Financial Planning, Essentials Edition

Preface x About the authors xi Chapter 1 Personal financial planning 1 Introduction 2 1.1 What is personal financial planning? 3 1.2 Why is personal financial planning important? 3 The increase in numbers in older age groups 5 The increase in longevity 6 Restricted access to the age pension 6 Compulsory superannuation contributions 7 Choice of superannuation fund 7 Retirement benefits provided by many employers 8 1.3 Professional standards for financial planners 9 What is a financial planner? 9 Who can be a financial planner? 9 New standards for financial planners 10 1.4 Understanding risk 10 1.5 Features of the economic environment 13 1.6 The global financial crisis and its impact on Australia 15 1.7 The evolution of the financial planning environment 16 1.8 The regulatory framework that applies to financial planning 18 Regulatory structure and influences 19 The role of ASIC 20 Dispute Resolution Scheme 21 1.9 What investors and financial planners can learn from history 23 Summary 24 Key terms 24 Professional application questions 24 Professional application exercises 25 Case study 1 25 Case study 2 26 Case study 3 26 Appendix 27 References 28 Acknowledgements 29 Chapter 2 Financial planning skills 31 Introduction 32 2.1 Preparing personal financial statements 32 Personal cash flow budget 33 Projected cash flow budget/statement 34 Personal balance sheet 34 2.2 The role of the financial counsellor 35 2.3 Using financial ratios as a planning tool 36 Net worth ratio 37 Liquidity ratio 37 Savings ratio 38 Debt service ratio 38 Personal finances through a business lens 39 2.4 Financial mathematical skills applied in financial planning 40 2.5 Compound interest and the time value of money 40 2.6 Nominal and effective interest rates 46 Credit cards 48 2.7 Net present value 51 2.8 Further applications of the time value of money concept 52 The internal rate of return 52 Fixed-interest securities 54 2.9 Effect of tax and inflation on the rate of return 55 Summary 57 Key terms 57 Professional application questions 57 Professional application exercises 58 Case study 1 60 Case study 2 60 Case study 3 61 Case study 4 61 Appendix 61 References 64 Acknowledgements 65 Chapter 3 Taxation planning 67 Introduction 68 3.1 The Australian taxation system 69 A short history of taxation in Australia 69 Taxation bases 70 Sources of taxation law 70 3.2 The components of taxable income 71 Assessable income 71 Allowable deductions 73 Individual tax rates 74 Residency 75 Tax rates payable by other entities 75 3.3 Calculation of net tax payable for an individual resident taxpayer 76 Tax offsets 76 Levies and charges 77 Taxation of minors 79 3.4 Impact of tax on investment income 80 Interest 80 Dividend income 80 Rental income 82 Income from managed investment schemes 83 Capital gains tax 84 3.5 Taxation planning 87 3.6 Income splitting 88 3.7 Income versus capital growth 88 3.8 Tax structures 89 Sole ownership 89 Partnerships 89 Companies 90 Trusts 91 Superannuation funds 91 3.9 Negative gearing 92 3.10 Salary packaging and remuneration planning 93 Fringe benefits tax 94 3.11 Goods and services tax 98 Summary 99 Key terms 99 Professional application questions 100 Professional application exercises 101 Case study 1 104 Case study 2 106 Case study 3 107 References 107 Acknowledgements 107 Chapter 4 Investment choices 109 Introduction 110 4.1 General attributes of investors 110 4.2 Broad investment classes 111 Cash 112 Fixed interest 112 Property 112 Shares/equities 113 4.3 The risk and return relationship 114 Inflation-adjusted rates of return 114 Definitions of risk 114 4.4 The benefits of diversification 117 How can diversification reduce risk? 117 Diversification across asset classes 119 Application of the diversification decision 120 4.5 Recent performance of asset classes 124 4.6 General investment strategies 125 Matching investors to products 126 4.7 Behavioural finance 127 Loss aversion 128 Herding 129 Overconfidence 129 Biased judgements 130 4.8 Investment scams 131 Bushfire relief scam 131 Other scam 131 4.9 Information sources for investment choices 132 Summary 133 Key terms 133 Professional application questions 133 Professional application exercises 134 Case study 1 135 Case study 2 136 References 137 Acknowledgements 137 Chapter 5 Fixed interest, shares and property 139 Introduction 140 5.1 Cash and fixed-interest securities 141 5.2 The nature of, and participants in, the fixed-interest market 141 The nature of fixed-interest markets and products 141 Participants in the fixed-interest markets 143 5.3 Different forms of fixed-interest investments 143 5.4 Discount and coupon securities and a change in interest rates 148 Discount and coupon securities 148 The effect of a change in interest rates 150 5.5 The nature of, and participants in, the share market 151 The nature of the share market 151 Participants in the share market 153 5.6 The influences on share prices 153 Analysis of share prices 153 Accessing the share market 158 5.7 The capital asset pricing model (CAPM) 159 5.8 Basic valuation models to value shares 161 Price–earnings ratio 161 Dividend yield ratio 162 The residual income model 163 ‘Growth’ versus ‘value’ investment 164 5.9 Alternative direct investments 166 Other markets 166 Ethical investment 166 5.10 Qualities and characteristics of property 167 5.11 Different forms of property investment 167 Direct property investment 168 Indirect property investment 168 Residential property 168 Commercial property 169 5.12 Features and benefits of property funds 169 Real estate investment trusts 169 Unlisted property trusts 170 Property syndicates 170 Property securities funds 170 Mortgage funds 171 Mezzanine funds 171 Hybrid funds 171 Unit pricing of property funds 171 Summary of benefits of investing in a property fund 172 5.13 Taxation of property investments 173 Tax advantages of a property fund 173 Tax-advantaged distributions 175 The impact of tax deferral 175 5.14 Property valuation methods 177 Estimating a market value 177 Net present value investment analysis 177 Summary 179 Key terms 179 Professional application questions 179 Professional application exercises 180 Case study 1 181 Case study 2 182 References 182 Acknowledgements 182 Chapter 6 Managed funds, leveraging and buying a house 183 Introduction 185 6.1 Characteristics of managed funds 185 Characteristics of managed funds 185 6.2 The regulation and structure of managed funds in Australia 187 The regulation of managed funds 187 6.3 Investing into managed funds —advantages, downsides and risks 189 Advantages of investing in managed funds 189 Downsides of investing in managed funds 190 Risks of investing in managed funds 190 6.4 Typical fee structures of MISs 191 Types of fees 191 Indirect cost ratio 191 6.5 The differences in managed funds 192 Investment objectives 192 Listed and unlisted managed funds 192 Types of investments undertaken by funds 194 Retail and wholesale managed funds 198 Investment structures and platforms 199 6.6 Measuring returns and analysing the performance of managed funds 200 Measuring returns from a change in unit price 200 Analysing and assessing managed fund performance 201 6.7 Leveraged investing 204 6.8 Gearing, income taxes and geared investments 204 Positive gearing 205 Negative gearing 206 Risks of negative gearing 207 Gearing ratio and loan-to-valuation ratios 207 6.9 Margin lending 208 Safety margin 209 Margin calls 209 6.10 Benefits and risks of margin lending 210 Benefits of margin lending 210 Risks of margin lending 211 Derivatives 212 6.11 Mortgages 212 6.12 Advantages and disadvantages of home ownership 213 Advantages of home ownership 213 Disadvantages of home ownership 214 6.13 Financial implications of home ownership versus renting 214 6.14 Financing a house purchase 216 Matching financial capacity to borrowings 216 Loan types 217 Home equity conversion loans 217 Interest rates and repayments 218 Summary 220 Key terms 220 Professional application questions 221 Case study 1 225 Case study 2 226 References 227 Acknowledgements 227 Chapter 7 Risk management and insurance 229 Introduction 230 7.1 Risk and risk management 231 7.2 Key concepts in insurance 232 The pooling of risk 232 The insurance marketplace 233 Insurance policies and the principle of utmost good faith 234 Terms, standard terms and severity limitations 236 7.3 Life, disability, trauma and health risks 239 Identification of personal risks 239 Evaluation of personal risks 240 Control measures for personal risks 243 Financing of personal risks 243 7.4 House and contents risk management 257 Identification of house and contents risks 257 Evaluation of house and contents risks 257 Control measures for house and contents risks 257 Financing measures for house and contents risks 257 7.5 Motor vehicle risk management 259 Identification and evaluation of motor vehicle risks 259 Control measures and financing for motor vehicle risks 259 7.6 Other insurances 260 Sickness and accident insurance 260 Consumer credit insurance 261 Travel insurance 261 7.7 Liability risk management 261 Identification and evaluation of liability risks 262 Control measures and financing for liability risks 262 7.8 Implementation and review 263 Summary 264 Key terms 264 Professional application questions 265 Professional application exercises 266 Case study 268 References 269 Useful websites 269 Acknowledgements 269 Chapter 8 Superannuation 271 Introduction 272 8.1 What is superannuation? 273 Why the need for superannuation? 273 8.2 The three pillars policy of superannuation 274 8.3 The legislative context for superannuation 274 8.4 Types of superannuation funds and who provides them 276 Accumulation accounts and defined benefit schemes 276 Major providers of superannuation funds 278 8.5 History of superannuation in Australia. 279 From white collar to blue collar to no collar 279 The need to stay in the workforce longer 280 Taking lump sums from superannuation 280 The tax-concessional environment — do we control the inputs or the outputs? 280 Is everybody treated equally? 281 8.6 Superannuation contributions 283 Overview of concessional and non-concessional contributions 283 Types of concessional contributions 284 Non-concessional contributions 288 Spouse contribution tax offset 288 Choice of fund 291 Bankruptcy provisions 291 Contributions overview 291 8.7 Investment and superannuation 293 Investment objectives and strategies 293 Investment choices 294 Investment restrictions 294 Investment performance 295 8.8 Taxation of superannuation funds 295 Assessable income 296 Allowable deductions 297 Taxable income 297 8.9 Relationship breakdown and the splitting of superannuation 298 8.10 Fees and charges 299 Superannuation fees and charges 299 8.11 How much will I accumulate in superannuation? 300 Summary 303 Key terms 303 Professional application questions 305 Professional application exercises 306 Case study 307 Appendix 308 References 314 Acknowledgements 315 Chapter 9 Retirement planning 317 Introduction 318 9.1 What is retirement planning? 319 Individuals’ needs in retirement 319 9.2 The three phases of retirement 320 The active phase of retirement 320 The passive phase of retirement 320 The support phase of retirement 320 9.3 Funding retirement 320 9.4 Ordinary money versus superannuation money 323 9.5 Options that a member has upon retirement with their accumulated superannuation funds 325 9.6 Implications of the transfer balance cap 326 9.7 Withdrawing a lump sum in order to fund retirement 326 Superannuation death benefits payable as a lump sum 328 Splitting the lump sum as a result of divorce or separation 329 Re-contribution of a lump-sum withdrawal 330 Employment termination payments (ETP) 330 9.8 Sources of income streams in retirement 332 Source of income in retirement 332 9.9 Main forms of retirement income streams 332 Determining income levels for account-based income streams 334 Taxation of retirement income streams 335 Pension tax offset 337 Taxation of retirement income streams on death 337 Choosing between an account-based and non-account-based income stream 337 The use of annuities to provide retirement income 337 Life expectancy 338 9.10 Other income support available in retirement 340 The assessment of superannuation accounts for Age Pension purposes 340 Treatment of superannuation where a member is under age-pension age 341 Treatment of superannuation where a member is of age-pension age 341 9.11 What is an adequate retirement income? 346 Summary 348 Key terms 348 Professional application questions 349 Professional application exercises 350 Case study 351 References 352 Acknowledgements 352 Chapter 10 Social security 353 Introduction 354 10.1 History of social security in Australia 354 Rationale underlying the provision of social security 355 10.2 Centrelink and Services Australia 355 10.3 The range of social security benefits 356 10.4 Pension and allowance benefit entitlements and eligibility rules 358 Pension and allowance benefit entitlements 358 Pension and allowance benefit eligibility rules 359 10.5 Assistance provided to retirees 359 Age test eligibility for the age pension 359 10.6 Means testing 360 Assets test 360 Income test 362 Means testing of allowances 367 10.7 Assistance provided to families raising children 367 Family tax benefit part A 368 Family tax benefit part B 368 Parental leave pay scheme 369 Child care subsidy 369 10.8 Assistance provided to those with disability or impairment 371 Disability support pension 371 Carer payment 371 10.9 Support for those undertaking study or an Australian apprenticeship 372 Austudy 372 Youth allowance 372 10.10 Taxation of pensions and allowances 373 Seniors and pensioners tax offset (SAPTO) 373 10.11 Accommodation in retirement 374 Special residence 374 Aged care accommodation 377 Summary 380 Key terms 380 Professional application questions 381 Professional application exercises 381 Case study 1 383 Case study 2 383 Case study 3 384 References 384 Useful websites 385 Acknowledgements 385 Chapter 11 Estate planning 387 Introduction 388 11.1 Obligations of the financial planner 389 11.2 The role of a will within estate planning 390 Drawing up a valid will 390 Rights of beneficiaries 393 Contesting a will 393 11.3 Dying intestate 395 11.4 Estate planning and taxes 396 Capital gains tax 396 The 3-year rule 397 Stamp duty 398 11.5 Estate planning and trusts 398 Essential elements of a trust 398 How a trust is controlled 399 Types of trusts 399 Use of trusts in estate planning 399 11.6 Superannuation death benefits 402 Binding death benefit nominations 402 Who can you leave your superannuation to? 402 Taxation of superannuation death benefits 403 11.7 Power of attorney 405 Types of powers of attorney 405 Executing a power of attorney 406 Cancelling a power of attorney 406 Choosing a power of attorney 407 Issues to consider in appointing a power of attorney or medical decision maker 407 Summary 408 Key terms 408 Professional application questions 409 Professional application exercises 410 Case study 1 412 Case study 2 413 Case study 3 414 Appendix 415 References 415 Useful websites 416 Acknowledgements 416 Chapter 12 Development of a statement of advice 417 Introduction 418 12.1 Regulation of financial advice 419 12.2 Disclosure documents required in respect of the provision of financial products 419 Financial services guide (FSG) 420 Statement of advice (SOA) 420 Product disclosure statement (PDS) 420 12.3 The legal obligations relating to the provision of financial advice 421 Best interest duty and safe harbour provisions 421 12.4 When is an SOA required and what is its purpose? 426 12.5 When is an SOA not required? 426 The obligations relating to the provision of further advice 427 12.6 Types of SOAs 427 12.7 The importance of effective communication in an SOA 429 12.8 The importance of the planner–client relationship 430 Obligations at the initial client meeting 430 12.9 The 6 steps of the financial planning process 432 Step 1. Gather client information 432 Step 2. Establish financial goals and objectives 435 Step 3. Analyse data and identify financial issues 436 Step 4. Prepare and develop the SOA 436 Step 5. Implement the agreed‐upon recommendations 437 Tax (financial) advice 437 Step 6. Review and revise the SOA 438 12.10 Ethical and legal compliance issues 438 Client records 438 Disclosure of remuneration 439 12.11 Important components of an SOA 440 The main components of an SOA 440 Other disclosure requirements 443 Summary 445 Key terms 445 Professional application questions 445 Professional application exercises 446 Case study 1 449 Case study 2 451 Appendix 12A 456 Appendix 12B 456 Appendix 12C 464 Appendix 12D 465 References 479 Acknowledgements 480 Future skills guide 481 Index 519