Nowadays, although our salaries are higher, our financial situations are becoming even more complicated and we are often demanding more to fulfill our lifestyle goals. Whilst many are taking advantage of opportunities to build their long-term wealth, such as additional contributions to superannuation, effective tax planning and paying off their mortgage, can this wealth building process be sped-up so that we can achieve our lifestyle goals, faster?
“Wealth creation can be accelerated very effectively and has an amazing application for a wide range of people,” says Ché Kulhan, an independent Consultant.
Ché says that we have to firstly identify the difference between good debt (deductible) and bad debt (non-deductible).
“Put simply, good debt is debt used for investment purposes and is tax deductible, such as the interest costs on a rental property or investment portfolio. Bad debt, on the other hand, is non-deductible debt, where interest is paid off after you pay tax, out of the money in your pocket. This is the debt that makes you feel stressed and worried”.
The basis for accelerated wealth creation is based on the premise of transforming the bad debt, such as your home mortgage, into good debt, which is used to fund investments.
So how do these strategies work?
Debt Transformation Strategy
If you are receiving a financial windfall, let’s say $100,000, which could come from an asset sale or an inheritance, with a “debt transformation” strategy, you could pay $100,000 down on your home loan account to reduce the outstanding mortgage balance. The key, however, is to maintain the current debt level, so that you can then borrow against the additional equity, using it as an investment loan. This investment loan should then become tax deductible, reducing the amount of tax you pay each year and increasing income – so that it is positively geared.
For example, a home owner with a property valued at $500,000 and an outstanding mortgage of $300,000, receives an inheritance of $100,000. With debt transformation, he could pay down his mortgage and by borrowing against the increased equity in his home, purchase an investment portfolio to build long term wealth. By using this strategy, he reduces his non-deductible, after-tax mortgage repayments and, at the same time, acquires an investment portfolio with tax deductible interest payments.
Another strategy is to take out a margin loan, another effective gearing strategy for accelerating your wealth creation. Most Australians are familiar with gearing when it comes to property, and are becoming aware that gearing can work for them when investing in the share market as well.
There are a variety of ways that you can borrow money to invest. Security for your loan can come from the existing equity in your home, just as you would use the equity in your home for a property purchase, your current share portfolio or managed fund portfolio.
For example, if you have $50,000 in a share portfolio, based on your personal circumstances you feel comfortable borrowing another $50,000. Maintaining a 50gearing ratio, you are making a total investment of $100,000. By adding money to your own funds through gearing, you have effectively increased the amount you have invested and potentially multiplied your returns as your portfolio increases.
“Providing the funds are used for income producing purposes, the interest on the loan is usually tax deductible. That’s the good, deductible debt we are after”, says Ché.
There are also other tax planning advantages. The use of company or trust structures, when couples are involved, investing in the name of the lowest income earner or benefiting from franking credits – the tax already paid by the company.
Long-term tax effective investments are another strategy that Ché says can be well utilised to accelerating wealth creation. These are particularly suitable for those looking to invest tax effectively over the longer term and minimise taxable income, and are therefore quite popular with higher marginal tax bracket earners. The projects tend to be agriculture based, offering the investor the opportunity to invest in a broad range of products from timber plantations, vineyards, olives and oyster f arms.
“These is an attractive year-end tax planning strategy as they offer the investor an immediate tax deduction”, explains Ché. “They are generally long-term investments, with a 10 to 20 year time-frame. However you do have the added benefits of tax effectiveness for the investor and the attraction of long-term, sustainable investments in rural and regional areas of Australia”.
So how do the tax-deductions work?
The government offers generous tax concessions to primary producers, such as income averaging provisions, indefinitely carry forward losses and valuation of stock. Due to the nature of the industry, by far the greatest proportion of tax-deductible capital expenditure occurs on the outset, such as the establishment of the crop or plantation. The government also expects them to pay tax on their earnings when they arise, therefore there can be a time-lag of 5, 10 or 15 years. Investors can qualify for tax concessions, claim back GST and therefore reduce their tax liability. Tax rebates can also help to kick-start the medium term investments, allowing the investments to become self-supporting.
“It is important”, stresses Ché, “that you don’t invest just for the tax benefit. The most important thing is the quality of the underlying investment and to confirm that the investment is supported by product rulings issued by the ATO.”
Ché stresses that these strategies for accelerated wealth creation are not for everyone. “While these strategies can potentially result in higher returns, they must be appropriate for you”, she explains. “They are complex wealth creation strategies. You should seek professional advice to determine if these strategies are right for your personal and financial situation”.
Additionally, taking a holistic approach to your financial situation and lifestyle objectives is essential. “When devising a recommendation, it’s imperative to look at the financial and lifestyle goals and objectives of the client, and the investment strategies as a whole. The strategies shouldn’t work in isolation. They are there to work together and complement each other. It is all a matter of timing and cash flow to get the desired results, without loss of your current lifestyle”.
Having used such wealth creation strategies and having achieved all their financial and lifestyle goals, many of her clients are now asking the question – what’s next?
“Many of our clients want to give something back to society, and that is where a charity trust is a great strategy”.
A contribution into a trust specifically set up for philanthropic purposes is tax deductible. Structures can be set-up anonymously, or if desired, created in the clients own name to be used as a valuable marketing tool. Nevertheless, Ché believes that the public benefit is significantly greater than the tax benefit an individual receives. “Irrespective of the motive, the act of giving is what matters.”
By using accelerated wealth creation strategies such as transformation of deductible debt, gearing and long term tax effective investments, clients will be on-target to achieve their financial and lifestyle goals and also be in a position to give something back to society.
About the Author
Ché Kulhan is an independent Consultant. He has taught marketing and other business related subjects at internationally recognised Universities and institutions. His work has been published in various international newspapers, magazines and internet websites.
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