Financial education and tips

How to make the most of the First Home Super Saver Scheme

Well the First Home Super Saver Scheme is about to reach the point where we could see our first withdrawals from superannuation as a deposit for a house. However, I don't think there'll be too many happening as I don't believe there's been a huge uptake so far. Which is a shame as it will be a really great tool for building a house deposit for first home buyers. Who doesn't like free money from the government (free money as in just paying less tax)?

So, how big is the benefit and how do you work it to maximise the benefit?

Well, firstly, someone who right now who has a deposit, or part of a deposit saved, they can immediately use those funds to make a tax deductible contribution to superannuation (which they can later withdrawal for their deposit), and then get a large tax refund when they do their tax return and in total boost their deposit by a couple of thousand $'s over a very short space of time.

Example (someone on the 34.5% marginal tax rate):
Contribute $15,000 to superannuation. Tax on entry is 15%, so net contribution is $12,750.
Then on withdrawal, they will pay tax at their marginal tax rate, less a 30% tax offset, so essentially 4.5% of $12,750 = $573.75 so the net withdrawal is $12,176.25.

BUT!!

You've got a tax deduction of $15,000, so you'll get $5,175 back in your tax return which means you've essentially turned $15,000 into $17,351 over the space of a couple of months. If you've got $30,000 saved as a deposit now and a spouse on the same tax rate as you, you can't boost your deposit by $4,700 pretty easily over a short space of time.

So, how to you maximise the benefit of the FHSSS?

Well, there are a number of points:

The cap is $15,000 per year (per person) and $30,000 (per person) in total. So use it! For both you and your spouse. If 2 people put in $15,000 each per year for 2 years, they'll be able to boost their deposit by over $9,000 above what they would otherwise have.
If you don't have any deposit at the moment but want to build one, ask your employer to salary sacrifice. If you can spare $100/week, then remember to gross that up to a pre tax amount, so that would be roughly $150/week salary sacrifice. Then it's gone before you get your pay. You'll very soon not even notice it's missing.
If you haven't been salary sacrificing all year and want to use the scheme, then make a lump sum tax deductible contribution to super. Otherwise, it's probably best to just salary sacrifice to superannuation as you get the tax benefits immediately rather than waiting for a big tax refund.
For a lot of first home buyers, they generally have less than 20% deposit so they need to pay Lenders Mortgage Insurance which is a complete was of money for you and protects they bank (but you pay), so every extra bit of deposit reduces this cost. So take an extra month, 2 months, 12 months to maximise the benefit of the scheme which also minimises your LMI. A double free kick.
When you withdrawal the funds, the money is added to your taxable income (and a 30% offset applied), so if your income sits near the top of a tax bracket, the withdrawal could push you into the next marginal tax rate, reducing the benefit of the scheme - so if that applies to you - try to do the withdrawal in the same year you are making the contributions so your taxable income that year is lower

Example: If someone earns $80,000, then when they contribute, they are getting a deduction at the 34.5% marginal tax rate. But, if they make a $20,000 withdrawal in a financial year which they haven't made any tax deductible contributions to super, then $7,000 will be taxed at 4.5% (34.5% less the 30% offset) and $13,000 will be taxed at 9% (39% less 30% tax offset) which would reduce the benefit of the scheme by $585. What they would be better off doing is timing it so they apply and make the withdrawal in the same year they've salary sacrificed at least $13,000 so their taxable income is low enough so they aren't pushed into the higher tax bracket on the withdrawal. The way that would work in practice would be that you salary sacrifice the $13,000 between say July and December, then in January apply for your determination and release, withdrawal the funds between January and June, then purchase your house.

Remember though, there is a limit to the scheme of $15,000 per annum. And you always need to keep your concessional contributions under the cap of $25,000. So if your employer's superannuation contributions are more than $10,000 per annum, then you won't be able to fully utilise the $15,000 per annum so it will take more than 2 financial years to fully utilise the scheme.

Glenn Hilber is a Certified Financial Planner with over 10 years experience and the owner of Precision Wealth Management.

This represents general information only. Before making any financial or investment decisions, we recommend you consult a financial planner to take into account your personal investment objectives, financial situation and individual needs.

Marginal tax rate or average tax rate?

I had a meeting with a prospect client a week or so ago and we discussed at what point they should look at making tax deductible contributions.

I said above taxable earnings of $37,000 you are on the 34.5% marginal tax rate so contributing to super has significant tax advantages at that point he said, "but our average tax rate doesn't get to 15% until earnings of $45,000 so wouldn't we contribute until we're above that point." or something to that effect.

I thought that was an interesting point he brings up and others may have a misconception on this when making these sorts of decisions. When we have our marginal tax rates, our average tax rate is always going to be different than our marginal tax rate (unless you earn less than $18,200 then it's just 0%) whereas superannuation and a company has flat tax rates (15% and 30%).

Well, obviously (to me anyway) looking at the average tax rate is wrong. For those earnings between $37,000 and $45,000, you are paying 34.5% tax where you could be paying just 15% tax you can see in the example below:

Tax on earnings up to $37,000 = $3,867
Tax on earnings $37,000 - $45,000 = $2,880 (note this is more than 34.5% of $8,000 and that is because of the impact of the low income tax offset - which I'll discuss below)

Total tax $6,747 = 15% of $45,000.

On the other hand, you could choose to direct funds to superannuation:

Tax on earnings up to $37,000 = $3,867
Tax on earnings $37,000 - $45,000 when directed to superannuation = $1,200.

Total tax $5,067 = 11.26% of $45,000

So unless the rules stated "Once you contribute to superannuation, all your income will be taxed at the superannuation tax rate", then you should work off your marginal tax rates.

Just a note on the marginal tax rates, whilst we apparently just have 5, we actually have a lot more because of the impact of the low income tax offset and medicare levy, both of which aren't applied uniformly. So, really, the following is the actual marginal tax rates when that is factored in:

$0 - $20,542 ... 0%
$20,543 - $21655 .... 19%
$21656 - $27068 .... 29%
$27069 - $37000 .... 21%

$37001 - $66667 .... 36%
$66668 - $87000 .... 34.5%
$87001 - $180000 .. 39%
> $180,001 .............. .47%

So, looking at those numbers, if you are earning $27,000, you might not normally think to salary sacrifice to super because you're only on the 19% marginal tax rate. But the additional boost of reducing medicare levy and increasing low income tax offset, a few thousand $ to superannuation in that band is quite attractive.

Glenn Hilber is a Certified Financial Planner with over 10 years experience and the owner of Precision Wealth Management.

Why Starting an SMSF To Buy Property is a Great Idea

Why Starting an SMSF To Buy Property is a Great Idea

Starting a Self-Managed Super Fund is quite an exciting prospect. No longer will an investor be constrained by the shackles of their tired superfund, an SMSF is an open road with untold freedoms ahead, but how to get started on that road? Luckily there are many eager experts out there ready to liberate investors from the boring returns of their banal old super funds and guide them into the riches of buying property within their SMSF.

Let’s say you and your partner are both in your early fifties, have maybe spent 30 years working and have managed to (between both of you) accrue $250,000 in super.

You may be with an industry super fund, maybe retail, maybe you have a financial planner, but for argument’s sake, let’s say the super fund costs are around 1% per annum or less. Let’s say it’s $2,000 to keep the maths easy. You also have an accountant who charges you $200 to do your taxes each year. Your “net worth” so to speak, to the finance industry is $2,200.

But $2,200 doesn’t feed many hungry mouths. It certainly doesn’t contribute significantly to support an assortment of professionals who can help with your SMSF and find you the perfect property. Nor does it contribute to the black hole of state government coffers or pay thousands in interest to keep bank CEOs happy.

To help all these people out, instead of paying your fees annually you could front load most of them and pay them up front so everyone can benefit now rather than having to wait for you to pay fees each year.

This is why it’s a great idea to set up an SMSF and buy a property.

Take that $250,000 from your super funds and set up an SMSF with your partner, you can then buy a brand new $700,000 apartment with a $500,000 loan (allowing $50,000 for stamp duty and expenses).

Upfront fees. $1,000 to $3,300 to your accountant. Legals? $1,000 to $3,000. Stamp Duty: $30,000 to $40,000 depending upon the state. Bank Valuation and other fees $500-1,500. Sales commissions are officially paid for by the vendor, not you. But all that means is that the sales commissions on your new apartment are embedded in the price. Add another $10,000 to $30,000.

Plus, now you have an annual $2,000 to $3,000 in accountants’ fees. And at 4.5% investor interest rates you are in for $22,500 in interest payments. You’re probably also now paying a financial planner to sign off on your strategy. At 1% that’s another $2,500.

With gross rental yields around 4%, you get income of $28,000 per year. Then you pay strata, insurance, rates, letting fees etc which means you are probably losing a few thousand each year.

Thankfully negative gearing gets you a discount. Oh. That’s right, an SMSF only pays 15% tax, which means there are almost no negative gearing benefits.

So let’s go through the maths:

Leaving your $250,000 in your boring old super fund:

Creating an SMSF to buy a $700,000 property:

Sure, you will wipe out close to 25% of your entire savings in upfront fees alone. And your annual fees are at least double what they were, maybe triple. But just look at the list of people who will benefit from your new SMSF: accountants, lawyers, governments, real estate agents and banks.

That’s a lot of marketing and lobbying power – to convince you to put your super into property via an SMSF, and to lobby the government to keep the changes that allow you to borrow in your SMSF despite ongoing warnings and objections from independent observers.

So you can see now see why setting up an SMSF to buy property is such a great idea

Well maybe not for you, but for everyone else in the game it makes perfect sense!

Note: this scenario highlights the associated issues related to off the plan property spruiking. For some investors there certainly are legitimate reasons to hold property within an SMSF. The moral of the story – ensure the strategy you take is the right one for your needs and comes with appropriate advice!

Credit: Mancell Financial Group and macrobusiness.com.au

Should you use the new first home buyers scheme?

First home saver scheme - Attempt number 2.

The previous first home saver scheme was separate to superannuation and due to a lack of take up, it was scrapped after a couple of years. Now we have the new and improved version 2.

I think part of the lack of interest in the old system was the minimum 4 financial year period in saving for a house, which wasn't very popular because (in voice of Veruca Salt) "I want it now".

Anyway, this new system gets away with this. Contributions can start from 1 July 2017 and withdrawals allowed from 1 July 2018. From what I can see, once we are at 1 July 2018, there is no minimum time period, but, worst case a maximum of a 1 year 'waiting period'. I don't think this is going to be an impediment to take it up.

So, should first home buyers be using it?

Well, as I usually say - if you are nearing retirement, salary sacrificing to superannuation is a no brainer. So, if you are nearing the purchase of a house, wouldn't salary sacrificing for a deposit also be a no brainer?

On the surface, Yes, absolutely. But there are a couple of small distinctive differences that we need to take into account.

The first one is that withdrawals are taxed, so this needs to be considered. Withdrawals are taxed at your marginal tax rate, less a 30% offset. Remembering that on the way into super, you are saving your marginal tax rate, less a 15% tax on entry to superannuation.

Even with the additional tax on exit, you are still better of salary sacrificing to superannuation for your house deposit (unless you earn less than $18,200).

Take for example an average person earning between $37,000 and $87,000. If they have $10,000 of pre tax dollars, then they would have only $6,550 remaining for house deposit savings after paying their income tax.

They could salary sacrifice that to superannuation, leaving $8,500 after paying the initial 15% tax. Then upon withdrawal, they would pay only 4.5% tax (34.5% marginal tax rate less the 30% offset) which would leave them with $8,117.50 - significantly more than the person who paid the income tax.

Where this would come unstuck would be if you are on a significantly higher marginal tax rate when you withdrawal as when you make the contributions. But for the example above, if that person was on the higher 39% marginal tax rate at the time of withdrawal, they'll still have $7,735 or $7,055 if they are on the top marginal tax rate. So it really only needs to be considered if you are earning below $37,000 when you make the contributions. But, if possible, planning a withdrawal in a year when you are on a lower marginal tax rate will be preferable.

It's important to also note the planned increase to the medicare levy by 0.5% from 1 July 2019 which will affect these numbers slightly and may also encourage you to withdraw and purchase a house prior to this coming into effect. But really, we're talking a few $'s and on a large purchase like a house shouldn't really sway your decision much.

Another thing to consider is how to invest the money. Most people when saving for a deposit, keep it in a high interest savings account, but most people when contributing to super investing it a mix of property, shares and bonds which provides a much better return over the long term. So what should you be doing?

Well, in terms of how much you will actually have to withdrawal for your deposit, it doesn't really matter as your withdrawal amount is going to be based on how much you contribute (less tax) then an additional deemed earning amount (based on the ATOs shortfall interest charge currently 4.78% per annum), regardless of how much your investment actually earns. If it earns more than that, the additional will stay in super, if it earns less, you will be dipping into your 'actual' superannuation balance.

But, the question is 'should you alter your investments within superannuation so this portion is aligned with the shorter investment time horizon?' Well, everyone is going to be different. Some might use this as a longer term saving strategy where they are happy to keep the money in growth assets and save for a house over 5-10 years and others may keep it in cash or bonds for a 1 - 2 year plan. The general rule is that you should invest with an appropriate amount of risk for the length of time you will be investing for, however as your withdrawal amount is based on a standard bank bill rate, a good starting point could be a diversified bond fund that will return roughly a similar amount.

It is also very important that you review your superannuation fund when doing this as well as you want to make sure that it is appropriately invested and fees are low.

So, based on these things, it appears to be a great tax saving vehicle for people to save for their first home. These contributions count towards your concessional contribution cap so you need to make sure you stay within your cap ($25,000 per annum). You can contribute up to $15,000 per annum and a total $30,000. This doesn't mean that you'll have $30,000 for a deposit, because you will be paying some tax, but you will have more than if you paid your regular income tax. And both members of a couple can do it.

But the very best thing about this new plan is that it is coming out of your income before you see it. A very disciplined savings measure that can't be dipped into a for a new car or holiday. So you can get your employer to start the salary sacrifice, then it's gone before you get your regular pay so you can go about your business spending all your money on craft beer and smashed avocados. So you really can have your smashed avo AND eat it too.

Glenn Hilber is a Certified Financial Planner with over 10 years experience and the owner of Precision Wealth Management.

The shining light of managed funds

When I joined the industry in 2007 and for a few years after that, you just couldn't escape the amazing reputation of the Platinum International Fund.

It truly was the shining light of the managed fund industry. The portfolio manager Kerr Neilson was the Messiah of fund managers, 'could predict the future', and you had to include this fund in portfolios, despite it's very high price tag (1.54% p.a management fee), because, as I've said, it was 'the fund'. The one that can shoot the lights out and do what others can't.

For myself though, I wasn't so convinced. Sure, the performance of the fund was staggering, but, my beliefs were and still are, that markets are efficient and it is very very difficult, if not impossible, to outperform the market consistently, especially after costs. Whilst the performance of the fund was good, these beliefs were core to me and I took the path that low cost, highly diversified, asset class investment model would be the best thing for my clients.

It has now been a number of years since I've been in 'that part of the industry'. Researching the flavour of the month, who's put on a really good sales pitch (over lunch at the Hilton) etc etc, so I don't monitor the movements or performance of funds.

Anyway, today I received my invitation to the annual FPA roadshow. I enjoy going to the FPA roadshow as it's usually a big event, I catch up with many old friends in the industry, it usually has a lot of important information, and it's free and includes a lunch. However, the free and includes a lunch usually comes with another price tag - having to listen to a presentation by the sponsor. Last year it was Challenger, proving an 'educational' session on including annuities in retirement portfolios (one of my bug bears is product providers providing education to financial planners as it can often be misleading but that is another story).

Anyway, this years sponsor is Platinum Asset Management and that struck me as very strange. My my last knowings of how they were going, they didn't need to advertise.

So, what was going on? I thought I would check it out. And what do you know, the Platinum International Fund had under performed for about the last 7 years (ups and downs along the way as it is quite volatile). I thought this was quite interesting on 2 fronts:

I was right in the fact that this fund couldn't consistently outperform like so many thought. Sure, they had done some things in the past that paid off very well, but clearly isn't a bulletproof strategy with 7 years of under performance. and;
Probably the bigger thing is the fickle nature of financial advisers, no longer content with this fund as it's under performed for a bit, they will now be piling their clients money into another fund which has just done well but has no basis that it will continue to do well. Always chasing 'last years' winner. A strategy that is guaranteed to cost the investors money over the long term.

This second point is evident when looking at the fund size compared with the movements of the global stock market (if no one invests new money and no one withdrawals money, the fund size should move in unison with the market movements)

As you can see, the blue line (platinum international fund size) has not grown anywhere near as much as the market (red line) has over this 6 year period, meaning there has been more money withdrawn than new money contributed.

So how do I invest clients money? Simple, low cost, highly diversified portfolios that capture the returns of asset classes efficiently. The structure of the portfolios asset classes is based on the clients specific goals, objectives and risk tolerance. Remain disciplined, invest regularly and concentrate on the things we can control.

Glenn Hilber is a Certified Financial Planner with over 10 years experience and the owner of Precision Wealth Management.

Warren Buffett's Big Bet

Warren Buffett has long been an advocate for index funds saying that for the average person, this is the best way for them to invest.

Well, in 2005's Berkshire Hathaway's annual report, Mr Buffett argued that active management in aggregate would over a period of time under perform the market index. Mr Buffett eventually followed it up wagering $500,000 that this would be the case (the winnings of which would go to charity).

It took some time, but eventually the bet was taken by Ted Seides. As part of the arrangement, Mr Seides selected 5 fund of fund hedge funds to be pitted against Mr Buffett seemingly amateurish selection of a run of the mill index fund.

The bet started at the beginning of 2008, so at the end of 2016, we had seen 9 out of the 10 years completed. There is 1 to go.

The results so far?

Let's just say, Warren Buffett's selected charity, Girls Inc. of Omaha, might want to plan what they might be able to do with $500,000.

After 9 years the growth of the index fund has been 85.4% (in total, not per annum), where as the best performing of the 5 hedged funds has returned 62.8% and the worst 2.9% - an average of 22.04% between the 5 funds. Just staggering. This selection of 5 funds coming from a co-manager of a major asset manager who has the financial resources and confidence to bet $500,000 on it.

But, the fact he has $500,000 to place on the bet is probably a good indication of the level of fees being charged by these managers and as academics can show, there is an extremely high correlation between higher fees and under performance.

For those who are interested, the information can be found in the Berkshire Hathaway's letter to shareholders for 2016 http://www.berkshirehathaway.com/letters/2016ltr.pdf starting on page 21.

Glenn Hilber is a Certified Financial Planner with over 9 years experience and the owner of Precision Wealth Management.

The US election and investment markets

This scary clown craze has just gotten out of control. They've even got 2 running for president in the United States.

Regardless of who you might think will be a better or worse president, should you be making changes to your investment portfolio in light of the upcoming election and the uncertainty it poses? Other than investing in Mexican wall building companies - of course!

Well, I'll let you in on a little secret. Everyone already knows that an election is coming up and everyone already knows that both candidates of the 2 major parties seems to have some flaws - like is always portrayed. It's not a secret, you and I don't possess any special insight.

This is the thing with investment markets, they're amazing at pricing in today's news and pricing in risk and uncertainty. What you already know is already in the price.

Sure, if the unlikely scenario of Trump being elected actually happens, there probably will be some volatility, because at the moment, that isn't the expected outcome and if Trump is elected it will add some uncertainty, but the long term investor doesn't care about short term volatility. The long term investor will be invested for this next presidential term and probably the next 5 presidents as well.

The chart below shows the US market since 1926 and shows you the president and the political party they represent. The key takeaway here is that over the long run, the market has provided substantial returns regardless of who was residing in the white house.

Equity markets can help investors grow their assets, but investing is a long-term endeavour. Trying to make investment decisions based upon the outcome of presidential elections is unlikely to result in a favourable outcome. At best, any positive outcome based on such a strategy will likely be the result of random luck. At worst, it can lead to costly mistakes. Accordingly, there is a strong case for investors to rely on patience and portfolio structure, rather than trying to outguess the market, in order to pursue investment returns.

Glenn Hilber is a Certified Financial Planner with over 9 years experience and the owner of Precision Wealth Management.