Bottrell Financial Planning Newsletter – November 2022
Welcome to our newsletter. While the race that stops a nation is always a highlight of early November, on the economic front the Labor government’s first Budget, handed down in late October, has been a talking point.
Treasurer Jim Chalmers’ first Budget was delivered against a backdrop of continuing turmoil on the global economic front. The UK reversed its promised tax cuts that spelled the end of Liz Truss’ brief tenure as Prime Minister. She was replaced by the more economically credible Rishi Sunak. In the US, media reports suggested the US Federal Reserve will scale back its aggressive interest rate hikes in December. Both events were welcomed by financial markets, but the same challenges remain. Escalating war in Ukraine, energy supply shortages, rising inflation and interest rate hikes to fight it, still point to a likely recession in the US and elsewhere. Oil prices continue to rise as OPEC restricts supply, with Brent Crude up about 13% this month, but recession fears are moderating the price pressures.
In Australia, economic signals are mixed. Reserve Bank assistant governor, Luci Ellis said in a speech that Australia’s ‘’neutral” cash rate should be at least 2.5%. The rate is already at 2.6% after a 25-basis point rise this month, but further increases are expected. Unemployment rose slightly to 3.5% in September, perhaps indicating labour shortages are easing. The ANZ-Roy Morgan consumer confidence index slipped below its 2022 average of 90.3 on recession fears and the falling Aussie dollar. The dollar fell another 2c to around US63.2c in October. Businesses are more optimistic, with the NAB business conditions index up 3 points to a 15-month high of 25 points in September.
Federal Budget 2022-23: From a tax perspective
Quiet on the tax front, for now
For once, tax measures took a back seat in a Federal Budget, with the second version for this year being billed as a “solid and sensible Budget suited to the times”.
The October 2022 Budget resisted the recent trend to continually tinker with our tax system, but it seems likely this steady-as-she-goes approach won’t last long, with the new Treasurer, Jim Chalmers, repeatedly referring to the need for tax reform in the days prior to delivering his first Budget.
Tax was not entirely forgotten, however, with the ATO to extend many of its tax compliance programs, a new focus on multinational corporate tax and higher fines for tax breaches.
ATO compliance focus
The ATO was a big winner in the Budget, receiving extra funding to help it achieve higher levels of tax compliance.
The tax regulator will receive $80.3 million to extend its current Personal Income Tax
Compliance Program for two years from 1 July 2023. This program will focus on overclaiming tax deductions and incorrect reporting of income.
The ATO also received additional funding for its Shadow Economy Program and Tax Avoidance Taskforce, with additional compliance activities in these areas expected to raise $3.7 billion over four years.
Tax penalty increases
Fines for breaches of the tax and financial laws will rise from 1 January 2023.
The current fine of $222 per penalty unit will rise to $275 per penalty unit, with fines to be indexed in line with the CPI again from 1 July 2023. This increase is expected to raise an additional $31.6 million over four years.
Multinational tax measures
The Budget included measures designed to close tax loopholes and ensure multinationals pay their fair share of tax in Australia. The multinational tax integrity package is expected to raise around $1 billion over 4 years.
The government also intends to focus on working with other countries to reform the international corporate tax system to “better address the challenges arising from digitalisation and globalisation”.
Electric vehicle buyers
More small businesses may be tempted to go electric with their vehicles, with the $345 million Electric Car Discount to exempt eligible electric vehicles from fringe benefits tax (FBT) and the 5 per cent import tariff.
On an electric car valued at about $50,000, the new FBT exemption will save an employer up to $9,000 a year. For individuals using a salary sacrifice arrangement, the saving could be up to $4,700 a year. As an additional sweetener, customs duties of up to $2,500 are also being removed if the vehicle was previously subject to an import tariff.
Supporting small business well-being
Small businesses have not been forgotten entirely, with the Budget providing $15.1 million in additional funding to extend the small business mental health and financial counselling programs, NewAccess for Small Business Owners and the Small Business Debt Helpline.
Almost $63 million in new grants will also be available to small and medium-sized businesses so they can improve their energy efficiency and reduce their energy usage by investing in energy efficient upgrades.
Lower eligibility age for downsizer contributions
The super system was given a break from its endless reforms, with only a minor tweak to the existing rules.
The Budget included a measure to allow more people to make downsizer contributions into their super accounts by reducing the minimum eligibility age from the current 60 to 55 years of age. Older Australians will also be encouraged to downsize by exempting their home sale proceeds from pension asset testing from the current 12 months to 24 months.
End of tax offsets and low-income payments
A noticeable absence from the Budget was new tax offsets and payments to lower-income earners.
There was no extension of the previous Low and Middle Income Tax Offset (LMITO), which means eligible taxpayers will no longer receive the offset when lodging their annual tax return. The Coalition’s one-off $420 cost-of-living offset was also not renewed.
Mortgage vs super
With interest rates on the rise and investment returns increasingly volatile, Australians with cash to spare may be wondering how to make the most of it. If you have a mortgage, should you make extra repayments or would you be better off in the long run boosting your super?
The answer is, it depends. Your personal circumstances, interest rates, tax and the investment outlook all need to be taken into consideration.
What to Consider
Some of the things you need to weigh up before committing your hard-earned cash include:
Your age and years to retirement
The closer you are to retirement and the smaller your mortgage, the more sense it makes to prioritise super. Younger people with a big mortgage, dependent children, and decades until they can access their super have more incentive to pay down housing debt, perhaps building up investments outside super they can access if necessary.
Your mortgage interest rate
This will depend on whether you have a fixed or variable rate, but both are on the rise. As a guide, the average variable mortgage interest rate is currently around 4.5 per cent so any money directed to your mortgage earns an effective return of 4.5 per cent.i
When interest rates were at historic lows, you could earn better returns from super and other investments; but with interest rates rising, the pendulum is swinging back towards repaying the mortgage. The earlier in the term of your loan you make extra repayments, the bigger the savings over the life of the loan. The question then is the amount you can save on your mortgage compared to your potential earnings if you invest in super.
Super fund returns
In the 10 years to 30 June 2022, super funds returned 8.1 per cent a year on average but fell 3.3 per cent in the final 12 months.ii In the short-term, financial markets can be volatile but the longer your investment horizon, the more time there is to ride out market fluctuations. As your money is locked away until you retire, the combination of time, compound interest and concessional tax rates make super an attractive investment for retirement savings.
Super is a concessionally taxed retirement savings vehicle, with tax on investment earnings of 15 per cent compared with tax at your marginal rate on investments outside super.
Contributions are taxed at 15 per cent going in, but this is likely to be less than your marginal tax rate if you salary sacrifice into super from your pre-tax income. You may even be able to claim a tax deduction for personal contributions you make up to your annual cap. Once you turn 60 and retire, income from super is generally tax free. By comparison, mortgage interest payments are not tax-deductible.
Personal sense of security
For many people there is an enormous sense of relief and security that comes with having a home fully paid for and being debt-free heading into retirement. As mortgage interest payments are not tax deductible for the family home (as opposed to investment properties), younger borrowers are often encouraged to pay off their mortgage as quickly as possible. But for those close to retirement, it may make sense to put extra savings into super and use their super to repay any outstanding mortgage debt after they retire.
These days, more people are entering retirement with mortgage debt. So whatever your age, your decision will also depend on the size of your outstanding home loan and your super balance. If your mortgage is a major burden, or you have other outstanding debts, then debt repayment is likely a priority.
All things considered
As you can see, working out how to get the most out of your savings is rarely simple and the calculations will be different for everyone. The best course of action will ultimately depend on your personal and financial goals.
Buying a home and saving for retirement are both long-term financial commitments that require regular review. If you would like to discuss your overall investment strategy, give us a call.