The danger for investors from today’s low interest rates

Australian interest rates have reduced significantly over the past few years and there is a real danger that this has encouraged investors to pay too much for many riskier, higher yielding assets, such as shares and property. Australian interest rates may even go lower and while this could lead to further increases in property and share prices, investors need to be aware that these riskier assets could fall significantly in the event of some unexpected event, like a major Middle East war.

Australia has followed interest rates in the rest of the developed world (USA, Europe, Japan, etc) to historic low levels and this has undoubtedly encouraged investors to buy assets that today offer a better return but, what of tomorrow? My concern is that the fundamentals, like earnings growth for shares or rental yields for property have not kept pace with price increases so there’s a real danger of a significant correction at some point. It seems strange to have property and share prices surging when everyone agrees the Australian economy is somewhat weak: low wage growth, the Budget deficit increasing and unemployment edging up.

When looking at your existing or new investments ensure you consider the fundamentals, in particular how the investment might look a year or two from now. I think now is a time to be cautious and to be wary of buying investments simply because low interest rates make bank deposits look unattractive. Ensure you don’t simply follow the crowd by buying what has already gone up significantly or whatever everyone else is talking about.

Possible changes to Tax treatment of Super or Negative gearing?

There has been considerable speculation that tax policy in respect of superannuation or negative gearing might be changed to help reduce the Federal Government budget deficit and on equity grounds.

The Labor opposition has proposed two changes to existing superannuation policy, being a 15% tax on earnings in the pension phase that exceed $75,000 p.a. and a cut from $300,000 to $250,000 in the existing income threshold where the tax on an individual’s superannuation contributions jumps from 15% to 30%.

My view is that no change is likely to apply before the next Federal election given the Prime Minister & Assistant Treasurer have both publically stated that there will no changes. “[We] will honour our commitment not to make any adverse or unexpected changes to superannuation during this term,” Mr Abbott recently said. While politicians have been known to show “policy flexibility” and go back on their word, it seems unlikely any changes will happen in the short term. However, it seems inevitable that there will be some changes in the next few years to reduce (but not eliminate) the tax savings available through superannuation for higher income earners and wealthier retirees.

Australian Banks versus the big Resource Companies

The attached chart compares the market capitalisation of BHP versus the big 4 banks back in June 2008 (less than 7 years ago i.e. during the mining boom) and contrasts that with just one of the banks, CBA, versus our three biggest resources stocks (BHP, RIO & Woodside)  as at January 2015.

This highlights how much relative valuations have changed and gives a sense of what many believe – that our banks currently are very fully priced because of their strong fully franked dividends and perceived safety. It also demonstrates why investors who favour direct shares over managed funds should beware of simply adopting a “buy and hold” strategy as this can result in holding underperforming stocks and missing out on better opportunities.

Changes to the age when you can access your Super

The age at which people can access their Superannuation savings is gradually being increased from the current minimum age of 55 up to age 60. This is important as if you have not reached what is known as your preservation age, you will normally not be able to:

  • withdraw a lump sum super amount;
  • start a Pension account, such as a Transition to Retirement pension.
Your preservation age is determined as follows:

 

  Your Date of birth Your Preservation age
 Before 1 July 196055
 1 July 1960 to 30 June 196156
 1 July 1961 to 30 June 196257
 1 July 1962 to 30 June 196358
 1 July 1963 to 30 June 196459
  After 30 June 196460

 

 

Concessional & Non- Concessional Contribution Caps – what are they?

Superannuation terminology and rules are confusing to many people and they are also unsure what the caps (fixed $ limits) are and even why Government limits how much you can put into superannuation each year. Superannuation is a concessionally taxed ownership structure. That is, the tax on earnings is generally lower than if the same asset was owned personally, jointly with your partner, or via either a company or trust.

A maximum of 15% tax applies to superannuation earnings for anyone, regardless of income, and under current rules, when the superannuation is turned into a pension the tax on earnings reduces to 0%. You can’t beat that! The low tax on superannuation means that many people – higher income earners, in particular – prefer to have a significant proportion of their savings/investments in superannuation as the tax on earnings (interest, rent, dividends, etc) and capital gains is less than they would pay if the same asset was owned personally. Government gives this incentive – the tax saving – as they want us to save for our eventual retirement. That is also why they restrict access to your superannuation until you get older i.e. reach your “preservation” age. The article above refers to this.

The General Concessional contributions cap, $30,000 per annum currently, applies to employer (SG) contributions -superannuation guarantee contributions of 9.5% and any salary sacrifice amounts. It also applies to tax deductible contributions made by self employed people and others who qualify to make such deductible contributions. An increased Concessional contribution cap of $35,000 applies to taxpayers who are aged 49 or more on 30 June 2015. A 15% contributions tax is applied to concessional contributions (except for high income earners where the tax is 30%) so if your annual employer SG contributions totalled $10,000 the after tax amount added to your super account would be $8,500.

The annual non concessional contributions cap, currently $180,000, applies to amounts you may choose to contribute to superannuation using your own money that is deemed to have already been taxed. For example, money held in a savings account, the proceeds from selling an asset like an investment property or an inheritance.  There is no contributions tax applied to any non concessional contributions you make.

It is worth remembering that these contribution caps apply at an individual level. So, for example, if a husband and wife sell a property they can each contribute up to $180,000 using the non concessional cap or a combined $360,000. There is also what is known as the “bring forward rule” which allows you to make 3 years non concessional contributions in one year i.e. $540,000 currently. If utilised then you can’t make any non concessional contributions in the subsequent two financial years. Effectively a couple can get $1,080,000 into Super in one go if they have the available funds.

Is it worth retaining private health insurance?

The significant and ever increasing cost of private health insurance, up around an average 6% again this month, leads many people to question whether it is worth it. As everyone’s personal circumstances and preferences are different I won’t enter the debate in respect of such things as  access to doctors of your choice, shorter waiting periods for some treatments, etc. but focus on the income tax consequences, specifically the Medicare levy surcharge (MLS) of up to 1.5%, if you choose not to have private health cover.

From 1 July 2014 the Medicare levy rose from 1.5% to 2.0% (to help pay part of the cost of the National Disability Insurance Scheme, the NDIS). You have to pay the Medicare levy surcharge (MLS) if your income for Medicare levy surcharge purposes is above a certain threshold and you (or any of your dependants) don’t have appropriate private patient hospital cover. The surcharge is in addition to the Medicare levy. Individuals and families on incomes above MLS thresholds, who do not have an appropriate level of private patient hospital cover, pay MLS for any period during the year that they did not have this cover.

The ATO says that f you become liable for MLS, your MLS rate can either be 1%, 1.25% or 1.5% depending on your income for MLS purposes. If your income for MLS purposes is above the base income threshold the ATO will apply the rate of MLS that corresponds with your income for MLS purposes. If you have a spouse (married or defacto) your combined income for MLS purposes will be used.

Table 1: Income thresholds
 UnchangedTier 1Tier 2Tier 3
Singles$88,000 or less$88,001 – $102,000$102,001 – $136,000$136,001 or more
Families$176,000 or less$176,001 – $204,000$204,001 – $272,000$272,001 or more
Medicare levy surcharge rate0%1%1.25%1.5%

Note, the MLS rate is applied to:

  • your taxable income
  • your total reportable fringe benefits, and
  • any amount on which family trust distribution tax has been paid.

 

This newsletter contains general advice. It does not take account of your individual objectives, financial situation or needs. You should consider talking to a financial adviser before making a financial decision. 

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