Are you blowing or growing your Mojo?

Over the silly season I have spent a bit of time out of the office and have spotted orange cards with “splurge” taped to them on at least a half dozen occasions. The Barefoot Investor seems to be gaining more momentum every day in Australia and has some great tips on how to budget and save. Scott Pape’s book and subscription only “Blueprint” are going a long way to helping make money management easy to understand for a wide spectrum of Australians. Anything that makes savings and budgeting easy for people to save we are all for. Using poetic license when writing on such a complex area as personal finance is essential as this needs to appeal to a wide audience.

The question I found myself asking was. “Is the rate on the ING High Interest Saver account (currently at 2.8%) that Mr Pape “recommends” higher than the interest paid on a mortgage?”

So I thought why not break this down a little. I had a chat with Julie Bishop, one of the specialists in my network, who has a depth of experience in this area so credit goes out to her for helping me put this short piece together.

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Barefoot buckets

You must have seen this by now.

The “bucket” concept is certainly not a new one in financial circles. This has been used for years, if not generations, to help manage cash flow. What we are trying to figure out is if this system could work efficiently with a mortgage which is often the highest debt a person will ever have and attached offset accounts. 

So what is an offset account?

Offset accounts are relatively common. If you have a mortgage of say $500,000 and have savings of $50,000 in an offset account you would pay interest on only $450,000 of your mortgage. So while your funds don’t earn interest as they would if they were in a pure savings account, they reduce the generally higher rate of interest you pay elsewhere so essentially you are making money. Plus as you are not earning any interest, there is no tax to pay.

Lets look at a quick example:

$50,000 in high interest account (2.8%)  = $1,400 (taxable)

$50,000 in mortgage offset account (3.8%) = $1,900 (not taxable)

I had a quick look around and found that Macquarie, Commonwealth (including Bankwest) ME Bank and Suncorp all offer multiple offsets. There may be a few more, I do not provide mortgage or finance advice so don’t have access to the tools that a good finance broker would.

So I have a mortgage and savings, I should be doing this immediately…right?

Making an extra 1% on your savings is great but if you are paying 0.5% higher interest across your entire loan for the privilege of having multiple offsets this is going to have you at a significant loss.  You need to figure out if these match your needs. If you are a sole trader or run a company it can be very handy to keep tax or other funds in separate accounts, you could even use them to save for a holiday or the kids over and above your bucket system.  There are also Professional packages are offered by some lenders and we often find these allow borrowers get into a home sooner with a lower deposit based on high future earning. Yes Doctors, this is you. Macquarie, NAB, Westpac and Commonwealth all offer up to a 90% LVR with no LMI. ANZ and BoQ Specialist can go even higher, with a few tricks.  LMI may sound like a small thing but typically costs around $20,000, depending on what you are borrowing.

source: https://www.finder.com.au/how-to-calculate-your-lvr

source: https://www.finder.com.au/how-to-calculate-your-lvr

Hold on a sec, what is this LMI and LVR stuff?

LVR or Loan to Value ratio is a percentage that the bank will lend you against an asset like your home. So if your house was worth $1,000,000 and you put in $200,000 deposit you would have an 80% LVR which as a rule of thumb is the maximum a lender will accept. If you go over this amount they will want to “insure” the bank in case you don’t pay your mortgage. This is LMI or Lenders Mortgage Insurance.

That is good isn’t it? You never stop singing the praises of insurance. More must be better?

While I like to cover any risk under that sun that can be insured for a reasonable price LMI doesn’t work in anyone’s favor other than the bank. The cost of this is often bundled into the mortgage so you pay for it over 30 years and if you do ever claim it you won’t see a cent. This pays the bank and then the insurer often asks for that money back. Paying for insurance on an unrelated party is never in your best interest. 

You should have a good relationship with your financial planner and also an independent mortgage broker that can help you work out a structure that is right for YOUR needs. There is no quick fix to why you cant save or which lender, or pillow for that matter, is right for you. Having multiple offset accounts with $200 in each charging you additional fees and a higher interest rate on your mortgage, plus a higher rate over all, is most certainly not going to help you get ahead.   Each part of your financial world need to be carefully considered in how it might impact other areas. This article was written as a concept only and should not be considered as financial advice in any way.


Notes: Some lenders offset accounts are only partially offset against Fixed rates and fully offset against variable. There are also often a small fees per offset account that we have not considered above.

Shaun ClementsComment
Common mistakes Doctors make when setting up Insurance Cover
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When we review insurance cover for our clients, we often find issues arise due to cover not being established correctly or that the clients situation has changed and cover has not been modified accordingly. Most of these problems are not identified until it is too late.

Some of the most frequent errors that we encounter are discussed below.

 

Incorrect levels of cover

It is very common to see medical professional’s with very high levels of income protection under an “indemnity” contract. This is often through Superannuation or via a direct insurer, that does not financially underwrite their policies. The danger here is that at claim time this insured value needs to be proved. For employees this may mean simply providing historical payslips (minimum). If you were self employed or a business owner this involves the release of company accounts including compilation of profits and losses etc. If there is any “unearned income” such as investments or other buisness income that did not require personal exertion, this could also offset the claim amount. A nasty surprise when you are quite possibly lying ill or injured in a hospital bed and having to provide these financials before payments begin.

There is also a tendency to only cover debt and replacement income in the event of death or total and permanent disability. This is more often than not insufficient. Factors such as housing modifications, employing carers etc etc need to be considered. As a general rule of thumb 12 times your living expenses is normally what would be required in these circumstances, though this is a very simplistic solution and does not take into account your unique circumstances. 

It’s not always just about you

Even if your family members do not earn an income, it is still a good idea to insure them. If a family member is injured or ill you will likely have to cover medical expenses or take time off work to care for them, thereby reducing your own income. From a long-term perspective if a spouse is no longer able to care for your young children or keep the home running alternative arrangements may need to be found and funded. Insurance such as trauma cover is often the simplest solution. It is key to also consider cover not only your spouse but also your children and even other members of your family if they are financially dependent on you.

 

Stepped vs Level premiums

Are you planning on holding cover for a long period of time? Medical professionals tend to work well into their 60s in at least some capacity. If you do still require some insurance cover at this age and use a “stepped” premium structure (which bases its premium on your age) this will become extremely expensive. Using a “level” premium structure means that your premiums are based on the age at which you established your insurance cover. If you started early enough this can mean that cover is much more affordable later in life, when you are far more likely to make a claim.

One of the common errors is often taking an “all or none” approach and having all cover on “level” or all cover on “stepped” structures. A blended approach involves making use of both types of insurance. Utilizing some “stepped” insurance to establish cover for debt and other short/medium term needs, the aim being to reduce this over time when high levels of cover are no longer required. At this point you would still have your “level” cover remaining as the baseline for long term protection.

 

Consider your tax structure

As most people know income protection is tax deductible, however using Superannuation to fund this type of cover means you might miss out on a personal deduction. As an alternative Life and Total/Permanent Disability insurance can be owned inside superannuation (linked policies allow TPD Own Occupation definitions to be used) and then a tax deductible contribution can be made to cover the premiums, often with a 15% tax rebate to the fund. If you are not maxing out your concessional contributions each year (currently $25,000 for the 2018-19 financial year) this can be very handy. It is also worth keeping in mind that TPD held inside superannuation is taxable if it is paid out and this needs to be accounted for.

 

Who does money flow to?

Following on from above, if you have insurance within your superannuation fund you will want to ensure that it is paid to the right person if a claim is made. This is done by completing “nomination of beneficiaries” paperwork, that instructs the trustee of the superannuation fund exactly who you want money to be paid to. A binding nomination like this must be followed by the trustee. However some superannuations don’t allow for these kind of binding nominations and a persons requested recepient is only seen as a “suggestion” by the trustee.

Far too often a nomination will include children and although they can accept the money paid at claim, they are probably not able to manage this at a young age. Other pitfalls are nominating adult children, siblings or parents - they are not considered dependents for superannuation purposes, which means this payout would be taxed. In extreme cases lack of a nominated beneficiary can result in funds being paid to ex partners in accordance with the law and almost certainly against the wishes of the deceased.  

 

The right legal documentation is critical

Insurance cover is intended to provide funding for a specific purpose in specific circumstances. This ranges from the very personal e.g. funding your loved ones living expenses if you die, to the professional e.g. succession planning and funding an exit strategy for a business, ensuring that other partners are not left with debt and have access to funds to cover your position.

All of these arrangements require legal documentation to be completed upfront to ensure that insurance payments are paid appropriately e.g an up to date will. In the case of succession planning other factors such as agreement on the valuation methods to be used, who exactly gets access to funds, how they can be used etc etc are vitally important and again this needs to be documented appropriately. We see time and time again businesses and practices being established on a handshake agreement but unfortunately this is seldom how they end.

 

Get the right advice

All of the examples used above are for illustration purposes alone and should not be taken as specific advice. When putting together risk protection strategies an adviser, or panel of specialists, should take into account all elements including your family, business and any trusts or superannuation structures used. They must then consider how these different elements might work together to form specific advice just for you. 

Shaun Clements
Why your Adviser will not make you money.
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At a conference in Sydney this weekend I overheard another adviser telling a story about a client who came to him late in life with significant assets that, based on their moderate lifestyle, they would have trouble spending before they died. He told them that they had only a small portion of their assets in Super and had they moved more over when they had the chance they would have saved significant tax but that ship had sailed. This client then said, “oh that’s unfortunate, so you are saying that if we had of seen you 20 years ago we would have far more money to live on?” the adviser replied “absolutely not, you have taken some huge risks that have paid off well for you, I would have advised caution so you would like have less, of course, this was just pure luck”

Financial advisers are not the keepers of a secret rule book that details how to get rich. They have some tools that help them to analyse and compare the VAST range of options for investments and other financial products but ultimately all this information is publicly available and though they might have their ear close to the ground, they cannot predict the future either.

Advisers use tried and tested financial products that produce predictable results and go through a significant vetting process before they are added to the advisers approved product list. Advisers cannot recommend the house down the road or a penny mining stock that their mate at the pub says is sure thing. These kinds of investments can be highly volatile which means that although they could potentially make you a lot of money, they could also lose it, advisers can’t gamble with your money.

ETFs and Robofunds are taking a lot of the arduous work and cost out of investing. These investment options have been in vogue for around 10 years, which has been essentially a bull market since the GFC, and have been giving the more expensive and hands on active managers a run for their money. Selecting a custom designed portfolio can take a lot of time and effort and this can help to provide significant downside protection that might be critical to your needs, but this will not make you money.

Insurance is a big part of financial planning. Unless you have a rich family or a very significant investment portfolio, any investment plan is based on your ability to earn an income. Without income this all falls apart pretty quickly so taking a small percentage of this income to ensure this continues as best as possible is a no brainer. If an insurable event occurs, this is often a significant event and the time off work will mean that event with great cover you are likely not going to be in a better financial position had you not fallen ill or been injured etc. There are a diverse range of insurance products available from different providers but there is one guarantee across all of them, you will pay a premium. So, in most cases, insurance won’t make you money either.

Advisers don’t work for free. Getting to know you and providing you with recommendations that suit your needs takes time and expertise. Advisers more often than not have staff on their payroll, or they outsource documentation and compliance work. They also have significant professional indemnity cover that means that if they step wrong, you get to lodge a claim against them to rectify any financial harm. Once again most of the rules and strategies that an adviser will use are publicly available and you can do this yourself. You pay an advice fee to ensure that you are not missing anything and don’t get caught out and while you might send less to the tax department and avoid making losses due to wise investment decisions this won’t make you money.

Ultimately, YOU are the person who decides if you will “get rich”. If it was easy everyone would be doing it. You can find out what you are good at and work hard at it. A good adviser might help you take an objective view to this process and make you aware of potential pitfalls, but they can never know your job and your aspirations as well as you do. They can also provide you with the tools to help you spend less and save money but this is down to your habits and lifestyle, something only you can control.

Shaun Clements - June 2018