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Before We Begin
• McMasters’ Independent Financial Planning is a licenced provider of financial services. AFSL 307248.
• The contents of this presentation constitute general advice only. They may not be relevant to your particular circumstances.
Good Financial Management = Good Financial Planning
• Good Financial Planning is:
– Consistent with other planning;
– Structural rather than schematic; and
– Based on common sense.
Elements of Financial Management
• Income
• Expenses
• Investment
• Wealth = (income – expenses) * investment
Employment Income:Doctors and Non Doctors
Income Across the Lifespan - FTE Doctors vs Non Doctors
0
50000
100000
150000
200000
250000
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52
Years in workforce
Do
llar
Valu
e (
2006 D
oll
ars
)
Points to Note
• Area under the doctor’s curve much greater:
– Doctor’s earn more;
– Their earnings are constant; and
– Their earnings last for longer.
• Therefore: trade being busy for being durable.
Investment Income
Income Across the Lifespan - FTE Doctors vs Non Doctors
0
50000
100000
150000
200000
250000
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52
Years in workforce
Dolla
r Val
ue (2
006
Dolla
rs)
Income Across the Lifespan - Investors Vs Non Investors
0200000400000600000800000
100000012000001400000160000018000002000000
1 6 11 16 21 26 31 36 41 46 51
Years in workforce
Do
llar
Va
lue
(2
00
6 D
olla
rs)
Investment Income: Benefits
• Not related to actual activity – earn it while you sleep, holiday, etc;
• Achieves compound growth;
• Reduces/removes reliance on employment income;
• Therefore: employment is on your terms.
‘Typical’ Cost Curve
The Cost Curve across Forty years of Career
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39
Years in practice
Child 1 Born
Child 2 Born
Child 1 Primary
Child 2 Primary
Child 1 Secondary
Child 2 Secondary Child 1 Uni
Child 2 UniGrad 1
Grad 2
Leave Home 1
Leave Home 2
The Two Curves
Income Across the Lifespan - FTE Doctors vs Non Doctors
0
50000
100000
150000
200000
250000
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52
Years in workforce
Do
llar
Val
ue
(200
6 D
oll
ars)
The Cost Curve across Forty years of Career
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39
Years in practice
Two Curves Together
• Income generally exceeds expense:– Pre-kids;– While kids pre-high school;– Once kids graduate.
• Therefore, these are optimal times for enhancing wealth creation.
(Legitimate) Ways to Reduce Tax
• Deferring Consumption; and/or
• Spreading Income;
All Tax = Consumption Tax.
Superannuation• Deducted Contributions taxed at 15%;
• Age-Based Deductible Limit is per related employer.
• Earnings taxed at 15%;
• Capital gains taxed at 15%/10% or nil;
• Post 60 – withdrawals not taxed at all;
• Post pension, earnings and income not taxed at all; • Asset protected.
Self Managed Super Funds
• Maximum control;
• No commissions;
• Main cost often accounting and audit fee;
• Simple investment strategy = low cost;
• Automation adds simplicity;
• 15 minutes per month.
Case Study - Superannuation
• Doctor intends to invest $10,000 of pre-tax income;
• Marginal tax rate = 40%;
• Therefore, can invest:
• $6,000 in own name; or• $8,500 in superannuation.
Case Study - Superannuation
• Assume investment earns income of 10%:
– Return in Dr’s name: $600 pa. Tax payable = $240. After tax return = $360.
– Return in SMSF: $850 pa. Tax payable = $127.50. After tax return = $722.50.
• Return on $10,000: – 3.6% in own hands;– 7.2% in SMSF.
Case Study - Superannuation
• Investment value after year one:– Own hands: $6,360;– SMSF: $9,222.50.
• Investment Value after year ten:– Own hands: $10,745;– SMSF: $19,218.
• Investment Value after year twenty:– Own hands: $19,242;– SMSF: $43,452
Superannuation Makes More Sense for Doctors
• Preservation effect lessened due to higher cash flow;
• Asset protection;
• Saving for future generations.
Personal Services Income – How to Reduce Tax
• Superannuation;
• Employing Others; or
• Negative Gearing.
Business Income – How to Reduce Tax
• Superannuation;
• Share income between more than one person (no need for employment);
• Investment company;
• Negative gearing.
Cars
• Home to Work = Business Travel;
• No limit on number of company cars;
• Car no 2+ taken as fringe benefits;
• Oscar Wilde and Accountants.
Interest
• Deductible debt is generally good…;
• Non-deductible debt is generally not so good (but not necessarily bad);
• Maximise borrowings for business/investment;
• Direct all available cash onto non-deductible
debt.
Transaction Costs
• If it moves, tax it!
• Avoid commissions and excessive fees;
• Don’t sell good assets.
Types of Investment
• Property:– Own home;– Investment;– Commercial and Residential.
• Shares
• Cash
• Superannuation is a special case
Key Points - Investing
• Simpler than it is made to look;
• Long term time frame essential;
• Control the investment.
Optimising Investment (2)
• Australian Experience:
• Conclusion: Everyone Should be a Long Term Investor!
Growth in Australian Share Market Value versus Increase in Wealth Per Capita. 1901 - 2001
2% per year
7.5% per year
Property Investment (1)
• Example (residential)
• Cost of debt = 7%;• Net Income return = 3%;• Income loss = 4%;• Tax Break ~ 2%;• Net loss ~ 2%.
• If capital growth > 2%pa, wealth created. • 2% pa means doubling every 36 years.• Inflation = 2.8%.
Property Investment (2)
• Manage Risk: Avoid duds. • Poor quality/High maintenance;• Low demand relative to supply (caution
‘Seachangers’);• Aesthetic pleasures.
• Avoid ‘off the plan’*
• Consider a buyer’s advocate.
Index Funds
• Indices used to measure market;
• IFs invest in accord with the index;
• Automatic diversity;
• Obtains the gross market average;
• No ‘research’ = Lower fees;
• Little trading = lower fees;
• Provides superior net return.
The Maths of Index Funds• Distribution of returns before fees (individuals and managed funds)
• Distribution of returns after average active fees of 1%; index fees = 0.5%
0 1 2 3 4 5 6 7 8 9 10 11
Percentage return
-1 0 1 2 3 4 5 6 7 8 9
Average return =
5%
Average return =
4%
Index Fund
return = 4.5%
Humility Helps
• “Welcome to Lake Wobegon, where all the women are strong, all the men are good-looking, and all the children are above average.”
– Garrison Keillor, Lake Wobegon Days.
Alternatives to Index Funds
• Listed Investment Companies (LICs);
• Exchange Traded Funds (ETFs);
• Same automatic diversity and efficiency;
• Not quite as tax advantaged;
• More manager risk – active management.
Case Study 1
• Doctor aged 35;
• Full time GP billing $300,000. Pays 35% mgmt fee;
• Taxable Income: $180,000. Tax rate = 45%;
• Employs husband as p/time administrator;
• Maximum deductible contribution 2007/2008: $50,000 each;
• Annual contribution: $100,000.
Case Study 1 - Solution
• Opens line of credit loan;
• Receives billings onto home mortgage;
• Borrows to pay:– Mgmt fee; and– Superannuation contributions
Case Study 1 - Solution
• Annual Contribution = $100,000;
• Therefore, monthly contribution = $8,333;
• Direct Debit 1st day of month:
– $8,333 from LOC to SMSF bank account.
Case Study 1 - Solution
• BPay 2nd Day of month:
– $7,000 from SMSF Bank Account to Vanguard.
• $7,000 = 84% of monthly contribution.
Case Study 1 – Key Elements
• Minimal fees: SMSF and Vanguard;
• Dollar Cost Averaging;
• No cash flow restriction;
• Immediate return of 30%: $30,000 tax saving for the family;
• Interest deductible at 30%; earnings taxed at 15%.
Case Study 2• GP in late fifties;
• Billing $400,000. Paying 30% mgmt fee.
• Taxable income: $250,000. Tax Rate = 45%;
• No personal debt;
• Wants to help children with home loan;
• Employs wife part time;
• Deductible contributions 2007/2008: $100,000 each.
Case Study 2 - Solution
• Opens Line of Credit loan;
• Contributes 1/12th of $200,000 into SMSF each month;
• Invests 84% into Vanguard;
• At age 60, withdraws money to finance home for children.
Case Study 3
• Dr in Mid 40s;
• Has principal and interest loan of $400,000 of deductible debt;
• Changes loan to interest only;
• Uses freed up cash to pay super contributions;
• This is effectively borrowing to pay superannuation contributions.
Case Studies 2 and 3 - Benefits• Debt must be repaid using after-tax dollars;
• Therefore, reducing tax payable reduces amount repaid.
• Eg: Loan of $400,000.
– If Dr pays tax at 45%, needs to earn $727,272 before tax to pay $400,000 after tax.
– If superfund pays tax at 15%, needs to earn just $470,588 to pay $400,000 after tax. Paid upon withdrawal from fund.
• Difference = $256,000 before tax. That is, virtually an entire year of full time work. $256,000 = 64% of the debt;
• Superannuation should precede debt repayment, especially if the debt is deductible.