Savings can also be made by consolidating the insurances held by yourself and family members into one policy.
Reduce your mortgage
One way to do this is by having your salary paid into a 100% offset account linked to your mortgage. You can still access the money for everyday transactions. Anymoney you put in the offset account is deducted from your loan balance before interest is calculated, meaning you save interest and pay off the home loan sooner.
Make the most of your super
By putting more money into your super, you can take advantage of tax benefits that may not be available to you otherwise.
Undoubtedly you would have heard the term salary sacrifice used a number of times. But it’s not about sacrifice, rather about investing a portion of your pre-tax salary into your super fund.
The beauty of this strategy is you pay less tax because your super contribution is taxed at a maximum rate of 15%. This could be much better than your marginal rate, which may be up to 46.5%1. You can even use this strategy for any bonuses youreceive.
If taken as cash, your bonus will be taxed at your marginal rate. Depending on your circumstances, a salary sacrifice strategy could reduce the tax rate payable on your bonus by up to 31.5%.
If you’re self-employed2 or not employed, you may be able to claim your personal super contributions as a tax deduction. Themore you do this, the less taxable income you receive, which reduces the overall amount of tax you pay.
Consider the caps
Before you decide to invest more in super, you need to be aware that caps apply to different contribution types and penalties may be payable if you exceed the relevant cap. You also need to consider that super contributions generally can’t be accessed until you retire. So if you are saving for something else, you’ll need to consider other options.
Next steps
To find out more about these and other strategies, speak to your financial planner who can help you identify the strategies that best suit your needs.
1 Includes a Medicare levy of 1.5%.
2 To qualify as self-employed, you must earn less than 10% of your assessable income plus reportable fringe benefits from eligible employment.
Pay off your home loan sooner
For many people, their biggest priority is to pay off their home loan as quickly as possible. It can provide a sense of freedom to actively reduce the amount you owe the bank, and know you own a bigger portion of your home. Here’s an example of how one couple took a different approach to achieve this goal sooner.
Carolyn and Ian have $300,000 left to pay on their home loan, and would like to pay this off as quickly as possible.
They want to minimise their interest payments to the bank and be free of debt as soon as they can.
They also think they could be doing things more efficiently to make the most of their money now and in the future.
Their planner assesses their situation and suggests a number of smart strategies to make their debt work more effectively. Whilethese strategies are fairly straightforward when used on their own, their true value comes into play when used collectively.
Strategy 1 — Consolidate debts to save money
Carolyn and Ian’s planner suggests they increase their mortgage and use the extra cash to pay off their personal loan and credit cards.
By doing this they’ll pay less interest, as the lower interest rate on their home loan will apply to all their debts.
However, it’s important they keep making at least the same overall loan repayments. Otherwise, it could take them longer to pay off their combined debt, and they could end up paying more interest over the life of the loan, despitethe lower interest rate.
How does it work?
Debts / Outstanding balance / Interest rate / Current repayments (p/month)Home loan (20year term) / $300,000 / 7% / $2,326
Personal loan (5 year term) / $10,000 / 12% / $222
Credit cards / $5,000 / 17% / $66
Tot al / $315,000 / $2,614
To save on interest, and use their debt more efficiently, they increase their home loan from $300,000 to $315,000 and use the additional $15,000 to pay off their personal loan and credit cards.
This means the home loan interest rate of 7% will apply to all their debts and the total minimum repayment will reduce to $2,442 – a cashflow saving of $172 in the first month alone.
But rather than spending this extra cash, they will continue to pay $2,614 into the consolidated loan each month until their home loan is paid off.
Debts / Separate loans¹ / Consolidated loan¹Outstanding loan(s) / $315,000 / $315,000
Monthly repayments / $2,614 / $2,614
Remaining term / 17.8 years / 17.4 years
Total interest payments / $241,958 / $230,526
By using this strategy, Carolyn and Ian pay off their debts sooner and save $11,432 ininterest.
Strategy 2 — Use your emergency cash reserve more effectively
Carolyn has just received an after-tax bonus of $12,000, which she and Ian keep in a joint cash account.
They treat this money as an emergency cash reserve, in case of unexpected bills such as home repairs, illness or even an unplanned holiday.
By using a cash account they’ll have immediate access to their money, but it haslimitations:
•The interest rate is much lower than whatthey pay on their home loan,and
•Every dollar they earn in interest is taxed attheir marginal rate of 31.5%.
To use their emergency cash reserve more efficiently, their planner suggests putting the money into a 100% offset account linked to their mortgage.
Not only will they have immediate access totheir money, but they will achieve a better return, save interest and pay off their home loan sooner.
Note: They could gain the same benefits by transferring the money directly into their home loan, as long as it has a redraw facility.
What are the benefits?
By transferring their emergency cash into a 100% offset account, they’ll effectively reduce the balance on which their home loan interest iscalculated.
This means they’ll ‘earn’ the rate of interest charged by their home loan, and won’t need to pay tax on thoseearnings.
By maintaining their repayments, they’ll paymore off their home loan and be debt-freesooner.
How does it work?
Carolyn and Ian’s outstanding home loan is $315,000 after consolidating their debts, and the interest on the loan is 7% pa. Their emergency cash reserve of $12,000 is currently sitting in a bank account, earning just 4% pa.
As they both pay tax at a marginal rate of 31.5%2, the after-tax return on the bank account is 2.74%; much lower than the net return of 7% on their home loan.
They transfer the $12,000 into a 100% offset account which immediately reduces the size of their home loan for interest calculation purposes to$303,000.
Even though they’re saving interest, Carolyn and Ian maintain their monthly repayments of $2,614. This reduces the principal further, as well as the term of their loan.
Debts / Before strategy / After strategyLoan term / 17.4 years / 16.2 years
Total interest payments / $230,526 / $203,734
Interest saving / $26,792
By using this strategy, Carolyn and Ian save $26,792 in interest payments and reduce the term of their home loan by 1.2 years.
Please speak to your financial adviser to discuss strategies that can help you play off your home loan sooner.
1 In both options, we’ve assumed repayments of $2,614 are made for the life of the home loan. With the separate loans, payments are re-directed to the home loan once the personal loan is repaid.
2 Includes the Medicare levy of 1.5%.
Facing redundancy? Make the most of your payment
While redundancy was once considered an unwelcome sign of the times, the new corporate reality means it’s becoming more likely that at some stage during your career, you’ll likely go through redundancy yourself.
Getting the right advice can help you make the most from a redundancy payment as you move into a new job. And if you’re thinking of taking a break between jobs, you’ll need to structure your finances to make your money last.
But first, let’s look at the redundancy payments, what types there are and how tax might affect you.
Types of redundancy payments
There are several components to redundancy payments such as:
- payments in lieu of notice
- a ‘golden handshake’ (or severance payment), and
- unused annual leave, sick leave or unused rostered days off.
But redundancy payments vary from employer to employer and from one industry to another. To confirm what entitlements may be available to you in the event of redundancy, it’s important to check your employment contract or refer to your award.
Tax-free redundancy payments
If you’re under 65, a redundancy payment will have a tax-free component which includes a base amount plus an extra amount for each completed year of service. Also, if you worked for your employer prior to 1983, the amount of the payment relating to this period will be tax-free.
The tax-free component is indexed each year. For the 2012/13 financial year, the base amount is $8,806 plus $4,404 for each completed year of service. Any payment over the tax-free component is taxed as an eligible termination payment (ETP).
If you’re 65 or over, the entire redundancy payment is taxed as an ETP.
The ETP must be paid as a lump sum, unless you meet transitional rules to allow the payment to be rolled over to a super fund.
Tax treatment of a redundancy ETP
If you’re 55 or older during the financial year you’re made redundant, all amounts up to the ETP cap are taxed at 16.5%. Employees under 55 will be taxed at 31.5% up to the ETP cap.
For all employees, the balance in excess of the ETP cap is taxed at 46.5%. All of the tax rates include a Medicare levy of 1.5%.
The ETP cap is indexed every financial year, and is set at $175,000 in the 2012/13 financial year.
Doing the math – a case study
While it wasn’t a surprise when Harry Thom was made redundant, he was certainly a little anxious. At 57, he was six years off his retirement, so wanted to make the most of his money but not have to go back to full time employment.
With eight years service with his employer, Harry was set to receive a $60,000 payment. Here is how that payment was treated.
Tax-free component = $8,806 + ($4,404 x 8) = $44,038
Taxable (ETP) component = $60,000 - $44,038 = $15,962
As the entire ETP component is under the ETP cap of $175,000 for the 2012/13 financial year, this amount is taxed at 16.5% (or $2,634).
Harry’s redundancy payment after tax was therefore $57,366.
If you are facing redundancy, or know someone who is, it pays to be aware of the taxation implications of receiving a redundancy payment. Contact us today for advice on making the most of a redundancy payment