DYING is bad for your health, and can also do some unpleasant things to your family’s wealth. While the impact of an unexpected death for young families is obvious, older Australians can also suffer financially on several fronts when their partner dies.
Knowing the rules, and how to work around them, is the key to leaving as much money as possible for loved ones.
More than a dozen major countries have death taxes, but not Australia. However, if you die without a dependant, such as a spouse, much of the money paid out from your superannuation can be slugged with a 17 percent tax. “Most people call it a pseudo-death tax – there’s no other way to describe it really,” said Hewison private wealth managing director Andrew Hewison.
“If you have all your wealth in super with a large taxable component paid out to a non-dependant,
15 percent tax plus the Medicare levy is going to be deducted.”
Mr Hewison said this made super a tricky estate planning tool. However, there are strategies available to some over-60s to withdraw their super then put it back as a nontaxable contribution.
Almost 80 percent of retirees receive a full or part age pension, and with the single rate set at about two-thirds of the couple’s rate, the death of a spouse delivers an instant household income cut.
“The age pension for a single person is $907.60 a fortnight – it’s not a lot of money,” Mr Hewison said.
Another big impact comes from lower means test thresholds for singles compared with couples.
Planning for Prosperity senior adviser Bob Budreika said dying was bad financially for pensioners’ partners.
“The biggest problem is when the spouse dies, the assets test limit goes down,” he said.
Strategies to solve the pension assets test squeeze are limited but may include gifting money to relatives, spending on something such as an overseas holiday, or upgrading your home – the
only asset that’s exempt from Centrelink testing. None seem palatable to many retirees.
Mr Budreika said it was common for one member of a couple to be more actively managing the money, and if they died first there was often trouble for the survivor. “It’s a pretty dangerous position to be in,” he said. “Even though one person may be more passive, at least have a broad overview and understanding.”
Mr Hewison said people of all ages should understand where their family income came from, ensure their wills and wider estate plans were up to date, and seek professional advice where needed.
When putting away money for a child, many people invest directly in the child’s name or on behalf of the child using managed funds or other options where the investment is held in the adult’s name ‘as trustee for’ the child. This usually results in the creation of an informal trust arrangement. When making a decision in relation to the appropriate ways to invest for your children, it is important to consider the following key thoughts:
What is the purpose of the investment and the investment time horizon
Have you thought about your tolerance to investment risk?
What will your ongoing taxation look like?
Do you have a date in mind of when access to the investment will be opened?
Have you thought about how much control you’d like to have over the funds?
Do you have much investment knowledge?
When investing for a child, there are a number of factors which will determine whether the income is taxed in the hands of the minor, the adult investing on the child’s behalf, or the trustee of a trust of which the minor is a beneficiary. This can become very complicated, so it’s important to remember to talk to your financial adviser before making any decisions.
Where the income is assessed as being derived by the child, the rate of tax payable by a minor depends on a number of factors, including:
the source of the income, and
personal circumstances of the minor, including employment status, and whether or not the person has a particular kind of disability.
Generally, income earned by a minor is taxed at special minor rates which are higher than adult rates, unless any of the above applies, and either the income is ‘excepted income’ or the minor is an ‘excepted person’. Unearned income derived by minors is generally taxed at the higher minor rate, except in special circumstances – talk to you financial adviser for more information on this.
The higher tax rates below apply to unearned income, which is generally passively derived income such as:
distributions from managed funds, and
distributions from discretionary trusts.
Your investment options
There are a number of options available to you if you’re considering investing for your child. The main options include:
Direct Australian Shares
Scholarship education bonds
These are the most common types of investment, however, some alternative options include:
Additional mortgage repayments
We understand that investing for children can be a highly complex financial decision, and we’re here to help you make the right choice. If you’re looking to invest on behalf of your child but don’t know which option will work best for your personal financial situation, get in contact with our office for some expert advice.
Source: MLC Investments – Technical News, ‘Investing for Children’ 23rd January 2018
Time and Patience is key to Successful Investing
There’s no doubt that time seems to be a commodity that we all think is in short supply. This almost seems absurd when you consider how we’ve progressed as a society that enjoys virtually limitless access to so many time-saving services and products. Unfortunately, the disadvantage of all this is that we’ve perhaps become less patient, demand more and have high expectations in all matter of things. The same behaviours occur with investors.
I find it interesting when we come across people who have held shares for decades – usually well before the advent of online services – that they’ve not been enticed to buy and sell but have sat on their holdings. I can’t think of any of these people who’ve spoken about bad decisions or regrets with their investments. I’m sure that if we researched their investment portfolios that we’d find that some of the investments may have not performed well or even lost value over the short to medium term yet, years later, this is forgotten and they reap the rewards of long-term capital growth and regular income. They’ve used time as their ally. This success factor isn’t limited to shares and it’s easy to find evidence in other investment categories such as property or operating a business.
From our experience, one of the most important roles a financial adviser provides is to demonstrate the benefit of time and patience on an investment portfolio and how this relates to client’s objective. A vital part of this advice process is to investigate a client’s objectives and how these relate to the time frame of matching capital and income requirements. This allows the adviser to construct a purpose-built investment portfolio tailored to what clients want to achieve. This approach takes the pressure off a client’s expectation of short-term market performance and provides an appreciation that the investment strategy has a specific purpose. It is a marathon, not a sprint.
There have been some negative headlines in the press recently criticising investment fund managers of underperforming their relevant benchmarks. These results were highlighted in the most recent S&P Global annual scorecard which tracks the performance of almost 1,000 actively managed funds versus their benchmark index. An index is simply a way of tracking a number of investments in a particular class as a whole, such as Australian shares. For example, the All Ordinaries measures the performance of the top 500 shares on the Australian Stock Exchange. The Dow Jones Industrial Average tracks 30 of the most influential US companies traded on the New York Stock Exchange.
What is active funds management?
In the world of investing, an active fund manager employs a team of people to carefully analyse the market and make trades to deliver an investment return that hopefully exceeds what you could have achieved, had you merely invested in the benchmark index. As you can appreciate this is quite a complex job and the fund manager charges a management fee to be remunerated for their skill and expertise. This style of investing is called ‘active investing’. The alternative, ‘passive investing’, refers to simply purchasing a more economical index fund and accepting the overall risk and return of the market.
Active investing rarely pays off
The theory behind active investing is that you pay experts (such as a fund manager or stock broker) to do the complex investing for you, so that after all fees and costs you’ll be better off in the long run. Does it work? Of course it works! Do the same active fund managers consistently outperform their benchmark indices? Usually never. According to S&P Global, Australian active managers are under-performing their benchmarks more often than not over 1, 3 and 5 year periods. In similar reports from Europe, 86% of active funds managers have not outperformed their benchmark in the past 10 years. This is not dissimilar to results in the US and UK.
Warren Buffett bets index funds outperform active management
Widely respected investment guru, Warren Buffett has been critical of the active funds management industry, arguing that they don’t add value to client’s portfolios. Knowing that the heirs of his estate won’t have his unique ability to manage investments, he has instructed the money to be invested in index funds. In fact, he believes in the process so much that in 2008 he made a bet with a US hedge fund that the S&P 500 index would outperform one of their hand-picked portfolio of funds. While there has been some lead changes since starting, after 8 years, Buffett remains ahead. Whether he wins in the end is not the point. The point is that active funds management is a zero sum game. While you may get lucky at some point, it is near impossible to consistently pick winners.
Benefits of index investing
Index investments are not as sexy as actively managed funds but they have some compelling benefits which are very hard to ignore:
Greater diversification – performance risk is spread across many more underlying investments
They have much lower associated costs than actively managed investments – while nobody can guarantee investment returns, a lower cost investment already puts you ahead
No key person risk – index funds run relatively simple processes that are not reliant on one key person or team of people with valuable intellectual property
Index funds are highly liquid – there is no risk of funds being ‘frozen’ in the event of a crisis
They never under-perform their benchmark – they are the benchmark!
We are strong advocates of index investing and have used this method to construct all of our client portfolios since day one.
The process of investing money can be quite tricky. There are many different markets and options to choose from, which can make it quite overwhelming for most. Before a single dollar is invested it is important to know the purpose of the investment other than to “make money”.
Identify your timeframe
A good starting point is to ask yourself how long the money will be invested for. As a general rule of thumb, short time frames should look at safer, more predictable options like cash and term deposits.
They are not the most exciting but they do provide you with liquidity and easy access when you need it. For investments over longer periods (generally greater than 5 years) it may be appropriate to incorporate a level of risk into a portfolio to help enhance the return. Growth or ‘risky’ assets typically include things like shares and property, whose value is less certain the further you look forward into the future. As the term ‘risk’ implies – we hope that these assets will grow to become more valuable over time but there is no guarantee.
Therefore it is generally not recommended to use risky investments (such as shares) to save for short term goals, like that holiday to Europe in 2 years’ time. You could get a rude shock to find your investment has fallen in value when you need it. On the other hand, if your timeframe is longer, the risk of a negative return is less likely. A good example is superannuation, which cannot be touched until retirement.
Know your tolerance to risk
As part of the investment process, we always have our clients complete a risk profile questionnaire to help us determine what sort of investor they are. We often find that there is quite a difference between what people think they are and the investments that they hold. A common example is someone displaying the characteristics of a low risk taker, whilst having an investment portfolio consisting of 100% shares – often all in one company (high risk).
While there is nothing wrong with holding shares – the perception by many who hold them is that they are low risk. It is also common to see share portfolios set up by stockbrokers that have little or no regard for the client’s risk profile.
Diversify, diversify, diversify
We have all heard of the phrase “Don’t put all your eggs in one basket”. In investing terms, this means spreading your money across different asset classes, industries and markets to avoid being exposed in one area. The theory is that if one investment performs poorly another one will do better – or more specifically – choosing investments that have a low correlation with each other.
Diversification should start broadly with an allocation to growth (risky) and defensive assets before diversifying into the different asset classes (shares, property, cash and bonds). Only after the allocation to each asset class has been made should the individual investments be selected. Farmers and small business people are often plagued by the decision to invest everything back into their business or diversify into other areas outside. This is a more complex question that can be answered with the help of someone independent.
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This information is of a general nature only and neither represents nor is intended to be specific advice on any particular matter. We strongly suggest that no person should act specifically on the basis of the information contained herein but should seek appropriate professional advice based upon their own personal circumstances. You should read the PDS and consider whether the product/s is right for you. Past performance is not a reliable indicator of future performance.
Strategic Advice Solutions Pty Ltd (ABN 86 619 221 662) t/as Planning for Prosperity is a Corporate Authorised Representative of Infocus Securities Australia Pty Ltd (ABN 47 097 797 049) AFSL and Australian Credit Licence No. 236523