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Wealth Brief The Wealth Brief is brought to you by
Edition 2
Contact us Suite 1/36 Sunshine Beach road Noosa Heads, Queensland 4567 T: 1300 761 236 E: advice@insuranceChampions.com.au W: www.insurancechampions.com.au
IN THIS ISSUE Why self-manage your super? Some words of wisdom Risk, return and diversification Free public trustee wills can be very expensive The widow, business partner and dead husband Keep your business running Maintain your family’s lifestyle
Why self-manage your super? When it comes to superannuation, there are two types of people – those who find it all “too hard” and don’t give it the attention it deserves, and the growing group – those who want to take complete control of their super by setting up a Self Managed Super Fund. But what does “take complete control” really mean when it comes to your largest asset? Often a superannuation fund will form the core of a financial plan. Choosing a super fund and using it effectively is a vital part of ensuring a secure financial future. With a Self Managed Super Fund you can control all aspects of your super... Investments
Tax
Your risk profile is determined by considering your current financial position, your needs and goals and how comfortable you are with certain investments and market movements. Investments that suit your profile are then selected. For instance, a fund can hold,
Although superannuation is concessionally taxed, it is difficult for commercial super funds to spread the tax benefits fairly over all their members. In a Self Managed Super Fund, the tax can be controlled. By careful planning you can:
• Direct property. This could include commercial, rural, retail and residential property, though you need to be aware that a super fund cannot borrow to invest.
• Defer payment of tax rather than it being taken directly from your contributions to the fund.
• Shares in listed companies, in Australian and overseas. You can choose the companies and give the investments your own flavour. You could avoid companies whose business you dislike and favour those of which you approve. Note, however, there are some restrictions about investing in private companies.
Some words of wisdom - A day without sunshine is like night.
• Reduce tax below 15% by investing in Australian companies paying franked dividends. • Minimise and eliminate capital gains tax.
Insurance The unexpected does occur and super funds can provide cost effective cover for life and total and permanent disablement. In a Self Managed Super Fund, you can choose the type and level of cover that suits you. Death benefits
- Remember, half the people you know are below average.
With many people living in more complex family relationships, “who gets your super when you die” is a key issue. In a Self Managed Super Fund, you have absolute control and can ensure your wishes are met.
- He who laughs last thinks slowest.
Costs
- The early bird may get the worm, but the second mouse gets the cheese in the trap.
Many commercial funds charge fees based on the amount of money you have invested. In a Self Managed Super Fund, fees can be much lower. Fees will usually be on a time cost basis.
- 2.7 percent of all statistics are made up on the spot. - 99 percent of lawyers give the rest a bad name.
- Support bacteria. They’re the only culture some people have. - A clear conscience is usually the sign of a bad memory. - Change is inevitable, except from vending machines. - If you think nobody cares, try missing a couple of payments. - OK, so what’s the speed of dark?
A Self Managed Super Fund does not suit everyone but they provide the potential for many more people to take control of their financial future.
Risk, return and diversification To be wealthy you have to invest. But where do you put your savings? The most popular choices are the four main asset classes of cash, fixed interest, property and shares. Each asset class has its own characteristics. For cash, the return is relatively low but certain. For fixed interest investments like bonds and debentures, the returns are higher but slightly more risky. In investment terms, risk means uncertainty or volatility and returns for these asset classes are reasonably certain. Growth assets like property and shares have greater uncertainty but investors are rewarded by higher returns. The table shows the asset class returns for the last 20 years to June 2005 based on wellknown indices. This period is long enough to show the patterns over a number of economic cycles. Risk is calculated using a figure called “standard deviation”. The lower the figure, the lower the volatility of returns.
Average return Risk or volatility
Cash
Fixed interest
Listed Property Trusts
Australian Shares
Unhedged International Shares
8.53%
10.39%
12.73%
13.74%
10.54%
4.48
5.85
8.33
12.18
18.35
As you can see, cash and fixed interest returns were lowest but most stable. The figures are influenced by the high interest rates in the 1980s – remember when rates were over 15% and inflation was almost 10%? Listed property trusts have performed well over the last five years whereas share investments have been the most variable but shown the highest average returns. International shares are the most volatile because investors experience the risk of currency movements as well as movements in markets. One way to smooth out returns is to diversify and “not put all your eggs in one basket”. The second table illustrates this using three portfolios based on the twenty-year history of asset class returns.
Portfolio 30 holds 30% in growth assets like shares and property; portfolio 70 holds 70% growth assets: portfolio 100 is all growth assets. Portfolio 30
Portfolio 70
Portfolio 100
Average return
10.22%
11.34%
12.36%
Risk or volatility
5.41
8.88
12.79
You can see that returns remain attractive but that the volatility is reduced. Of course, it is not possible to predict the future and these illustrations are based on historical information. If you would like to understand more about investment risk and return talk to your adviser.
Free Public Trustee Wills can be very expensive ANSWER: QUESTION: My mum made a Will with the Public Trustee a long time ago. We have just found out that her “free” Will may cost us a lot of money. She made the Public Trustee the Executor of her Will. Is it true that when she dies, they are going to charge fees to administer the estate based on what she owns? Apparently, they count your knifes and forks and even the sheets in your linen press. The Public Trustee’s fees went up a few years back, but mum claims that she was never notified of the price hike. My two brothers and I are happy to carry out the job of Executor for free (after all, we are getting everything when mum dies) but Mum is too frightened to approach the Public Trustee.
I am not sure which Public Trustee you are talking about. Each state is different. However, the general rule is that the Public Trustee is great for poor people that have no assets. However, if you have assets they usually charge a percentage of your estate. The good news is that a completely new Will always revokes and old Will. So if your Mum makes a new Will she automatically dumps the Public Trustee. Your mother seems happy with her Will - except she wants to update the Executor. All she needs to do is ‘fire’ the Public Trustee as your executor. She can do this using a “Codicil to change the Executor” at LawCentral. Your mother is only removing the old Public Trustee executor and appointing you and your brothers as executors. You can build this document on the web in about 7 minutes.
Brett Davies, Lawcentral.com.au
www.insurancechampions.com.au
The widow, business partner and dead husband The widow stood at the graveside as the coffin was slowly lowered. She looked across at her late husband’s business partner. “I’ll make that bastard pay double if he wants my husband’s half of the business,” she thought. The business partner caught the widow’s mournful eye. “I’ll offer her one tenth. She wouldn’t know what it is worth. Anyway, without me it is worth nothing”.
Did You Know? That for 2 male business partners both aged 35, the probability that one will die or become totally and permanently disabled before aged 65 is 52%. For 4 partners the risk increases to 77% and with 6 partners 89%. Women on the other hand statistically make for a better risk. Business succession planning is not about selling life insurance, legal documents or detailed financial plans. It is about developing a strategic plan to ensure a smooth and trouble free hand over following a trauma event, disablement and death.
How is Business Succession Planning best achieved? Protecting your business and your family Business owners think they do not need or are too busy to get around to creating their Business Succession Plan. The spouses generally don’t know the risk their business spouse is taking in not planning for disasters. Let me give you an example: Not so long ago I saw “John” in our office. John runs a small, successful real estate company with his business partner Keith. Shortly before I saw John, Keith had developed cancer and died. He left everything in his Will to his wife Nicole. Nicole inherited Keith’s interest in the real estate business. Nicole had never been involved with the business. Not only did Nicole not want to have anything to do with the business, she told John she would camp on his doorstep until he purchased Keith’s half of the business from her. In the meantime, she wanted Keith’s usual wage. She needed money to support herself and the children. John would have been happy to pay her half of the value of the business IF: 1. He knew what the business was worth; 2. Nicole agreed with the value (and wanted to sell); and 3. He could find the money to pay her To compound the problem the bank wanted additional security for the business’s overdraft.
Was Nicole willing to go as a guarantor to the business overdraft to replace her husband? John was frantic. Would he have to sell the business (his life’s work) at a fire sale?
Why was this? It is NOT well known that in the majority of any Banks fine print clauses on security for a Business loan, the death or disability of a guarantor or co-surety to a business is an “event” of default. This means that if any person, who is a party to a Bank’s security dies, becomes disabled or suffers a traumatic event, the Bank is able to seek repayment or renegotiate the loan facility. The answer here is proper Key Person Insurance (as distinct from insurance for a Business Succession Plan).
What is the answer? John and Keith together with their Adviser, Accountant and Tax Lawyer could have prepared a Business Succession Plan. A Business Succession Plan is an agreement between the business partners to deal with a principal: 1. dying; 2. becoming disabled; 3. retiring; 4. divorcing; 5. resigning; 6. being convicted of a criminal offence; 7. becoming bankrupt, and; 8. taking unauthorised absences from the business Nicole could then have required John to purchase her half of the business for a predetermined price. Alternatively, John could have required Nicole to sell her half of the business for the same predetermined price.
How can you afford to pay the purchase price? Even with a Business Succession Plan, to ensure the transfer of a business interest upon death, all problems are not solved. The remaining partners need money to buy out the deceased’s family. A number of funding mechanisms are available. The most successful funding method is a combination of life policy, trauma policy and total and permanent disability policy. We suggest you contact your financial planner to discuss the many products out there.
What about tax? Yes, you have to be very careful to structure your Business Succession Plan so that you avoid unnecessary tax. 1. A properly prepared Business Succession Plan ensures that only nominal stamp duty is payable when you sign the Business Succession Plan.
2. Capital Gains Tax can be triggered on the “disposal” of the business (that is when Nicole sells to John). There are many avenues available to you to ensure the assets are transferred without the expense of capital gains tax provided you take the proper precautions before entering into the Business Succession Plan. Exemptions in The Income Tax Assessment Act (such as section 160ZZI) give further protection. 3. Some of the business assets can be income producing for the taxman (e.g. trading stock). Proper mechanisms can circumvent this problem.
How do I create a Business Succession Plan? Put and Call options are the easiest to set up and explain. Let’s look at an example of how this works using John, Nicole & Keith. John gives Keith the “right” (option) to purchase Keith’s interest in the business following the occurrence of any of those specified events listed above and Keith gives me the same right. To make the arrangement even more secure, we each grant both “put and call options”.
The protection for John is as follows: Assume Keith has died; John may exercise the option to “call” upon Nicole, as the Widow, to sell Keith’s interest in the business to John at a predetermined price.
The protection for Nicole, the Administrator of Keith’s estate is as follows: Alternatively, Nicole may have the option to “put” to John that he must buy Keith’s interest in the business.
The Put and Call Agreement Arguably, the most tax effective way of structuring an agreement to embody your objectives is through an option agreement.
Conclusion A senior Adviser, the business’s Accountant and a Tax Lawyer when acting in concert together can achieve proper tax effective Business Succession Plans for their clients. LawCentral.com.au
Keep your business running Tony & Andrew run a veterinary practice.
• If you are self-employed or in a small partnership, business expenses insurance covers certain business overheads should you be unable to work due to injury or illness • The insurance helps a business to remain afloat and ready to be sold should the need arise • It usually provides a maximum ‘benefit payment period’ of 12 months
For the practice (per month)
Per partner (per month)
Pre-tax income
$40,000
$20,000
Busines expenses
($16,000)
($8,000)
Pre-tax income (after business expenses)
$24,000
$12,000
Andrew has income protection insurance, while Tony has both income protection and business expenses insurance. What would happen if either Andrew or Tony are disabled?
Tips & Traps • Regular reviews of insurance are vital to ensure that cover changes with the needs of a business • Insurance policies that allow you to automatically increase your cover in line with the CPI should be considered Premiums for Income Protection and Business Expense insurance are generally tax deductible.
Andrew Protection plan without business expenses (per month)
Tony Protection plan with business expenses (per month)
Income protection insurance benefit
$9,000
$9,000
Business expenses insurance benefit
$0
$8,000
Total insurance benefits
$9,000
$17,000
Less ongoing business expenses
($8,000)
($8,000)
Pre-tax income (after business expenses)
$1,000
$9,000
Maintain your family’s lifestyle
Tips & Traps
• Following death, TPD or critical illness, a lump sum received from an insurance claim can be invested to provide an income stream • This can provide on-going income support for a family Vanessa & Peter have three children (all under 6 years) and they have the following financial commitments: Commitments
Amount
Frequency
Annual amount
Groceries
$800
Monthly
$9,600
Education fund (for 3 children)
$300
Monthly
$3,600
$2,250
Quarterly
$9,000
Household expenses (e.g. electricity, gas, phone, insurance and petrol) Other living expenses (e.g. clothing and entertainment)
$150
Weekly
Total Peter expects to work for another 27 years and to continue to support his family for at least 18 years. Peter decides to take out life and TPD insurance with a cover of $500,000. (This is in addition to insurance taken out
$7,800 $30,000
for $240,000 to cover existing debts). Should Peter die or become permanently disabled an insurance claim of $500,000 would be available to his family to be reinvested. This could provide an income stream of $30,000 pa. over 18 years if lump sum invested returned 6%.
• When determining a lump sum requirement, it is important to accurately calculate financial commitments • Provisions should be considered for expenses that may be incurred at the time of death or disability • All those whose death or disability would have a serious financial impact on the family need to be insured • Insurance that allows you to automatically increase your cover in line with inflation (CPI) should be considered • Insurance cover can be reduced over time • A lump sum can be paid to your estate and a trust set-up to distribute benefits tax-effectively Speak with your adviser to determine the correct amount and type of cover.
Disclaimer The information in this newsletter is of a general nature and is provided for illustrative purposes only. It is not intended to constitute advice of any kind. The information has been prepared without taking into account the objectives, financial situation, needs or circumstances of any particular person and should not be relied upon. You should not act on the information, rather it is designed for you to contemplate whether you should obtain professional advice if an issue may be of relevance, having regard to your objectives, financial situation, needs and circumstances. Authorised representative no 282461 of AAA Shares Pty Ltd AFS licence no 222138
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