Too much income......

[The Falcon]

Thought that would get your attention

Last time I was posting on this site was 3 years ago, when my wife and I were intending to purchase our first IP. Heres the thread

http://somersoft.com/forums/showthread.php?t=

In the end, after engaging BA, lining up loan and looking at properties we just couldn't find value (in our view) so decided to discontinue the search. By way of background, in July of 2010 I started a company with a business partner and that was also taking a lot of my time, so that also figured into the decision making process.

2.5 years ago we fell in love with a house and bought it as our PPOR, and sold our previous PPOR which was a unit. We have made no investments since that point.

Our sole investment is a shareholding in the company I cofounded, which is held by our family trust. Fortunately, the performance of that business has been beyond all expectations with franked dividend payments of 60k in FY 13 and we are on track for a significantly larger dividend in FY14. It is our expectation that earnings will continue to grow strongly in coming years and top out in the 200-300k PA franked range within 5-7 years time. In addition, we have salary income as below :

1 @ 185k PA
1 @ 75k PA

Where this brings us now is that at some point PPOR will be paid off, and we will have income surplus to requirements. Accordingly, we will want to establish a structure for investment purposes. I'd like to be clear that my investment strategy is fairly conservative, and at this stage does not include any direct resi property outside of the PPOR.

Having said that, my view of investment is very much along the lines of Peter Thornhill, but with International exposure and 30% fixed interest, so this slow and patient approach lines up with the way a lot of IP investors think.

I am thinking growth assets (ie. equities / REIT) held by a Trust and cash / fixed interest held by a Pty Ltd as there is no CGT discount for company. I would imagine the flows would go something like this :

Growth Assets :
Franked dividends via Trust, to adult beneficiaries, top up tax paid in the hands of adult beneficiaries, post tax funds returned to trust for investment in growth assets

Income Assets:
Franked dividends via Trust to Pty Ltd, tax paid in the hands of Pty Ltd via franking credits, funds held in cash / fixed interest.

Now I have some questions :

- We already have a trust structure with corporate trustee established to hold shares in my business. Is it wise to create another separate trust structure along with Pty Ltd for above purposes - ie. to grow assets ?

- how would income streaming (cash/fixed interest) take place ex this Pty Ltd to beneficiaries? back through the trust I presume, not via dividends to shareholder beneficiaries?

I am very keen for input from people in the know, so far we need all the dividend income to pay down our PPOR (our choice) but at some point that will stop and we need to invest. Accordingly, want to get my head around this now so I can discuss with my accountant.

Many thanks guys.

 

[Aaron_C]

Best not for the business entity to also hold the investment assets as they are very different risk profiles.

 

[The Falcon]

Hi Aaron, The business entity won't hold any assets as I am not sole shareholder.

I am talking about a seperate pty ltd which would be investment vehicle linked to discretionary trust.

 

[Aaron_C]

Oh sorry yes if the family trust held the assets that would be OK but I think it best to keep it separate. Reason being if you want to leverage it's best not to compromise the trust's other assets like shares in a business.

 

[geoffw]

As you're asking questions in a property investment forum, I think it's fair to ask why you wouldn't be considering real estate as a part of your investment strategy. You have the luxury of funds available, you are in a good position to mix.

I'd be thinking that you couldn't- or would not be wise- to link two Pty Ltd companies to a single trust. If it was a duplication of what you have- trust with PL trustee- distribution would be the same as you currently have.

While it's good to talk with your accountant about structure, I suspect that you would also be wise to talk to a financial planner, especially about structures- and one who would look at properties in the mix. He may have other ideas- for some people a self managed super fund may be appropriate (depending on circumstances, age etc) as a way of protecting assets and reducing tax liabilities.

 

[The Falcon]

Hi Geoff, fair question....We already have $1.2M exposure in the form of our PPOR. So currently its our biggest asset class behind private equity (operating business). Yes I now realise I will need to have a chat with a few planners as there are a few balls in the air

 

[handyandy]

I would be of the opinion that you can use your current trust to hold equities.

The equities risk is the same as your business shares as long as neither the business shares nor the equities have any loan exposure. If you were to get into margin loans than I would strongly suggest that another trust be used.

The problem with margin loans is that they invariably want directors guarantees so it's really hard to limited liability exposure.

The Pty Ltd company you mention to distribute excess income should not, under any circumstances, be the trustee company.

Ideally the shares in the Pty Ltd would be held by another trust. In this way you can hold the income in the Pty lTd with franking credits until you want to distribute them via dividends. It's the only way to get money out of Pty Ltd. The assets in this company are safe because all shares in company held by a trust that has no liability exposure.

Have you thought about reducing your income and streaming more into super.

Even reducing your income and taking that income as dividends into the trust etc will limit the tax to the company tax level rather than the highest marginal tax you would be paying now.

We also bought a property from which the company operated. Subsequently this became an CIP when we ceased operating our business.

Any property purchases should be in a separate trust as property as a liability issue ( you can get sued ) and as such does have a completely different risk profile.

All trust should have separate trustee companies so that it is clear when the trustee is acting for the trust. If you share trustee then you will need to document whenever the trustee is acting for one or another trust.

Cheers

 

[The Falcon]

Thanks Andy, I appreciate that. Makes sense.

 

[TPI]

Erko,

In your case it may be ok to have your growth investments in the same trust as your business, but you might need to check this with your accountant/solicitor to be sure.

Holding fixed interest in a new Pty Ltd (not a trustee company) may be ok, but I wonder whether this will be overkill unless you have a lot of money held in fixed interest and the costs of the structure (including additional tax return costs) justify it.

Also note that if you later decide to hold bonds as part of your fixed interest portfolio, these have some potential for capital gains.

If you have a lot of dividend income in the trust then you can move excess income after distributing to other trust beneficiaries to the Pty Ltd.

Having a trust as a shareholder of the Pty Ltd would make sense as handyandy describes.

 

[The Falcon]

Appreciate your input TPI.

There is a lot to be said for simplicity and keeping an eye on costs. As is, there is already one trust and a corporate trustee.

Post tax, the majority of dividend income which is surplus will go to diversified ETF / Wholesale Index fund portfolio so that side of things will be straight forward from a tax perspective. I intend to this to be held by "Trust A", which also holds our shareholding in the business. Per your suggestion, there may not be a need for a Pty Ltd company, as its better to reinvest in growth assets, which pay dividends rather than leave in cash. The ETFs / MFs distribute regularly so we will have access to cash as required without need to sell.

 

[TPI]

ETFs/index funds sound like a good move as it would seem that your energies would be most rewarded by focusing on your business rather than stock picking.

I personally think a 30% allocation to fixed interest is a bit high, but this largely depends on your age/risk tolerance/personality/circumstances etc.

Liquidity comes in a number of forms, and as you say regular distributions from ETFs can provide that to some extent if needed.

 

[The Falcon]

Spot on TPI. I have no interest in stock picking nor direct resi, I have learned to do what you are good at and what interests you. When the business is providing 500k pa gross in salary and divvies which it will be shortly, that must be my main focus. I am also considering negotiating with Vanguard/DFA on their wholesale diversified growth products. Then I don't need to be concerned with portfolio rebalancing / asset allocation. I can live with 7%+ net of fees with 30-40% franking over 10+years

 

[handyandy]

Sorry, but it sounds like you are quoting straight out of the financial advisers hand book. Worse it seems to be the clique's section.

My personal experience is that funds will give very mediocre results and worse almost immediately adjust their returns based on current investment returns.

What I mean by this is when markets are good they follow the market and returns are good. As soon as the markets turn down not only is there no capital growth (read losses) but there are suddenly no dividend returns. Worse is that there are constant fees whether there is a profit or loss.

I have found that the best performers have been higher dividend (but not above market) shares, as even when their share price is down they still maintain a steady income stream.

If you are not prepared to work at property or even share trading then I would suggest that you simply pick a selection of dividend paying shares and invest directly.

If you feel that you need to have a balanced approach then you can simply base your share criteria on different sectors.

This is the approach that I have used in my super fund and my shares have outperformed any managed funds that I have held, both directly and in the superfund, over the same time.

I appreciate the concept of concentrating on your business but I still think that you are dismissing a major contributor to the building of wealth by ignoring property. There are many different ways to approach property investing and with the resources that a successful business can provide should be able to manage a substantial portfolio over time.

One person on this forum is 'Ace in the hole' who is running a successful business and has established a substantial resi property portfolio by building new. We also have Dazz who established a substantial CIP portfolio whilst employed in a high level engineering job.

I myself established a property portfolio whilst in exactly the same position as you describe. My gross was somewhat higher and I didn't have a business partner but I always had the view that I wanted investments that would replace my income from the business.

Cheers

 

[The Falcon]

H.A., you misunderstand me....you are preaching to the converted

I am not talking about actively managed index huggers at 2% fees with a high stock turnover (portfolio churn...with CGT exposure due to trading)....quite the opposite. I am talking about index based passive funds with costs below 0.50% with no active trading, in set asset allocations, or alternatively doing the same thing with ETFs and LICs..I'd suggest in time I will use all 3. Appreciate your comments though H.A. Cheers.

 

[TPI]

Spot on TPI. I have no interest in stock picking nor direct resi, I have learned to do what you are good at and what interests you. When the business is providing 500k pa gross in salary and divvies which it will be shortly, that must be my main focus. I am also considering negotiating with Vanguard/DFA on their wholesale diversified growth products. Then I don't need to be concerned with portfolio rebalancing / asset allocation. I can live with 7%+ net of fees with 30-40% franking over 10+years

Fair enough.

Keep an open mind though, you may get more comfortable with direct shares and direct property later on.

When I started investing in shares I initially invested in managed funds, then moved on to index funds, then DFA's index funds, then ETFs, then LICs.

Now I only invest directly in individual shares (on the ASX).

I initially only invested in this way in my own name with cash, then also in my SMSF with cash, then also in my family trust with cash and borrowings (against property), and now in my family trust with cash, borrowings and margin loans.

It's just a matter of reading and educating yourself, gradually pushing your comfort zones and risk tolerance, and developing a simple system that you can understand and is easy for you to implement (like handyandy describes in his post).

Right now I think it's more important to be in the market rather than out - and if it's easiest for you to go down the index fund/ETF route, then that's better than not being invested at all.

And even if you have a dislike for residential investment properties, I think there is always some merit in having a few of these that you can either downsize to later on in life after selling your PPOR CGT-free, and/or pass on to your kids as an inheritance or earlier when they move out of home.

If your business goes really well, then you may have enough cash flow and equity to invest in commercial property too.

 

[The Falcon]

Just wanted to post a quick note of thanks Handyandy and TPI. Your input was very good.

I've gone with a long term direct share strategy, (inc. large LICs when can be had at significant discount to NTA) and complemented by ETFs for sector specific. Have gone down the maximum salary sacrifice route into SMSF (both incomes) using same strategy as above which works nicely with dividend distribution from trust. Major focus is on ongoing, growing franked dividend streams and happy to say I don't follow the market noise around price.

Will continue to follow the IP situation, you never know I might get involved at some point. Thanks again.

 

[TPI]

Thanks for the update Erko, looks like a good strategy.

 

[redwing]

Hi Erko, HandyAndy & TPI

Just reading this <older> post and wondering how are things travelling now with all of you and the strategies within

 

[danwatto]

Well done on the business, not many start out and do that we'll I'm sure it's been alot of hard work to get there too.

On investing I have to agree with others that being a property forum we have to mention property could suit you as well, including reducing the tax you pay on all that income.

While you mention 1.2m exposure in property is kind of true, a PPOR is not an investment it's a lifestyle asset in my opinion.

Being conservative, and investing in property are not two different things at all. It's true property doesn't always go up, but it also depends on your time frame. If you're investing for 15-20 years like most then it's very hard to go wrong.

Personally I'd put the PPOR outside of investment decisions and then calculate your asset mix excluding it. For a small deposit and a little leverage you could hold 1 or 2 direct IPs, use depreciation to reduce your tax and cover the expense bills, and put the rest in the other asset classes.

Another question is - why is fixed interest being considered prior to retirement phase? Another tax effective alternative would be an offset account until it's maxed and then reinvest.

 

[The Falcon]

Redwing, I am still on track as per last post.....geez the original post was a long time ago and I didn't have much of a clue. Things have moved along quite well, By way of reference household income was $344k last FY, will be $404k this FY and tracking to $470k approx. next FY (I've got forward visibility of divis )

SMSF, fully salary sacrifice ($60k pa now) mostly ASX stocks, target allocation 80/20 Oz/Intl, due to tax treatment of franked dividends in super. If I look at the portfolio today is a mix of LICs (ARG/MLT/BKI) bought at discount, Some ETF's (VAS/VHY/VTS/IXI) and some direct shares CBA/BHP/SOL/WES/WOW. Picked up WPL recently in the sell off as well, and MPL in the IPO. Some of these holdings are geared via Macquarie equity lever margin at low LVRs. I'll probably pay out the margin on these in coming months, margin really doesn't work too well in such a low tax environ.

In family trust, which is fed by PPOR LOC (bought a new PPOR $1.52M in Sept.) the allocation is about 50/50 AU/US. In the AU part of the portfolio, there are the usual LICs and ETFs as well as a fairly large holdings in MPL (via broker firm bid process) and SVW. Also picked up STO 2 weeks ago in the sell off. The US component largest holding is BRK.B then the likes of MKL, GLRE, Y. Bought CBI as a long term energy play in the recent sell off. Can afford to be neutral or a bit negative on this part of the portfolio due to trust has a lot of other income.

This part of the portfolio has really held the thing up, really shows the importance of diversification across markets and currency. Overall return 7.43% YTD net of all costs as of last night, but short term results don't matter. Just focussing on paying down PPOR and dragging some, but not all of that equity out.

I'll be looking for emerging market opportunities next year and will increase my tilt to this and US Small caps in coming years.

@ Danwatto - will be looking for Sydney semi blue chip resi IP when I see the market turn...maybe 3-4 years? I'll have approx. $200k equity put aside for deposit 1 property.Re fixed interest, well that was a "dry powder" situation, but yes now I keep equity against LOC for that. The St George Portfolio loan is quite good for quickly moving equity around and freeing it up as required.