More cash for more investments
By Scott Francis
|PORTFOLIO POINT: It is not a big sum, but an extra $750 from tax cuts can go towards creating further wealth or be frittered away.
For investors the budget does one thing very well: it puts more money in your bank account to make new investments. After that, the key changes are selective, but could be very useful to investors in key areas such as MIS (agricultural investment) schemes.
Another year of tax cuts also brings a financial "moment of truth". The headline discussion leading into the budget was personal tax cuts. Most Australians will indeed receive some tax relief, with a $750 annual saving for most as the 15% tax bracket is raised to $30,000.
Successive years of tax cuts, significant changes to superannuation rules, booming asset values (over the medium term) in both property and shares and what is still a relatively low interest rate environment mean it is vital to take stock and be sure that wealth is being created at an individual level now. Looking forward, the Government projection is for wages to grow at 4.25%, well above the 2.5% growth in inflation. This growth in wages above the rate of inflation provides even more reason for optimism.
This latest tax cut, which will flow through to most Australians, is valued at $750 (a 15% tax saving on the $5000 of income between $25,000 and $30,000). It should be seen as part of the continued favourable economic conditions that we find ourselves in, and a call to arms to take advantage of the favourable personal finance environment to strengthen our financial situation at an individual and family level.
The $750 is not a huge sum of money; however, it can either be put to use in creating further wealth, or frittered away as an opportunity lost.
If we don't take the chance to improve our financial situation now, when "all the ducks are in a row", then it is going to be considerably harder in the future when economic, political and investment environments are not nearly as favourable.
Perhaps at an individual level we should take our lead from the Government:
Spending less than it earns (Government surpluses).
Getting rid of debt (Government debt all but eliminated).
Investing in growth assets for the future (the Future Fund and the Higher Education Endowment Fund).
Forestry investment schemes
Trading of holdings in forestry managed investment schemes is currently only allowed in exceptional circumstances. Proposals in the budget provide measures to allow trading of these interests after the initial investment has been held for a minimum of four years. This will allow trading of investments commenced on and before July 1, 2003, to be able to be traded as of July 1, 2007. These rule changes apply to past and future forestry MIS products.
The impact is that units in these investments now become a tradable commodity, providing greater levels of liquidity for holders of these investments. Rather than waiting for returns to filter through, investors can sell their interests to secondary buyers - which will potentially see the development of a secondary market for forestry investments. This makes this style of investment more attractive for investors because they would not be locking their capital away for what could be 15-20 years, when the trees are harvested. As such, this change possibly establishes a new asset class for the future.
The Government has also confirmed its policy to allow upfront deductions of investments in forestry managed investment schemes from July 1, 2007, provided at least 70% of the expenditure on the underlying scheme is directly related to developing forestry.
Does this make forestry schemes a more viable option for investors? I believe that the added liquidity - that is, the ability to buy and sell forestry holdings - does make forestry schemes a more attractive investment. Investors can potentially sell the scheme well before the 20-year maturity, and other investors have the possibility of buying into schemes some years that are already established.
Of course, this is only the first step in the establishment of a viable secondary market for forestry schemes. I don't think there is an urgency for investors to rush out and be "overweight timber". Regardless of tax deductions and increased investment liquidity, these schemes will only be successful if the underlying scheme assets (timber) produce a reasonable return.
SATO and super
The Senior Australian Tax Offset (SATO) is an offset that reduces the tax payable for Australians of age pension age.
A couple can now earn up to $43,360 and a single person up to $25,867 before paying any tax because of the Senior Australian Tax Offset. This is a significant amount of income to earn, particularly when most retirement assets are likely to be held in superannuation and be paying a tax free income stream (to people over the age of 60 from July 1 this year).
The point is this: SATO means that few people will be paying tax after the age of 65, particularly if they have a reasonable portion of their assets in superannuation.
There seems to be a strong movement at the moment of people selling up assets, paying capital gains tax and dumping money into superannuation. There is nothing wrong with superannuation; indeed, it is a great investment environment. However, you need to be sure that the tax saving you will receive from putting assets into superannuation actually saves tax in the future - otherwise you are paying more tax than you should.
Even if you are a self-employed person and have reduced your capital tax liability by making a tax deductible contribution to superannuation, you will pay a 15% contributions tax on that contribution. So there is also a tax liability there.
The message is this: SATO means that people will be able to have a reasonable level of assets outside of superannuation, easily $400,000-500,000, and not pay any tax after the age of 65. Be careful that in selling up assets and putting them into superannuation - and paying either capital gains tax or superannuation contributions tax - that you are actually saving some tax in the future. Otherwise you are paying more tax than you need to!
I saw an example of this recently. A couple aged 64 had a share portfolio of $200,000 producing gross income of just over $10,000. They both work part-time, each earning about $30,000. They wanted to retire next year, at age 65, with combined superannuation assets of $500,000. The original cost of the shares was $50,000.
They wanted to sell the shares and put the money into superannuation, for a "tax-free environment". The would have paid just over $25,000 in capital gains tax (a $150,000 gain, discounted by 50% and then taxed at 31.5%) in selling the share portfolio.
The reality is that they would not have paid any tax on the share portfolio because of the Senior Australian Tax Offset; they were just creating a tax liability (capital gains tax) where one would not have previously existed!
Rethinking negative gearing
Recent budgets have seen: The top marginal tax rate decrease to 45% plus 1.5% Medicare levy (from 47% plus 1.5% Medicare levy); the level at which this tax rate kicks in increased to $150,000, and moving to $180,000.
Negative gearing is the term that applies when money is borrowed to invest and the interest costs of the borrowing are greater than the investment income, causing an investment loss. This loss can be used to reduce a person's taxable income.
Negative gearing is a favourite wealth-creation strategy for Australians. Its genesis would seem to be in our love affair with investment property, which has carried over into borrowing to invest in the sharemarket.
A key input into the value of this strategy is the value of the tax deduction. A $10,000 loss with a marginal tax rate of 48.5% provided a tax saving of $4850. On a 31.5% tax rate this saving is only $3150. This is a significant difference.
These tax changes, combined with interest rate rises, mean that borrowing to invest is not as attractive as it has been previously.
The Government co-contribution
Those Australians lucky enough to receive a Government co-contribution in the 2005-06 tax year will receive another bonus with a doubling of the co-contribution received. This means that some people who contributed an extra $1000 to superannuation will actually receive a $3000 Government Co Contribution. (To read more about the co-contribution, click here.)
It is too late to do anything about this now; however it is a reminder of the most effective wealth creation strategy that there is, the Government co-contribution. Having $1 increase to $2.50 because the government adds an extra $1.50 provides an immediate return of 150%.
If your income is under $58,000 you need to investigate this possibility.
Keep in mind that you don't have to put in the full amount. If all you have is $50 then put that in, and enjoy the extra $75 the Government puts in for you. Turning $50 into $125 is still a pretty neat investment.