planning strategies for thirtysomethings andrew lawless and paul sarkis technical managers, mlc 22...

Planning Strategies for Thirtysomethings

Andrew Lawless and Paul Sarkis

Technical Managers, MLC

22nd November 2006

Important informationThis information has been prepared by MLC Limited (ABN 90 000 000 402) 105 - 153 Miller Street, North Sydney NSW 2060, a member of the National group.

This information was produced as an information service and without assuming a duty of care. This information is for adviser use only. It contains general information only. It does not constitute financial advice and should not be relied upon as a substitute for financial or professional advice.

In preparing this information, MLC Limited did not take into account the investment objectives, financial situation or particular needs of any particular person. Before making an investment decision, a person needs to consider (with or without the advice or assistance of an adviser) whether this information is appropriate to their needs, objectives and circumstances.

The information in this presentation is based on our interpretation of relevant laws as at 1 November 2006 and is subject to change.

No responsibility is taken for persons acting on the information provided. Persons doing so, do so at their own risk.

Agenda• Should cashflow always be used to reduce inefficient debt?

• Does gearing actually work?

• How does gearing compare to salary sacrifice?

• Planning strategies for young families

Meet the ‘thirty somethings’• Aged 30 to 45

• Over 4 million people in segment

• Nearly 1 million have household incomes over $100k

• Two-thirds of segment own home or have mortgage

Surplus cashflow

31.5%

41.5%

46.5%

Marginal taxrate

11.3%

13.2%

14.5%

Pre-tax returnrequired

Home loan interest rate 7.75% pa

• Too simplistic, ignores: franking credits discounted capital gains ‘strategy-specific’ benefits

• Break-even point is likely to be a lot lower

• Brendan (age 40) pays tax at 41.5%• Home loan is $250,000 (P&I)• Interest rate is 7.75% pa• Repayments are $2,052 per month (20 year term)• Extra $200 per month in disposable income

Case study

Surplus cashflow

1. Pay $200 p.m. into mortgage, then invest surplus cashflow in unit trust

2. Invest $200 p.m. in unit trust

3. Invest $200 p.m. in super as undeducted contribution

4. Invest $342 p.m. (pre-tax) in super as salary sacrifice

5. Invest $400 p.m. in unit trust using instalment gearing (ie $200 own funds plus $200 borrowed funds)

6. Invest $600 p.m. in unit trust using instalment gearing (ie $200 own funds plus $400 borrowed funds)

Brendan is considering six options...

Surplus cashflow

• Unit trust and super invested in Australian shares• Investment return is 8.5% pa (split 3% income and 5.5% growth)• Franking level on income is 75%• Interest on instalment loan is 7.75% pa• 20 year comparison

Assumptions

Surplus cashflow

Results (after 20 years)

4. Super - salary sacrifice

3. Super - undeducted

20 years

20 years

$180,361

$124,131

2. Unit trust (only)

1. Loan then unit trust

Option

20 years

16 yrs, 4 months

Mortgage repaid

$104,315

$112,500

Invest valueMTR 41.5%

$123,39320 years5. Instalment gearing (50% geared)

For geared investment, where interest payments exceed investment income and tax savings, a portion of investment is sold to cover shortfall. Otherwise excess investment income and tax savings reinvested. All figures after income tax, CGT (including discounting) and repayment of all borrowings.

$142,47120 years6. Instalment gearing (67% geared)

$179,78120 years7. Lump sum gearing

$130,315

Invest value MTR 31.5%

$154,031

$124,131

$111,904

$113,896

$148,726

$184,282

Surplus cashflow

The bottom line?

• Numbers vary depending on assumptions• Paying off mortgage may be better if client:

is risk averse and prefers ‘guaranteed’ return doesn’t want to lock-up money in super (preservation) isn’t comfortable with gearing

• However, using surplus cashflow to reduce inefficient debt is not always the best option

Surplus cashflow

“I have never, repeat never, had any client or …fund manager reveal factually to me that gearinginto the sharemarkets has been beneficial enoughto warrant the … risks taken.

The challenge is there for you to prove me wrong.”

Does gearing actually work?

Does gearing actually work?Modelling

• Modelled gearing using historical returns since 1910• Australian equities only• Index returns• No allowance for fees or active management• Assumed current tax rules apply throughout entire period

(eg current corporate and marginal tax rates)

Data source

• Some tables and charts use data presented in DMS Data Module offered through the Ibbotson Associates’ software program EnCorr

• Based on copyrighted books by Dimson, Marsh, and Staunton, Triumph of the Optimists, Princeton University Press, (c) 2002, and Global Investment Returns Yearbook 2003, ABN AMRO/London Business School (c) 2003. All rights reserved

• Used with permission

Does gearing actually work?

• Gearing strategy: $100,000 own capital, plus $100,000 borrowed (ie 50% geared)

• No gearing: $100,000 own capital• Investment loan interest is cash rate plus 250 bp• Marginal tax rate 41.5%• Income franked at 75% • A portion of investments are withdrawn to repay loan and CGT

on amount withdrawn

Lump sum gearingAssumptions

-$100,000

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

1 2 3 4 5

Value added - 5 years

Sources: MLC and data from DMS Data Module offered through the Ibbotson Associates’ software program EnCorr

Lump sum gearing added value 74% of the time

-$100,000

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

1 2 3 4 5 6 7 8 9 10





-$200,000

-$100,000

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20



Hurdle rates% of times gearing outperformed non-gearing (in real terms) by more than 20%

50% geared 45%

5 years

58%

10 years 20 years

71%

67% geared 59% 72% 79%

50% geared,interest rate 1% pa higher

41% 53% 65%


Assumptions• As per previous analysis, except:

Instalment gearing strategy: invest $10,000 own capital pa, plus $10,000 borrowed money pa (ie 50% geared)

Non-geared investment plan: invest $10,000 own capital pa

Instalment gearing

% of times gearing outperformed non-gearing (in real terms) by more than 0%

50% geared 70%

5 years

85%

10 years 20 years

86%


How can you enhance gearing?• Own funds (low income earner) and borrowed funds (higher

income earner)• Higher yield (lower income earner) and lower yield (higher income

earner) • Reinvest after-tax income in lower income earners name• Minimise CGT (eg get lower income earner to sell assets to pay-

off loan)

Assumptions

• As per previous analysis, except: Salary sacrifice strategy: pre-tax contribution of $17,094 pa

(equivalent to $10,000 after-tax at MTR of 41.5%) Instalment gearing strategy: invest $10,000 own capital pa,

plus $10,000 borrowed money pa (ie 50% geared) Investments are cashed out and figures are after CGT

(including discounting) and repayment of loan (for instalment gearing)

Salary sacrifice

% of times salary sacrifice outperformed instalment gearing (in real terms) by 0% or more

50% geared

New super rules

99%

5 years

100%

10 years 20 years

100%

80% geared 51% 45% 47%


Hurdle rates

Hurdle rates% of times salary sacrifice outperformed instalment gearing (in real terms) by 20% or more

50% geared

New super rules

95%

5 years

100%

10 years 20 years

100%

80% geared 32% 29% 34%


Planning strategies for young families

Government benefits

• Replaces ‘baby bonus’ • Tax free lump sum• Must be claimed within 26 weeks of birth

Maternity payment

Currently* From 1/7/2008*

$4,100 $5,000

NOT MEANS

TESTED

* Indexed in line with CPI in March and September each year

• Claim 20% offset for birth related expenses above $1,500 pa• Obstetrician’s cost now refunded through

Medicare safety net– 80% above certain thresholds

Out of pocket medical expenses

Government benefits

Family tax benefit part A

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$0 $10,000 $20,000 $30,000 $40,000 $50,000 $60,000 $70,000 $80,000 $90,000 $100,000

Maximum rate: $4,318 p.a.

Base rate: $1,829 p.a.

Rate reduces: 20c/$1

Rate reduces: 30c/$1

Benefit pa

Combined Income pa

$88,622

INCOME TEST ONLY

(Couple Combined)

Government benefits

Source: SMH 12/08/2005

Government benefitsFamily tax benefit part B

* Payment based on age of youngest child

^ Shade out at 20 cents per $1 # Effective from 20/9/2006

Max. benefit Shade-out^

Child* < 5 $3,467 $4,234 - $21,572#

Child* > 5 $2,511 $4,234 - $16,790#

INCOME TEST ONLY

(Secondary Earner)

Government benefitsFamily tax benefit part B

• Jack earns $80,000 pa• Jill now on maternity leave after birth of first child

Benefit Amount

Maternity payment $4,100

FTB part A $1,829

FTB part B $3,467

Total $9,396

Government benefits

• Must be approved or registered care• No income test for min. benefit* of $11.93 per week• Shade out for maximum benefit^ of $148 per week

- Combined income of $98,348 (1 child)

* Based on 24 hours of care

^ Based on 50 hours of care

Child care benefit

INCOME TEST ONLY

(But not for min benefit)

Government benefits

• Must be in receipt of Child Care Benefit • 30% offset for out-of-pocket expenses (up to $4,000) • One year lag in payment

Child care tax offset

NOT MEANS

TESTED

Government benefits

Strategies for broken work patterns

• Sell an asset, minimise CGT, re-invest proceeds• Ways to minimise risk of Part IVA

– Wait to re-enter the market

– Purchase different asset

– Invest ‘as trustee for’ child (or in child’s name)

Broken work patterns‘Refresh’ the CGT cost base

• Transfer ownership to spouse or child (where available) outside deferral period

• Achieved by completing ‘Standard Transfer Form’• No stamp duty payable• Income and gains taxed in hands of lower income earner

Employee share schemes

Broken work patterns

• Co-contribution (when returning to work)• CGT offset strategy (when not returning to work)• Contribution splitting

Superannuation strategies


Consider impact on benefits and entitlements?

Strategy

• Refresh cost base

• CGT offset

FTB part A

FTB part B

Child care benefit

Could reduce…

• Gearing (own money to LI spouse)

• Share scheme transfer (LI spouse)

FTB part B


Other advice opportunities• Debt reduction

• Salary packaging

• Investing for children

• Insurance

• Estate planning

Support tools

Questions?