On Track To Independence
Personal Investment
Saturday August 31, 1996
When Helen Coles' marriage broke down 18 years ago, her "new life" was a fairly daunting prospect. She was 34, had two young children and a huge mortgage on the family home. She was determined to survive, and naive enough not to see the full extent of her challenge.
Today, buoyed by the fact that she "made it", and armed with plenty of crisis stories, she has to sit down and think about how to manage her achievements: principally a big house with a little mortgage. She needs to work out how to turn that into an investment that will provide her with a steady income when she retires.
Her major asset is her home on Sydney's North Shore. She bought it for $90,000 in 1984 as an investment property, while she retained the family home. She has spent $150,000 on a substantial renovation make-over that has pushed its value beyond $500,000. There were some nail-biting times during the renovation: the builder went bust and Coles was caught in a financial squeeze. Her bank manager was getting edgy about late mortgage repayments, but she couldn't cut any further into the family's living expenses.
She was forced to resolve the crisis in 1986 by selling the family home, just before Sydney's big property boom began. She had hoped to rent it out to cover the payments on the new property, but selling meant that at least part of the strategy was kept in place.
Coles took on the big-house project because it was close to where her children went to school and she added a few more bedrooms in the hope that she might board a couple of foreign students to defray the costs.
For some time now Coles' friends have been offering advice on what they would do "in her circumstances", which are that her children are no longer dependent; that one has left home and the other one is likely to follow, and that she has a challenging, well-paid job.
The advice she has been given includes that she should rent out the spare rooms or take in students; sell the house and buy two units - one to live in and one to rent; or mortgage it to the hilt and buy shares.
Coles qualified as an occupational therapist but after her divorce began training as a secondary school teacher so that her working hours were more compatible with school-aged children. She taught home economics and physical education for several years but then decided on a complete career change and went into publishing as a sales representative. After a few years she returned to an occupational therapy. She now works as a rehabilitation consultant for an independent private company, Vocational Rehabilitation Services. VRS has been going for over 14 years and its main business is getting injured workers back to work as quickly as possible, and introducing occupational health and safety practices into workplaces to curb the number of injuries.
Coles is well paid. She's in the top income bracket and has a serviced company car. But like many women of her generation, particularly those who have had periods out of the workforce to raise children, there's not much superannuation to talk about: $8000 is not much by today's standards.
After meeting all her living expenses, bank mortgages, insurance, rates and everything else associated with keeping a house, Coles estimates she can save $700 a month. But can she possibly turn that into a situation that would pay her the equivalent of, say, $30,000 a year in today's dollars when she retires? And would it mean parting with the house she transformed. Coles says she could part with it, but it is more likely her heart would rule her head and that she would remain asset rich and income poor.
So for a totally independent review of what Coles should do, Personal Investment went to Laura Menschik, the national financial planning manager with Davey Financial Management and chairman of the NSW division of the Financial Planning Association. Menschik has known other women in Coles' situation.
She says the centrepiece of the strategy is that Coles will need about $600,000 worth of financial assets, generating income and providing some growth, to have any hope of reaching that $30,000 target.
This means Coles has to accumulate about $377,000 between now and when she retires, assuming that the present home is sold and that $260,000 is set aside to buy a house or unit for her to live in.
Menschiks' advice to Coles is that she needs to be "firm in her convictions for her future lifestyle and might need to be even more determined in her outlook to achieve what she wants". If the statistics are right, Coles might live for at least 20 years after retirement, a long time to be paying yourself a decent wage.
If Coles kept her home as an investment and bought another, the net yield before expenses would be less than 5 per cent, which then puts a lot of reliance on capital growth to ensure the investment meets her expectations. But Menschik says buying another property would leave Coles heavily overweighted, "with her only form of easy liquidity being refinance should she need money for any unexpected reason".
Another scenario involves selling her current home, which doesn't attract capital gains tax because of the time it was bought. A sale would allow Coles to repay the mortgage (which doesn't currently give her any tax relief) and then buy a unit for, say, $260,000. The balance, probably about $215,000, could be used as an investment portfolio and depending on her preference could be made up of property, shares or managed funds.
Having reached this point Coles would probably find that her living expenses would be a little less than previously and she would also have the $600 a month she used to pay off her old mortgage as well as the $700 or so a month she estimates she can now save. Apart from immediately giving her a bit of freedom to lash out on a holiday if she had the urge, Menschik says she is avoiding any "non-deductible" debt which is not tax-effective, especially as she is on a high marginal tax rate.
Coles might then be able to salary sacrifice some of her "surplus" income - in other words bump up the amount of money she contributes to super. Tax on approved contributions to super is 15 per cent, as opposed to the contributor's own marginal rate as high as 48 per cent.
Having freed up her mortgage commitment, Coles can consider "gearing" or borrowing money for her investment portfolio, either on an interest only or principal and interest basis, depending on future strategies. She can improve her cashflow to service these loans by applying to have her PAYE tax deduction altered. This effectively apportions the tax deduction across the whole year, rather than waiting to the end of the year for a lump-sum claim.
Another strategy Coles could consider would be to pay interest only on the loan, target growth investments and get the full tax deduction on payments. Some time in the future Coles might then sell all or part of her investments, repay all interest and with some of the remaining capital make an undeducted contribution into a superannuation fund to get a tax-effective allocated pension to meet here needs in retirement.
Having dealt with the financial approach to Coles' situation, Menschik injected a dose of pragmatism into the scenario. Coles must distance herself from the sentimentality attached to her home and ask whether the return - the combination of net income and growth - is the best investment she can make? She then has to remind herself that property is an illiquid investment and she "can't sell off the lounge room to take a holiday or pay for unexpected capital outlays".
If Coles did want to take in boarders, Menschik says she has to realise that there's a lot of work involved and a big commitment in terms of her own time. On top of that, any income would be taxed at the top marginal rate and the combination of both might dampen her enthusiasm.
And to complete the package, Coles should ensure that her will is current and she has an appropriate power of attorney to take care of her affairs if she travels or has an accident or illness.
© 1996 Personal Investment