Financial Management Across a Career in Medicine 2007

Before We Begin McMasters’ Independent Financial Planning is a licenced provider of financial services. AFSL The contents of this presentation constitute general advice only. They may not be relevant to your particular circumstances.

Good Financial Management = Good Financial Planning Good Financial Planning is: –Consistent with other planning; –Structural rather than schematic; and –Based on common sense.

Elements of Financial Management Income Expenses Investment Wealth = (income – expenses) * investment

Income Two Types: –‘Employment Income’ – medical practice –‘Investment Income’

Employment Income Doctors and the Olympic Creed: Higher; Stronger; Longer.

Employment Income: Doctors and Non Doctors

Points to Note Area under the doctor’s curve much greater: –Doctor’s earn more; –Their earnings are constant; and –Their earnings last for longer. Therefore: trade being busy for being durable.

Investment Income

Investment Income: Benefits Not related to actual activity – earn it while you sleep, holiday, etc; Achieves compound growth; Reduces/removes reliance on employment income; Therefore: employment is on your terms.

Expenses

‘Typical’ Cost Curve Child 1 Born Child 2 Born Child 1 Primary Child 2 Primary Child 1 Secondary Child 2 Secondary Child 1 Uni Child 2 Uni Grad 1 Grad 2 Leave Home 1 Leave Home 2

The Two Curves

Two Curves Together Income generally exceeds expense: –Pre-kids; –While kids pre-high school; –Once kids graduate. Therefore, these are optimal times for enhancing wealth creation.

Major Areas of Expense Taxation; Cars; Loan interest; and Transactional Costs.

(Legitimate) Ways to Reduce Tax Deferring Consumption; and/or Spreading Income; All Tax = Consumption Tax.

Superannuation Deducted Contributions taxed at 15%; Age-Based Deductible Limit is per related employer. Earnings taxed at 15%; Capital gains taxed at 15%/10% or nil; Post 60 – withdrawals not taxed at all; Post pension, earnings and income not taxed at all; Asset protected.

Self Managed Super Funds Maximum control; No commissions; Main cost often accounting and audit fee; Simple investment strategy = low cost; Automation adds simplicity; 15 minutes per month.

Case Study - Superannuation Doctor intends to invest $10,000 of pre-tax income; Marginal tax rate = 40%; Therefore, can invest: $6,000 in own name; or $8,500 in superannuation.

Case Study - Superannuation Assume investment earns income of 10%: –Return in Dr’s name: $600 pa. Tax payable = $240. After tax return = $360. –Return in SMSF: $850 pa. Tax payable = $ After tax return = $ Return on $10,000: –3.6% in own hands; –7.2% in SMSF.

Case Study - Superannuation Investment value after year one: –Own hands: $6,360; –SMSF: $9, Investment Value after year ten: –Own hands: $10,745; –SMSF: $19,218. Investment Value after year twenty: –Own hands: $19,242; –SMSF: $43,452

Superannuation Makes More Sense for Doctors Preservation effect lessened due to higher cash flow; Asset protection; Saving for future generations.

Personal Services Income – How to Reduce Tax Superannuation; Employing Others; or Negative Gearing.

Business Income – How to Reduce Tax Superannuation; Share income between more than one person (no need for employment); Investment company; Negative gearing.

Cars Home to Work = Business Travel; No limit on number of company cars; Car no 2+ taken as fringe benefits; Oscar Wilde and Accountants.

Interest Deductible debt is generally good… ; Non-deductible debt is generally not so good (but not necessarily bad); Maximise borrowings for business/investment; Direct all available cash onto non-deductible debt.

Transaction Costs If it moves, tax it! Avoid commissions and excessive fees; Don’t sell good assets.

Investment

Types of Investment Property: –Own home; –Investment; –Commercial and Residential. Shares Cash Superannuation is a special case

Key Points - Investing Simpler than it is made to look; Long term time frame essential; Control the investment.

Optimising Investment (1) Maddison.

Optimising Investment (2) Australian Experience: Conclusion: Everyone Should be a Long Term Investor! 2% per year 7.5% per year

Property Investment (1) Example (residential) Cost of debt = 7%; Net Income return = 3%; Income loss = 4%; Tax Break ~ 2%; Net loss ~ 2%. If capital growth > 2%pa, wealth created. 2% pa means doubling every 36 years. Inflation = 2.8%.

Property Investment (2) Manage Risk: Avoid duds. Poor quality/High maintenance; Low demand relative to supply (caution ‘Seachangers’); Aesthetic pleasures. Avoid ‘off the plan’* Consider a buyer’s advocate.

Shares (1) Two Ways to Invest in Shares: 1.Index Funds; 2.Direct Portfolio.

Index Funds Indices used to measure market; IFs invest in accord with the index; Automatic diversity; Obtains the gross market average; No ‘research’ = Lower fees; Little trading = lower fees; Provides superior net return.

The Maths of Index Funds Distribution of returns before fees (individuals and managed funds) Distribution of returns after average active fees of 1%; index fees = 0.5% Average return = 5% Average return = 4% Index Fund return = 4.5%

Humility Helps “Welcome to Lake Wobegon, where all the women are strong, all the men are good- looking, and all the children are above average.” –Garrison Keillor, Lake Wobegon Days.

Strategy for Index Funds Dollar Cost Averaging; Buy and hold; and Reinvest distributions.

Dollar Cost Averaging – October 1987

Alternatives to Index Funds Listed Investment Companies (LICs); Exchange Traded Funds (ETFs); Same automatic diversity and efficiency; Not quite as tax advantaged; More manager risk – active management.

Case Study 1 Doctor aged 35; Full time GP billing $300,000. Pays 35% mgmt fee; Taxable Income: $180,000. Tax rate = 45%; Employs husband as p/time administrator; Maximum deductible contribution 2007/2008: $50,000 each; Annual contribution: $100,000.

Case Study 1 - Solution Opens line of credit loan; Receives billings onto home mortgage; Borrows to pay: –Mgmt fee; and –Superannuation contributions

Case Study 1 - Solution Annual Contribution = $100,000; Therefore, monthly contribution = $8,333; Direct Debit 1 st day of month: –$8,333 from LOC to SMSF bank account.

Case Study 1 - Solution BPay 2 nd Day of month: –$7,000 from SMSF Bank Account to Vanguard. $7,000 = 84% of monthly contribution.

Case Study 1 – Key Elements Minimal fees: SMSF and Vanguard; Dollar Cost Averaging; No cash flow restriction; Immediate return of 30%: $30,000 tax saving for the family; Interest deductible at 30%; earnings taxed at 15%.

Case Study 2 GP in late fifties; Billing $400,000. Paying 30% mgmt fee. Taxable income: $250,000. Tax Rate = 45%; No personal debt; Wants to help children with home loan; Employs wife part time; Deductible contributions 2007/2008: $100,000 each.

Case Study 2 - Solution Opens Line of Credit loan; Contributes 1/12 th of $200,000 into SMSF each month; Invests 84% into Vanguard; At age 60, withdraws money to finance home for children.

Case Study 3 Dr in Mid 40s; Has principal and interest loan of $400,000 of deductible debt; Changes loan to interest only; Uses freed up cash to pay super contributions; This is effectively borrowing to pay superannuation contributions.

Case Studies 2 and 3 - Benefits Debt must be repaid using after-tax dollars; Therefore, reducing tax payable reduces amount repaid. Eg: Loan of $400,000. –If Dr pays tax at 45%, needs to earn $727,272 before tax to pay $400,000 after tax. –If superfund pays tax at 15%, needs to earn just $470,588 to pay $400,000 after tax. Paid upon withdrawal from fund. Difference = $256,000 before tax. That is, virtually an entire year of full time work. $256,000 = 64% of the debt; Superannuation should precede debt repayment, especially if the debt is deductible.