Financial Management Across a Career in Medicine

1. Financial Management Across a Career in Medicine 2007

2. Before We Begin • McMasters’ Independent Financial Planning is a licenced provider of financial services. AFSL 307248. • The contents of this presentation constitute general advice only. They may not be relevant to your particular circumstances.

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

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

5. Income • Two Types: • ‘Employment Income’ – medical practice • ‘Investment Income’

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

7. Employment Income:Doctors and Non Doctors

8. 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.

9. Investment Income

10. 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.

11. Expenses

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

13. The Two Curves

14. 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.

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

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

17. 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.

18. 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.

19. 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.

20. 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 = $127.50. After tax return = $722.50. • Return on $10,000: • 3.6% in own hands; • 7.2% in SMSF.

21. Case Study - Superannuation • Investment value after year one: • Own hands: $6,360; • SMSF: $9,222.50. • Investment Value after year ten: • Own hands: $10,745; • SMSF: $19,218. • Investment Value after year twenty: • Own hands: $19,242; • SMSF: $43,452

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

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

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

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

26. 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.

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

28. Investment

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

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

31. Optimising Investment (1) • Maddison.

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

33. 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%.

34. 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.

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

36. 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.

37. 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%

38. 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.

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

40. Dollar Cost Averaging – October 1987

41. 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.

42. 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.

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

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

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

46. 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%.

47. 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.

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

49. 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.

50. 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.