What young people need to understand about a trust

If I had a dollar for every young person that has said to me, “I need to set up a trust”, I would probably have enough money for a deposit on another investment property!

Seriously, though, the problem with such a statement is that most people don’t understand why they think they need one in the first place.

Let me explain.

Tax savings not enough

For young people especially, owning property in a trust for supposed tax or “protection” benefits doesn’t necessarily make it a good idea.

Firstly, most young people – in fact, most people – aren’t employed in a profession where they are likely to be sued, such as in the medical field, and, therefore, they need to protect their assets from litigation.

In fact, age is a big factor to consider because young people generally don’t have enough wealth created to make the expense of operating a trust worthwhile.

One of the main reasons that people have a “rose-coloured glasses” view of trusts is because there can be tax concessions such as reduced land and income tax.

Also, income earned from assets held within trusts can be distributed to beneficiaries on low incomes who have reduced tax thresholds.

The thing is, unless you already own a substantial portfolio, successful business, or a brood of children, opting to own property in a trust while you’re young doesn’t make much financial sense if you ask me.

That’s because the Australian Tax Office is well aware that people sometimes use trusts to potentially reduce their tax liabilities so there a number of rules and regulations that result in high operational costs.

Over the years, the ability to distribute income to children, for example, has been tightened by the ATO so that the maximum amount that can be paid to minors tax-free is now just $416, with the remainder taxed at a staggering 45 per cent.

A time and a place for trusts

Personally, I don’t have any of my portfolio in a trust, because I am only 29, plus Sophie and I are yet to have children.

In the future, as our business and family grow, then we will likely consider trusts so that our company is legally protected but also our children can benefit from our endeavours in the years to come.

Ideally, with a multimillion-dollar portfolio, we will be able distribute income to whichever one of us stays at home with the children when they are young, which will be taxed at marginal rates because of that person’s low income.

When our children are older and perhaps at university, then they can also benefit, with the income distributed via the trust helping to support them during their studies.

Also, much further down the line, a trust can be used to protect a family’s intergenerational wealth when it comes to succession planning.

Say, for argument’s sake, our future daughter or son marries but then divorces.

Any property that is held in our family trust cannot form part of a financial settlement if one of our hypothetical children’s marriages doesn’t work out.

As you can see, though, I am talking about things that, as a young person, have yet to become a reality.

Sure, at some point in the future, when our ages start with a “three” or perhaps a “four”, then we will consider asset protection measures such as trusts.

Until then, though, I would rather spend any extra money we have on building our wealth to such a point that we need a trust – rather than just merely wanting one for reasons that most people don’t fully understand.

Why using multiple banks can supercharge your portfolio

Did you know that about half of Australians remain loyal to their first-ever bank throughout their working lives?

Their mortgage, credit cards, and savings accounts are all with one bank from their first day to their last.

Competition in the banking sector has skyrocketed over recent decades, which means that such misguided loyalty can often result in poorer financial outcomes over their lifetimes.

Not only that, property investors who own more than one or two properties will likely see their portfolio flatline because all of their loans are with one lender.

To better illustrate my point, here are seven reasons why using multiple banks can supercharge your portfolio.

  1. Using one lender for all of your property loans means that your fortunes will always be dependent on their policies. Perhaps they decide to slow down lending to investors or they increase their serviceability calculations which means you are no longer able to borrow funds to grow your portfolio.
  2. A common trap for novice investors is cross collateralisating property loans with one lender. They often do this because they don’t have enough savings to invest in a second or third property, so they cross collateralize it with their home for example. One of the major problems with this is that even if another bank wants to lend them money, they can’t easily refinance because their loans are all tied together with one lender.

 

  1. Another major issue with cross collateralisation with one lender is that if an investor wants to sell one of their properties, for whatever reason, they can’t do that without it impacting the other property loans. Say, you wanted to sell a property to free up some cash, but the bank indicates that some of that money will need to be used to pay down the loan on one of the other properties. The end result? Less cash in your pocket and more in the bank’s.

 

  1. Ultimately, whether it’s crossing properties with one lender or being too loyal to one bank, the outcome is that they will potentially have more control over your financial future that you do. By using a mix of different lenders, you will be in control and will be able to buy, sell or extract equity more easily because you have spread the “loan love” around.
  2. Ditto, if you have property loans with multiple banks, your risk profile will be lower with each lender because of your smaller borrowings with them specifically. Rather than having $2 million-worth of debt with one lender and hitting their debt ceiling, you may have four lots of $500,000 spread across four banks who are likely to still be happy for you to borrow more.
  3. By spreading your loans across a variety of lenders, you will have access to different loan products as well as interest rates, which will benefit your portfolio over the long run. You will also be able to grow your portfolio when it is the right time for you.
  4. I’ve mentioned this briefly already, but one of the biggest benefits of using multiple lenders is that if one bank won’t let you extract equity, another bank might. This happened to me with one lender saying no and the other saying yes. So I extracted $100,000 of equity and bought another investment property that has grown in value by $50,000 in just one year. If I had had all my loans with one bank, I would literally be poorer because of it.

As you can see, there are myriad reasons why becoming friendly with multiple banks is a sound strategy.

Not only will it ensure you retain control over your portfolio and your wealth creation efforts, it will create competition between them, which means the power is in your hands and not theirs.

Why now is the hour to invest

The Federal Budget has now been released and in it came plenty of handouts but not many new housing policies as such.

Now, with the Federal Election still a few weeks away that could change, but as I see it investors are perfectly placed to buy now.

Before you say, “Daniel, of course you would think that”, just hear me out.

Let’s consider the major policies of the two main political parties.

Economic stimulation

As was sung from the roof-tops last night, the Federal Budget will soon be back in black for the first time in more than a decade.

It appears the LNP has done its job, like it often does, and got our nation’s accounts back in order, which is no mean feat given the GFC was only a little over a decade ago.

Now that there is seemingly some extra cash floating around, they have announced $100 billion in major infrastructure projects over the next decade, which will stimulate the economy generally.

The federal budget also revealed tax cuts for middle income earners, who usually miss out on anything much, will result in a kickstart in our retail sector after 1 July.

Creating more job opportunities – such as the promise of 80,000 new apprenticeships – generally will also see our economy start to strengthen over the short- to medium-term.

Another solid economic policy from the federal budget is the reduction in the small business company tax rate to 25 per cent, which enables business owners to expand and hire more staff.

Ditto, with the increase to the small business asset write-off to $30,000, which will incentivize businesses to spend money on a variety of products.

All in all, the LNP is heading to the election with an economy that is in good shape as well as a number of policies to stimulate growth, both of which work to strengthen property markets.

Negative gearing to go 

On the other hand, the ALP maybe pinning its hopes on the fact that it is ahead in the polls and therefore probably already have one foot in The Lodge.

However, most of its policies also aim to stimulate the economy and fund essential services such as health and aged care, however, its point of difference is when it comes to housing.

As I written about before, the ALP has announced a policy that will restrict negative gearing to new properties as well as slash the Capital Gains Tax discount from 50 per cent to 25 per cent.

Last week, they announced that, should they win office, they will implement the policy from 1 January 2020.

They have previously indicated that the policy will be grandfathered, meaning current investors will not be impacted.

In fact, given we have a start date of 1 January next year, that means that investors who buy before that date will not affected.

Now that we have the proposed start date, savvy investors are acting now to ensure they are included in the grandfathering provision before the start of next year.

What is helping them do so is the renewed push for investment loans from lenders now that the banking royal commission is over and done with.

While sophisticated investors understand that negative gearing is not a strategy but a moment in time, it is still worth their while to utilise tax deductions if they can.

They know that after a few years their properties will be neutrally or positively geared, however, if they have the ability to offset some of the costs during the first few years of ownership they might as well.

From 1 January next year, unless investors buy new properties – and most smart ones don’t – then that taxation benefit will no longer be around.

So, regardless of your political persuasion, that is why I believe now is the hour to invest.

The economy looks set to strengthen under LNP, while negative gearing will also be axed under the ALP.

Either way, investors currently have the opportunity to make the most of the market, and the most of beneficial taxation policies.

Why I think the cash rate will hit zero

There is always a lot of chatter about interest rates and now is no different.

Most economists are predicting that rates will reduce at some point this year, because of our relatively flat economy.

However, going out somewhat on a limb here, I believe the cash rate will hit zero in the next few years.

The reason why I think zero, or very close to, is that inflation is so low that the Reserve Bank needs to motivate people to spend more money.

When you have interest rates going down, it almost is forcing people to say, “It’s not making sense for me to have money in the bank anymore”, so they start spending it on everything from assets to a new outfit.

One of the other factors behind this because lending restrictions are not likely to get any easier in the short-term, which will stymie in any real growth in the property market.

However, before they start cutting the cash rate to zip, I believe the order of economic stimulation will likely be personal and business tax cuts first, then reducing interest rates.

At the end of the day, small businesses are the backbone of the Australian economy so incentivising them to employ more staff will have a positive impact on the health of the economy.

Trigger timing

The thing is, the cash rate is 1.5 per cent, which means the Reserve Bank doesn’t have much left in the tank to stimulate the economy – contrary to the big rate drops that happened after the GFC more than a decade ago now.

So, there has to be a multi-faceted approach to kickstart the economy, that is more than just reducing rates by a few hundred dollars per month for most borrowers.

Recent data suggested that we are in a technical recession, according to per capita measures, with the economy declining by 0.2 per cent in the three months to the end of the year, following a 0.1 per cent decline in the three months to September.

Yet, the latest commentary from the Reserve suggests that rate cuts are not imminent.

In my opinion, I believe they are waiting until economic indicators are more concerning before pulling the trigger.

That’s because, if they cut the cash rate by 25 or 50 basis points now it’s probably not going to make much of a difference to the economy without the other elements, such as tax cuts, also in play.

It’s almost like they are keeping their cards close but are ready to make a move as soon as necessary.

The property price contractions in some of our major cities clearly are impacting consumer confidence.

That’s because if the value of your home has reduced, people feel poorer, so they don’t go on that holiday or eat out at that restaurant.

However, at the moment, the employment sector remains robust – especially in Sydney and Melbourne.

If that situation changes, though, then that is when stimulatory measures will need to be put into practice.

But where not in that situation yet – regardless of what the headlines might be shouting at us.

Market opportunities

As I’ve mentioned before, there remains myriad property investment opportunities, which won’t disappear just because interest rates drop.

There is a plethora of investment options in Brisbane, Adelaide, regional Victoria and Hobart, which is where we will likely see growth due to affordability reasons.

These markets also have higher yields, which means if we see interest rates drop it will increase your return on investment.

Those numbers will be attractive to savvy investors because they could either leave their money in the bank and earn a paltry two per cent interest, or they could invest in one of these locations, with long-term growth fundamentals as well as yields of five to six per cent.

As the old saying goes, the smartest investors buy when others are fearful because of the opportunities to cherry-pick the very best properties at bargain basement prices.

While I am predicting that interest rates might hit zero in the next year or two, that state of affairs doesn’t frighten me.

I believe there will be a rate reduction after the Federal Election this year, with another one by the end of the year, so the cash rate will be one per cent.

Next year, well, there are too many variables to accurately forecast what might happen then.

One thing is certain, regardless of who wins the election, no political party wants to be the government in power when Australia’s historic run of strong economic growth comes to an end.

And that means that there is much to gain in the market at the moment, rather than fearfully waiting on the sidelines for a situation that is unlikely to materialise.

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