This is something that is often overlooked by many investors. In the hope of accumulating some wealth, an investor may rush off and buy a property, some shares or managed funds and pay little consideration to the impact of that decision on their financial future.
Before you go and buy any investment we always recommend that you speak with a licenced wealth adviser (or financial planner). Only they can give you advice on this area and tell you how to manage cash flow as well as diversify your asset base to grow wealth over your working life.
However, a tax adviser can and should tie in with the wealth adviser’s advice to ensure you implement the recommended strategies in the most tax-effective way.
Where to start
The primary consideration that many people neglect before making any investment is asset protection. Hopefully your accountant is aware of its importance in relation to your overall financial position.
Essentially, if you are in a high-risk business, self-employed, employing staff or have significant debt then any assets you accumulate in your name could be subject to future litigation by potential creditors or re-possession by a bank.
For these reasons, many doctors who find themselves working as sole traders within clinics, for example, realise – often too late – that owning investments directly may not be in their best interest.
What are the options in terms of asset ownership?
Holding investments personally
If you do own investments in your name, then you have control. You can choose to buy more or sell as you see fit. However, any capital gains derived from the sale of these investments will be assessed at your marginal tax rate. So will income derived from the investments (rent, dividends, distributions etc). This gives no flexibility in terms of tax strategy, though you will access the general Capital Gains Tax (CGT) discount, currently 50%, for assets you hold for more than 12 months.
When you pass away, the investments form part of your estate which is either distributed on to beneficiaries in accordance with a standard form will or perhaps ownership is assumed by a Testamentary Trust.
Holding investments in Trusts
Another option is to own your investments through a Trust. It can be a Discretionary Trust meaning the Trustee (you or a company of which you are a Director) can choose where the income and capital should be distributed. This gives the flexibility in tax planning because Trusts do not pay tax**, instead beneficiaries pay tax on the income they receive from the Trust. It also means the investments are not held in your name and are therefore protected from those potential creditors.
The CGT discount can also be accessed by the individuals that receive these distributions, after offsetting any carry forward losses.
A Fixed Unit Trust is similar, except that the income must be distributed in proportion with the unit holding, therefore there is less flexibility in the tax planning.
On your passing, the Trust can continue on, albeit with a new Trustee in accordance with the Trust Deed which you should have expertly prepared by a lawyer. You might be leaving a big capital gain or other mess for future beneficiaries so be sure to seek advice before going down the Trust path.
Holding investments in a Company
The third option is to hold investments inside an investment company.
The pro is again the fact that the assets are protected from any personal/business risk. However, if you are a company Director, then you will have a whole raft of responsibilities under the Corporations Act you need to be sure not to fall foul of.
The income the Company generates is likely taxed at a flat rate of 30% subject to the Base Rate Entity Rules. After paying this tax the net income can be retained indefinitely (companies do not have a finite life). Some people would opt to access these retained earnings via franked dividends later in life as their income from work stops. Beware, if you access cash from the company without paying tax at your marginal rate, you will likely have a Division 7A problem that will need to be dealt with by a lawyer and your accountant.
Furthermore, companies do not access the CGT discount, paying tax at the top marginal tax rate after applying the discount is generally still better than paying a flat 30% in a company.
Holding investments in Super
Lastly, any financial adviser will include superannuation in a financial plan.
It is, in most cases, the most tax-effective way to save for retirement as it accesses a 15% tax rate for income, a 33.3% CGT discount and, in retirement, all income and capital gains are tax free! The main downside is the fact that funds are locked away until you retire.
One downside for investing in the name of an entity separate to you is the cost of setting up the Trust, Company or Self-Managed Superannuation Fund (SMSF).
The investment entity you have created is required to maintain financial records and lodge an income tax return of its own every year.
- A Trust must also resolve to distribute its income prior to 30 June every income year.
- A company must pay dividends or director’s fees if individuals wish to access cash.
- A SMSF must also have its records audited each year to ensure compliance with the SIS Act. A SMSF specialist accountant will do all of this for you, but they will usually charge a fee.
These costs should be weighed up against the future tax benefits and the peace of mind that the asset protection provides.
If you would like to learn more about which structure is right for you, our specialised medical financial services advisors and tax consultants can be contacted here.
**A Trustee can be assessed to pay tax on income derived from Trust assets, though this is usually best avoided as the top marginal tax rate often applies.
Disclaimer: * The information contained in this site is general and is not intended to serve as advice. DPM Financial Services Group recommends you obtain advice concerning specific matters before making a decision.