Wealth Creation

Strategies for building long-term wealth

2007/2008
This brochure is published by MLC Limited (ABN 90 000 000 402), 105–153 Miller Street North Sydney. It is intended to provide general information only and has been
prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on any advice in this communication, consider
whether it is appropriate to your objectives, financial situation and needs.
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the MLC MasterKey Investment Service.
You should obtain a Product Disclosure Statement or other disclosure document relating to any financial products mentioned in this brochure and consider it before
making any decision about whether to acquire or continue to hold the product. A copy of the Product Disclosure Statement or other disclosure document is available
upon request by phoning the MLC MasterKey Service Centre on 132 652 or on our website at mlc.com.au
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Building wealth with managed
investments
Some people think saving and investing is In this guide we outline ten strategies that
the same thing. But the truth is, each involve investing non-superannuation money
requires a different approach and a different in growth assets using managed investments
way of thinking. such as unit trusts. Together with
superannuation, managed investments can
Saving is simply putting aside some of your
help you reach your long-term goals sooner.
disposable income for a short-term goal,
such as a holiday or a car. It’s a We recommend you speak to your
conservative approach that involves taking financial adviser before acting on any of
very little risk with your money. A bank these strategies.
account or cash management trust is
usually sufficient for this purpose. Important information
Investing, on the other hand, means taking The information and strategies provided in
a measured degree of risk to achieve your
this booklet are based on our interpretation
longer term goals – such as your children’s
of relevant taxation and social security laws
education or your retirement. To do this, you
as at 16 November 2007 .
need to purchase growth assets (like shares
and property) that have the potential to Because these laws are complex and change
make your money work harder. frequently, you should obtain advice specific
Although growth assets are more volatile to your personal circumstances, financial
over the short-term, they have historically needs and investment objectives, before
provided higher long-term returns and are implementing any of these strategies.
generally more tax-effective than other
asset classes, such as cash and bonds.

1
Investment basics
Choosing the right mix of assets can make a big difference
to your investments
Growth assets – such as Australian and global shares and property – have delivered higher
returns for investors over longer time periods (ie seven years or more). However, these asset
classes have also been more volatile than cash and bonds over the short-term (ie one to three
years) as the graph below demonstrates.

Asset class comparison – $10,000 invested

$400,000

$350,000

$300,000

$250,000

$200,000

$150,000

$100,000

$50,000

$0
2001
1991
1985

2005
1983

19 92
1987

1990

1993

1997

2002

2003
1982

1986

1989

2000
1996

1999
1988

1994

1995

1998

2006
1984

2007
2004

Global Shares Australian Property Cash

Australian Shares Australian Bonds Inflation

Note: Year ended 30 June

This comparison is based on historical performance and is not indicative of future performance. Future performance
is not guaranteed and is dependent upon economic conditions, investment management and future taxation.
Source data: Australian Shares: S&P/ASX 200 Accumulation Index (All Ordinaries Accumulation Index prior to
April 2000), Global Shares: MSCI World Gross Accumulation Index ($A), Property: ASX 200 Property Accumulation
Index (Property Trust Accumulation Index prior to July 2000), Australian Bonds: UBS Composite Bond Index – All
maturities (Commonwealth Bank Bond Index prior to November 1987), Cash: UBS Bank Bill Index (RBA 13 Week
Treasury Notes prior to April 1987), Inflation: Consumer Price Index. Assumes income is reinvested.

So ...
If you plan to invest for at least seven years, you may want to consider investing a significant portion
in growth assets. Before you make your investment choice, you should consider your goals,
needs, financial situation and comfort with market ups and downs.
To determine a mix of assets that suits your needs, you should speak to your financial adviser.

2
Contents
Managed investments can help you reach your financial goals 4

Strategies at a glance 5

Strategy 1 Compound returns: the essential ingredient 6

Strategy 2 Growth assets can provide a growing income 8

Strategy 3 A balanced approach beats trying to pick winners 10

Strategy 4 Dollar cost averaging: taking the guesswork out of investing 12

Strategy 5 Income splitting: a simple way to save tax 14

Strategy 6 A tax-effective way to invest for your children 16

Strategy 7 Discretionary trusts: a flexible income splitting alternative 18

Strategy 8 Use borrowed money to build wealth 20

Strategy 9 Use losses to reduce capital gains tax 22

Strategy 10 Defer asset sales to manage capital gains tax 24

Assets: the building blocks for wealth creation 26

FAQs 28

Glossary 31

3
Managed investments can help
you reach your financial goals
Direct versus indirect Over time, unit prices can go up and down,
depending on the changing value of the
investment fund’s assets. However, investment managers
Some people like to invest in shares through generally have professional investment
a stockbroker or the internet. Others like to experts who act on your behalf to reduce the
buy property through a real estate agent. risk of a negative return and help grow your
However, these direct approaches to investment over the longer term.
investing usually require considerable time To find out how much your investment is
and expertise. worth, simply multiply the number of units
A potentially smarter and more rewarding you have by the current unit price.
alternative is to invest indirectly, by purchasing
units in a managed investment. A notable The benefits of
example is a unit trust, which is the focus
of this guide.
managed investments
Managed investments can also be accessed Diversification
via super funds, account based pensions, Even a modest amount of money can be
investment bonds and friendly society bonds. spread a long way to help reduce your risk.
For instance, an investment of $2,000 can
What is a unit trust? provide access to shares, property, fixed
interest and cash, spread across different
A unit trust is a type of managed investment
markets and geographical areas. Some unit
purchased with non-super money.
trusts also diversify across a range of fund
Your money is pooled with other investors to managers with varying, yet complementary,
form a large fund, often exceeding millions of investment styles.
dollars. This pool of money is then managed
by a team of investment experts. Depending Expert management
on the investment objective of the fund you Your money is managed by investment
choose, the money could be invested in professionals who are supported by the latest
shares, property, bonds, cash or a mix of technology and information. Fund managers
these asset classes. and analysts constantly research and monitor
When you invest in a unit trust you are investment markets to help build your wealth.
allocated a certain number of units,
depending on the unit price. The unit price Convenience and ease
reflects the value of the fund’s investments of management
at any particular point in time. For example, Unit trusts are easy to use. Accurate records
if you invest $1,000 and the unit price on are kept (eg for capital gains tax purposes) and
the date of investing was $2, you would be you are informed of the progress of your
issued 500 units. investment on a regular basis.

4
Strategies at a glance
Strategy Key benefits Page

1 Compound returns: the essential ingredient • Maximise the value of your investment 6
• Save in a disciplined way

2 Growth assets can provide a growing income • Generate a growing, tax-effective income stream 8
• Protect the purchasing power of your money
2
3 A balanced approach beats trying to • Achieve more consistent returns 10
pick winners • Minimise investment risk

4 Dollar cost averaging: taking the guesswork • Takes the emotion out of investing 12
out of investing • Save in a disciplined way

5 Income splitting: a simple way to save tax • Reduce tax 14

• Increase the value of your investment

6 A tax-effective way to invest for your children • Reduce tax 16

• Increase the value of an investment for a child

7 Discretionary trusts: a flexible income • Distribute income in a tax-effective manner 18

splitting alternative • Reduce the amount of tax payable as a
family unit

8 Use borrowed money to build wealth • Accelerate the creation of wealth by having 20
more money invested
• Reduce tax on other income through
negative gearing

9 Use losses to reduce capital gains tax • Minimise or eliminate capital gains tax 22
• Free-up money for more suitable investment
opportunities

10 Defer asset sales to manage capital gains tax • Defer the payment of capital gains tax 24
• Reduce your capital gains tax liability

5
 Compound returns:
the essential ingredient
If you start investing now, time can be a 2. Give your investment time to grow
powerful ally. Year after year, the money you by starting your investment as soon as
invest has the potential to earn more money. possible and keep it going for as long as
And if you reinvest your earnings, you can you can.
earn even more money in the future. This is
For instance, if you invest $10,000 at 8% pa
called compounding returns and it's one of
until age 65, the table below shows how much
the keys to making your money work harder.
you would get back, depending on your age
For example, if you invest $1,000 at 10% pa, when the investment is made.
you receive $100 interest during the first year.
But if you reinvest the interest, you will have
Age when you invested the $10,000
$1,100 working for you in year two. If your
20 yrs 30 yrs 40 yrs 50 yrs
investment then earns another 10%, your interest
will come to $110 in the second year, and so on. $319,204 $147,853 $68,485 $31,722

Over a period of several years, compounding

returns can make a significant difference to Note: This example ignores the impact of tax on
your wealth. And the sooner you start investing, investment earnings and inflation.
the more compounding can work to
By simply investing ten years earlier, and
your advantage.
reinvesting your earnings you could more than
double your money!
How does the The rate of return can also make a big
strategy work? difference if you leave your money to
For compounding to work its magic, you need compound over longer time periods (see
to do two key things: case study).

1. Reinvest your investment returns

(eg dividends and interest), rather than spend
it on other things. This will enable you to turn
your investment earnings into capital and
generate even more future earnings. An easy
Strategy # way to reinvest income is to participate in a
dividend, interest or income reinvestment
scheme.

01 6
The benefits
• Build wealth by reinvesting the income from your investments.

• Maximise the potential return by giving your investments time to grow.

Case study
Twin sisters Anna and Ingrid both started an investment plan at age 25. They contributed
Tips and traps
$2,000 a year and reinvested the investment income.
• To maximise the benefits of compounding,
Anna invested her money in a unit trust share fund that earned 8% pa. However, she stopped it’s important to give your investments time
contributing after ten years and left her money in the share fund to grow over time. to grow. This could involve investing from an
early age where you may be able to take
Ingrid, on the other hand, continued investing each year right up until age 65. But she chose
advantage of lower financial and family
a more conservative fund that included cash and bonds and earned 5% pa. commitments. Alternatively, you could
Who do you think ended up with the most at age 65? Anna who only contributed $20,000 consider deferring your financial goals to
or Ingrid who contributed $80,000? increase your investment time horizon.

• Consider increasing the regular

Summary investments as your disposable income
rises. The compounding effect of making
Anna Ingrid additional contributions will assist you in
generating long-term wealth.
Amount invested $20,000 $80,000
Years invested 40 40 • Before embarking on an investment
program, it’s important to seek financial
Annual return 8% 5% advice to ensure your mix of investments
reflects your financial objectives,
You would think Ingrid should end up with more money by investing the extra $60,000. But as investment timeframe and attitude to risk.
the chart shows, Ingrid and Anna's investments grew to $253,680 and $314,870 respectively. It’s also a good idea to review your
financial plan regularly.
That’s a difference of $61,190 in Anna’s favour.
• Investing on a regular basis can enable
Anna vs Ingrid (over 40 years) you to take advantage of dollar cost
averaging – see Strategy 4.

$400,000 • The income distributed by a unit trust

is taxable, regardless if the income is
Anna
received directly or reinvested to compound
$300,000 $314,870
Ingrid your returns. To minimise the amount of
$253,680 tax payable, you could consider holding
$200,000
the investment in the name of a
low-income spouse (see Strategy 5) or
$100,000 using a discretionary trust (see Strategy 7).

$0
25 30 35 40 45 50 55 60 65
Age

Note: This example ignores the impact of tax on investment earnings and inflation.

The reason Anna had a greater account balance was the compounding effect of earning an
extra 3% on her investment each year.
If Anna had also contributed $2,000 a year for 40 years, she would have an account value
of $559,562.

7
 Growth assets can provide a
growing income
Putting money in the bank is safe – or so How does the
it seems. Although your capital is protected,
the buying power of your money is not. strategy work?
The problem is inflation, which drives up the Shares have three major benefits when
cost of goods and eats away at the value of compared to term deposits.
your money.
1. A growing capital value
Remember when a newspaper cost 50 cents Over the long term, shares have provided
and a loaf of bread $1? Now consider what significant capital growth, as a result of
would happen to your money if you invested increasing share prices (see case study).
in a term deposit for the next 20 years. If With term deposits, you invest a dollar and
inflation averaged 3% pa, the value of your get nothing more than a dollar back
term deposit would decline by around 50% in (ignoring interest).
real (inflation adjusted) terms*.
2. A growing income stream
If you want to protect the purchasing power Even if the income from shares is initially
of your money (and the income you receive), lower than a term deposit, it doesn’t
consider investing in growth assets such necessarily stay that way forever. As share
as shares. prices rise, the dividend income typically
* Assumes you don’t reinvest interest received increases accordingly#.
each year.
3. Tax-effective income
The imputation credits that often come with
dividends from Australian shares, can be used
to offset the tax payable on the dividends and
other sources of income. What's more, any
excess imputation credits are usually
refundable (see FAQs on page 28).
# Dividend income may fall if share prices fall.

Strategy #

02 8
The benefits
• Build wealth by investing in growth assets.

• Generate a growing income stream to keep pace with inflation.

Case study
Jack and Vanessa are friends who each had $10,000 to invest 20 years ago. Jack decided it was
important to protect his capital, so he put the money in a term deposit. After seeking advice,
Vanessa invested her money in an Australian share fund via a unit trust. Both used the after-tax
income from their investments to meet their financial commitments each year. The chart below
compares the income they received over this period. Who was the more astute investor? Tips and traps
Income • Purchasing shares through a unit trust
provides greater opportunities and
$3,000
Income from an investment of $10,000 made in June 1987 reduced investment risk. A unit trust
$2,500
provides broad diversification because
your money can be spread over different
$2,000 investments, asset classes, sectors,
markets and fund managers. This degree
$1,500
of diversification is hard to achieve when
$1,000 investing directly.

• A growing income stream is also

$500
favourable in retirement to help ensure
$0 the purchasing power of your money
1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

(and your income) keeps pace with

Australian Shares - Dividends Term Deposits - Interest
Note: Year ended 30 June inflation over the longer term.

• Should you need to sell all or part of

Clearly Vanessa made the right move. Initially, her share fund paid less income than the term
your investment, the resulting capital
deposit but as her capital grew in value, so did her dividend income. By contrast, Jack’s term
gain may be eligible for concessional
deposit paid interest at the prevailing rates, based on the original capital value only.
tax treatment. Provided the asset has
Even more compelling is the growth in capital. Vanessa’s share fund has grown to $53,174 been held for at least 12 months,
(before tax), while Jack simply gets his initial $10,000 back (as the graph below reveals). only 50% of the capital gain is taxable.
However, the benefits of investing in shares would also have been significant, had Vanessa You could also reduce (or eliminate)
and Jack decided to reinvest their pre-tax investment income to compound their returns capital gains tax by using capital
(see Strategy 1). In this scenario, their investments would have been worth $124,462 and losses (see Strategy 9) or deferring
$44,666 respectively. the asset sale to a new income year
(see Strategy 10).
Capital growth • Property investments can also provide
a growing income stream and long-term
$60,000 Capital growth from an investment of $10,000 made in June 1987 capital growth. Investing in property via a
unit trust can provide additional benefits
$50,000
including diversification, lower costs and
$40,000 easier access to your capital, when
compared to investing directly.
$30,000

$20,000

$10,000

$0
2007
1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

Australian Shares - Value Term Deposits - Value Inflation

Note: Year ended 30 June

Assumptions for Income and Capital Growth graphs: Returns are based on the S&P/ASX 200 Index (prior to April
2000 – All Ordinaries Index) and the RBA Banks' Term Deposit Rate (1yr $10,000). This example does not take
into account the impact of fees or taxes on distributed income and capital gains. This example is based on
historical performance and is not indicative of future performance. Future performance is not guaranteed and is
dependent upon economic conditions, investment management and future taxation.

9
 A balanced approach beats trying
to pick winners
Successful investors usually set lifestyle and Year ending Global Aust. Property Aust. Cash
financial goals, invest a set percentage of their 31 Dec shares shares securities bonds
money in each of the main asset classes 1981 1.2% -12.9% 32.1% 8.5% 14.0%
(ie shares, property and bonds), and resist the 1982 28.1% -13.9% 5.2% 24.1% 16.0%
temptation to switch their money around, based 1983 34.3% 66.8% 50.2% 12.9% 11.7%
on short-term performance. We call this a 1984 15.1% -2.3% 10.1% 12.0% 11.2%
balanced approach.
1985 71.7% 44.1% 5.2% 8.1% 15.9%
Chasers by contrast move their money into an 1986 46.6% 52.2% 35.4% 18.9% 17.0%
investment that has just shown a period of 1987 7.5% -7.9% 5.7% 18.6% 15.2%
strong returns and take additional risks by
1988 4.8% 17.9% 16.1% 9.4% 12.9%
investing in a single asset class.
1989 26.7% 17.4% 2.3% 14.8% 18.3%
Over time, we believe taking a balanced 1990 -14.6% -17.5% 8.7% 19.1% 16.3%
approach is key to investment success.
1991 20.9% 34.2% 20.1% 21.7% 11.2%
1992 5.1% -2.3% 7.0% 13.2% 6.9%
How does the 1993 25.0% 45.4% 30.1% 10.8% 5.4%
strategy work? 1994 -7.6% -8.7% -5.6% 4.5% 5.4%
Balanced investors realise the best performing 1995 26.5% 20.2% 12.7% 12.9% 8.0%
asset class in one year is not necessarily the 1996 6.8% 14.6% 14.5% 12.4% 7.6%
best performer the following year. 1997 42.0% 12.2% 20.3% 12.5% 5.6%

Take 1994 for example. A chaser would have 1998 32.6% 11.6% 18.0% 8.2% 5.1%
invested in Australian shares based on the 1999 17.5% 16.1% -5.0% 1.5% 5.0%
strong returns in 1993, only to incur a loss 2000 2.5% 3.6% 17.8% 10.3% 6.3%
of 8.7%. Then in 1995, they would have moved 2001 -9.3% 10.1% 14.6% 5.8% 5.2%
to cash after its good performance the previous 2002 -27.1% -8.1% 11.8% 8.4% 4.8%
year, and missed out on the outstanding
2003 0.0% 15.9% 8.8% 3.0% 4.9%
performance of global shares.
2004 10.9% 27.6% 32.0% 7.0% 5.6%
Chasing returns can be likened to driving a car 2005 17.6% 21.1% 12.5% 5.8% 5.7%

Strategy # with your eyes fixed on the rear-view mirror.

When you only look backwards, it can be more
difficult to get where you want in the future.
2006 12.3% 25.0% 34.0% 3.2%

Performance indices used to compile this table are

6.0%

outlined on page 11.

03 10
The benefits
• Achieve more consistent returns by not chasing past performance.

• Minimise overall risk by spreading your money across a suitably diversified mix
of asset classes.
Case study
Paul and Denise each invested $10,000 on 31 December 1981.
Tips and traps
At the end of each year, Denise moved her money from one asset class to another, based on • It’s important to set financial goals to
the returns from the previous year. By chasing returns, Denise ended up buying assets at higher provide direction and help you avoid
prices and selling assets when their values had declined. the temptation to change your portfolio
in response to short-term market
Paul, on the other hand, wasn’t too concerned with short-term performance. After speaking to
movements.
his financial adviser, he selected a portfolio consisting 35% in Australian shares, 25% in global
shares, 10% in property securities and 30% in Australian bonds*. • By sticking with your investment strategy,
you can minimise transaction costs such
Once his portfolio was established, Paul bought and sold enough assets at the end of each year as brokerage fees and stamp duty.
to bring his portfolio back to its original weighting. By implementing this rebalancing strategy,
• Multi-sector unit trusts provide
Paul was able to buy assets at bargain prices and sell when prices had reached higher levels.
ready-made diversification. To achieve
Over this 25–year period, Paul came out on top earning $63,486 more than Denise, with less effort your own spread across different asset
and less anxiety. classes, you can invest in a range of
specific sector unit trusts.
Value of $10,000 invested over 25 years • Unit trusts that use a multi-manager
investment process can offer further
diversification by blending investment
$300,000 managers with different but
$253,579 complementary investment styles.
$250,000
• As investment values change, your
$200,000
allocation to the various asset classes
$150,000 will change over time. In order to maintain
$190,093 your investment strategy, you should
$100,000
consider rebalancing your portfolio
$50,000 regularly. Some multi-sector unit trusts
automatically rebalance the portfolios
$0
on a regular basis.
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006

Balanced investor (Paul) Chaser (Denise)

Note: Year ended 31 December

* This is based on the asset allocation of the Average Balanced Fund from the Mercer Wholesale Manager
Performance Analytics software as at 30 June 2007, adjusted to take into account only the asset classes
included above.
The performance indices used on page 10 and 11 are: Australian Shares: S&P/ASX 200 Accumulation Index (All
Ordinaries Accumulation Index prior to April 2000), Global Shares: MSCI World Gross Accumulation Index ($A),
Property: ASX 200 Property Accumulation Index (Property Trust Accumulation Index prior to July 2000), Australian
Bonds: UBS Composite Bond Index – All maturities (Commonwealth Bank Bond Index prior to November 1987),
Cash: UBS Bank Bill Index (RBA 13 Week Treasury Notes prior to April 1987). All earnings are reinvested but do
not take into account the impact of fees or taxes on distributed income and capital gains. This example is based
on historical performance and is not indicative of future performance. Future perfromance is not guaranteed and
is dependent upon economic conditions, investment management and future taxation.

11
 Dollar cost averaging: taking the
guesswork out of investing
You don’t need a crystal ball to build wealth You may think it would be hard to make any
in investment markets. You can make money money. After all, the unit price ended up at
by simply investing a fixed amount at regular exactly the same point as it started. However,
intervals over a period of time. You can also during months when the unit price is lower,
take the guesswork out of trying to pick the you can buy more units with your $200.
right time to buy and sell, and not have to As shown in the table below, investing a total
worry about putting all your money in the of $1,000 over five months, you are able to
market at the one time. This strategy is called purchase 140 units. At the end of the period
dollar cost averaging and it can help to turn these units are worth $1,400 – representing
the ups and downs of investment markets a profit of $400.
to your advantage. Note: Dollar cost averaging doesn’t guarantee a profit
or protect you against a loss, particularly if you are
forced to sell when the market is falling.
How does the
strategy work? Month Monthly Unit Units
investment price purchased
Dollar cost averaging is a simple concept that
can work really well when investing on a 1 $200 $10.00 20
regular basis via a unit trust. Assuming you 2 $200 $6.66 30
invest a set amount each month, your money 3 $200 $5.00 40
will buy more units when the unit price falls,
4 $200 $6.66 30
and fewer units when the unit price rises.
5 $200 $10.00 20
Let's say you invest $200 per month in a
managed share fund over a five-month period. Total $1,000 140
For illustrative purposes, we have assumed
Average price paid = $7.14 (ie $1,000/140 units)
the unit price drops from $10 to $5, before Investment value at the end of 5 months = $1,400
returning to $10 at the end of the fifth month. (ie 140 units at $10 each)

Strategy #

04 12
The benefits
• Takes the guesswork and emotion out of picking the right time to buy and sell.

• Allows you to start investing earlier, as you don’t necessarily need to have a substantial
amount before you begin.
Case study
Robert and Michael each want to invest $2,400 a year in a balanced fund unit trust for ten
Tips and traps
years. Robert decides to use dollar cost averaging and arranges for $200 to be transferred from
• Investing in shares or property (either
his bank account on the same day each month.
directly or via a unit trust) allows you
Michael, on the other hand, decides to invest his $2,400 as a yearly lump sum when the to access the potential for long-term
market is at its lowest. That way, he can purchase more units with his money. After spending capital growth.
a lot of time monitoring unit prices, Michael surprisingly ends up investing at the lowest price • An easy way to implement this strategy
every year. But was it worth it? is to pay yourself first (ie invest a fixed
Despite all Michael’s hard work over the ten years, there is only around $4,000 difference amount of your salary each month
before you spend your money on other
between the value of their investments, as the graph below reveals. This also assumes Michael
things).
is lucky enough to pick the right time to invest each year – a difficult task that could easily
have backfired. • You can purchase units in a unit trust
automatically by arranging to have
Value of $24,000 invested over 10 years money transferred directly from your
nominated bank account or salary.
Direct debit is available through most
$50,000 financial institutions and fund managers.

$40,000
$36,247 • By reinvesting your income to purchase
additional units, your regular
$30,000 investments can benefit from the power
of compound returns (see Strategy 1).
$20,000 $32,058
• To accelerate the creation of wealth,
$10,000 you could consider instalment gearing,
which allows you to supplement your
$0 regular investments into a unit trust with
1998

1999

2000

2001

2002

2003

2004

2005

2006

2007
1997

regular drawdowns from an investment

Relaxed Robert Stressed-out Michael
loan (see Strategy 8).
Note: Year ended 30 June

* This example assumes Robert invests $200 at the end of each month, whereas Michael invests $2,400 at the
lowest price each year. It also assumes both Robert and Michael invest in a balanced fund comprising 35% in
Australian shares, 25% in global shares, 10% in property securities and 30% in Australian bonds. This is
based on the asset allocation of the Average Balanced Fund from the Mercer Wholesale Manager Performance
Analytics software as at 30 June 2007, adjusted to take into account only the asset classes included above.
The performance indices used in the graph above are: Australian Shares: S&P/ASX 200 Accumulation Index
(All Ordinaries Accumulation Index prior to April 2000), Global Shares: MSCI World Gross Accumulation Index
($A), Property: ASX 200 Property Accumulation Index (Property Trust Accumulation Index prior to July 2000),
Australian Bonds: UBS Composite Bond Index – All maturities (Commonwealth Bank Bond Index prior to
November 1987). All earnings are reinvested but do not take into account the impact of fees or taxes on
distributed income and capital gains. This example is based on historical performance and is not indicative
of future performance. Future perfromance is not guaranteed and is dependent upon economic conditions,
investment management and future taxation.

There are two reasons why the value of Robert investment was so close to Michael’s:

1. Robert didn’t try to time the market, so when the unit price was low his money automatically
bought more units.
2. By investing on a monthly basis, Robert allowed his money to benefit from the power
of compounding returns (see Strategy 1).

13
 Income splitting: a simple way
to save tax
It's no secret that tax can eat away at your How does the
investment returns. There is, however, a simple
way to ensure you don't pay more tax than you strategy work?
have to. It's called income splitting and it There are several ways you can split
involves placing investment assets in the name investment income with a lower income
of your partner (or another family member). partner. The easiest way is to buy all new
The benefit of this strategy is that the owner investments in your partner’s name. However,
is required to pay tax on any income and capital if you currently own the investments yourself,
gains from the investment. So if he or she is you can achieve income splitting by:
on a lower tax rate or not working at all, you 1. Transferring ownership of the
may be able to minimise your household tax investments to your partner – but be aware
bill and make your money work harder. this may have capital gains tax (CGT) and
stamp duty implications.
For example, a low income earner can now
2. Investing the after-tax income from your
earn up to $11,000 pa* before tax is payable.
investments in your partners name.
* Takes into account the low income tax offset and
Not only will your partner pay less tax on the
uses the 2007/08 individual tax rates and
theresholds. income received from the investments held
in their name, but they will also pay less CGT
Note: You can only split income from investments such
when it comes time to sell them.
as dividends, rent and interest. You cannot split
income you earn from working. Before implementing an income splitting
strategy, it’s a good idea to speak to your
financial adviser.

Strategy #

05 14
The benefits
• Reduce tax by investing in a lower income earner’s name.

• Maximise the value of your investment by reinvesting the after-tax income in the name of the
lower income earner.
Case study
Greg and Astrid are married and both aged 30. Greg pays tax at a marginal tax rate of 41.5%*,
Tips and traps
while Astrid works part-time and is on a marginal tax rate of 16.5%*. They wish to invest $400
each month into a balanced fund in a tax-effective way, and they are considering the following • When setting up a new investment,
it may be beneficial to place it in the
options:
name of the person on the lower
• Investing in Greg’s name. marginal tax rate.
• Investing in joint names.
• Negatively geared investments (see
• Investing in Astrid’s name. Strategy 8) may be better held in the
name of the person with the higher
The graph below compares the value of the investment under each alternative, in 20 years time
tax rate, due to the ability to use
before it is sold.
tax deductions to reduce tax on
other income.
Investment value after 20 years ($400 per month)
• To minimise CGT when transferring
assets between partners, it may be
$230,000 better to defer the transfer to a lower
$225,343
income year (eg retirement) or transfer
$220,000 the assets progressively to spread the
capital gain over a number of financial
$210,000 $208,212
years (see Strategy 10).
$200,000
• You can reduce CGT by using capital
$189,116 losses (see Strategy 9).
$190,000

• Discretionary trusts (eg family trusts)

$180,000
can also be used to distribute income
$170,000 to beneficiaries in a tax-effective
Greg's name Joint names Astrid's name manner (see Strategy 7).

• Unit trusts typically pay income

Assumptions: A 20-year comparison. Total return is 7.5% pa (split 3.5% income and distributions at the end of each quarter.
4% growth). The overall franking level on income is 20%. All figures are after income Distributions are taxable in the hands
tax at Greg and Astrid's marginal tax rates of 41.5%* and 16.5%* respectively. These
of the investor and must be included
rates are assumed to remain constant over the investment period.
in annual tax returns, even if the
Clearly the balanced fund is more tax-effective if invested in Astrid’s name, as the income would distributions are reinvested to buy
more units.
be taxed at a rate of only 16.5%*, allowing it to compound and grow into a much larger amount.
However, the benefit of income splitting also applies to the capital gain made on the sale of the
investment. For example, when Astrid withdraws her money after 20 years, the after-tax amount
would be higher than if they had invested in either Greg’s name or in joint names. This assumes
their respective marginal tax rates don’t change over time.
* Includes a Medicare levy of 1.5%.

Investment value (after CGT)

Greg’s name Joint names Astrid’s name
$176,707 $199,233 $219,802

This case study shows even simple strategies can increase your wealth!

15
 A tax-effective way to invest
for your children
Putting money aside for your children, or When the child reaches 18 and ceases
grandchildren, can give them a kick-start to be a minor, the investment can be
later in life. It’s also a smart way to save for transferred into their own name and
a specific purpose such as their education. no capital gains tax (CGT) is payable.
If they later decide to redeem the
However, for contractual reasons, a child is
investment, CGT is payable at normal adult
generally not able to invest in a unit trust in
marginal tax rates.
their own name. So for a child to be able to
access the many benefits a unit trust can 2. A parent or grandparent can invest
provide (including broad diversification and directly in his or her own name. In this
expert investment management), you need scenario, all income and capital gains from
to consider other approaches. the investment will be assessed against that
person. To minimise tax, it’s a good idea to
choose an owner who pays tax at a lower
How does the marginal rate (see Strategy 5). However,
strategy work? CGT is potentially payable by the parent
Generally speaking, there are two main ways or grandparent if the investment is
you can invest tax-effectively in a unit trust transferred to the child at a later date.
for a child: The best approach for you will depend on
1. A parent or grandparent can invest a range of factors, including the amount
as Trustee for a child. In this situation, invested and the income generated
the income is taxed at a special rate (often (see case study). Other (non-tax) issues
referred to as children’s tax). The first should also be considered – including who
$1,666* of non-employment income is should have control over the investment
tax-free, but amounts over this can be taxed decisions. For these reasons, you should seek
as high as 45% (see FAQs on page 29). professional financial advice before investing
money on behalf of children.
* Takes into account the maximum low income
tax offset.

Strategy #

06 16
The benefits
• Accumulate savings on behalf of a child in a tax-effective manner.

• Reduce tax by investing in the appropriate person’s name.

Case study
Richard and Lisa would like to save enough to send their new-born daughter, Abigail, to Tips and traps
university when she turns 18. Richard is currently paying income tax at a marginal rate
of 41.5%*, while Lisa pays tax at a marginal rate of 16.5%*. • When making larger investments, you
They plan to invest $10,000 for Abigail in a share-based unit trust and are considering the may want to invest a small amount
‘as Trustee for’ a child (to take
following options:
advantage of the tax-free threshold
• Investing in Richard’s name. of $1,666 pa and the rest in a lower
• Investing in Richard or Lisa’s name, as Trustee for Abigail (where the income will be taxed income adult’s name (to avoid being
at children’s rates). taxed at up to 45%).
• Investing in Lisa’s name. • Regardless of whose name the
The graph below compares the value of the investment under each alternative, in 18 years time. investment is in, if the parent or
grandparent makes all decisions in
relation to the investment and uses
Investment value after 18 years (lump sum of $10,000)
the income as if it were their own, they
$50,000 are likely to be considered the owner
for tax purposes. As such, all income
$42,290 $43,179
and capital gains will be taxed at their
$40,000
marginal rate.
$30,524 • If you want the children’s tax rates to
$30,000
apply when investing as Trustee for
$20,000 the child, you typically need to supply
the child’s Tax File Number (TFN). You
could instead provide the parent’s TFN,
$10,000
Lisa Richard/Lisa Richard where the income from the investment
(MTR = 16.5%*) as trustee for Abigail (MTR = 41.5%*) is less than $1,666 pa, however you
will need to supply the child’s TFN
Assumptions: Total return is 8% pa (split 3% income and 5% growth). The overall franking level on income is 25%. once income exceeds this level.
All figures are after CGT. Upon sale of her investments at age 18, Abigail is taxed at adult marginal tax rates and
• Investment income may be exempt
receives no other sources of income. These rates are assumed to remain constant over the investment period.
from children’s tax rates if the child
* Includes a Medicare levy of 1.5%.
is in full-time employment and/or the
As you can see, it would have been better to invest in Richard’s or Lisa’s name as Trustee for investment was made with money
Abigail given the taxable income from the unit trust would have been less than the tax-free earned by the child from employment.
amount of $1,666 for all of the investment period. • If you are a grandparent investing on
It should be noted however, if the investment for Abigail were larger, say $30,000, then the behalf of a grandchild, the amount
results would have been quite different. gifted to the grandchild could affect
your social security entitlement.
Investment value after 18 years (lump sum of $30,000)* • Discretionary trusts (eg family trusts)
can be used to direct earnings from
Lisa’s name In trust for Abigail Richard’s name investments to children in a tax-effective
$125,370 $119,425 $91,572 manner (see Strategy 7).

* After CGT.

In this scenario, Lisa is likely to pay less tax over the life of the investment – highlighting
the importance of making the right ownership decision.
Before you decide how you are going to invest, you should speak to a financial adviser as
circumstances vary from person to person.

17
 Discretionary trusts: a flexible
income splitting alternative
Investing in the name of your partner or on How does the
behalf of a child (see Strategies 5 and 6)
can help you save tax as a family. Another strategy work?
tax-effective strategy worth considering is Provided the trust deed allows, the Trustee(s)
holding assets in a discretionary trust has the flexibility to decide which beneficiaries
arrangement (eg a family trust). receive investment income from the trust each
When you set up a discretionary trust, all assets year, and in which proportions. The Trustee(s)
are owned and controlled by the Trustee(s) on can therefore direct income to different
behalf of the nominated beneficiaries. This gives beneficiaries in a tax-effective manner.
the Trustee(s) the opportunity to distribute For example, the Trustee(s) could elect to
income in a tax-effective manner, as well as distribute investment income to:
protect the assets from risks such as
spendthrift beneficiaries. • Children under the age of 18 (who can
receive up to $1,666* tax-free each year).
Discretionary trusts also offer estate planning • Children over the age of 18 (who can earn
advantages and the Trustee(s) can choose up to $11,000* pa without paying any tax).
from a wide range of managed and directly
• A low-income or non-working spouse (to
owned investments.
take advantage of their lower marginal
tax rate).
Income can also be directed to different
beneficiaries each year, without having to
transfer ownership of the assets.
Given the potential complexities involved with
establishing and running trusts, you should
always seek legal, taxation and financial advice
before using this strategy.
* Takes into account the maximum low income
tax offset.

Strategy #

07 18
The benefits
• Reduce the amount of tax payable by a family group.

• Reinvest more money to build future wealth.

Case study
Tips and traps
Craig and Nicole are Trustees of a discretionary trust. Craig earns a salary of $100,000 pa,
while Nicole earns $20,000 pa from part-time employment. The other beneficiaries of the trust
• A discretionary trust can protect the
are their two children – Laura (aged 19) and Harry (aged 15), neither of whom earn income assets in instances where beneficiaries
from other sources. are spendthrift, suffering from
For the 2007/08 tax-year, the discretionary trust generates taxable income of $15,000. addictions, handicapped, unable to
manage their own financial affairs or are
To minimise the amount of tax payable as a family unit, the Trustees decide to distribute the in unstable relationships.
income among the beneficiaries in the following manner:
• Any income from the discretionary trust
• $1,666 to Harry because he is taxed at child rates and can receive this amount without investments must be allocated
paying any tax. to beneficiaries and included in their
annual tax return – even if the income
• $11,000 to Laura to make maximum use of the tax-free threshold of $6,000 pa plus the
is reinvested. Otherwise the unallocated
low-income tax offset.
trust income will be taxed at the highest
• $2,334 (ie the remaining income) to Nicole because she pays tax at a lower marginal rate marginal rate of 46.5% (including the
than Craig. Nicole will also pay tax at the same (or a lower) marginal rate than her children, Medicare levy).
should this additional income be distributed to them.
• The assets of a discretionary trust do
The table below summarises the income allocation and tax payable by each of the beneficiaries. not form part of a deceased beneficiary’s
estate. Upon death the remaining
Beneficiary Income allocation Tax payable beneficiaries of the trust will continue to
receive income.
Harry $1,666 Nil
• A testamentary discretionary trust can
Laura $11,000 Nil
be established via your Will for dealing
Nicole $2,334 $385 with your estate assets in the event of
Total $15,000 $385 your death.

• Despite distributing income in a

By implementing this strategy, they will pay a total tax bill of $385 on $15,000 in investment tax–effective manner each year,
income. This represents an effective tax rate of 2.57% – a great outcome. discretionary trusts are unable to
distribute trust losses. Consequently,
They might also benefit further from a refund of excess franking credits, if the taxable income discretionary trusts rarely work well
contained franked dividends from Australian shares (held directly or via a unit trust). when implementing a negative gearing
strategy (see Strategy 8).
If they had not set up a discretionary trust (and invested purely in Craig or Nicole’s name) they
would have paid tax of $6,225 and $3,425 respectively on the investment income of $15,000 • Before gifting an asset into a
in the 2007/08 financial year. discretionary trust, make sure you take
into account any capital gains tax and
stamp duty that may be payable.
Gifting assets may also impact social
security entitlements.

• You should carefully consider whether

the benefits of having a discretionary
trust outweigh the costs. A trust could
cost several hundred dollars to establish
and annual accounting and other fees
may be payable.

19
 Use borrowed money
to build wealth
Just as you can borrow money to buy a home, How does the
you can borrow to build wealth. This is commonly
known as gearing and it can multiply your strategy work?
profits since: There are a variety of ways you can borrow
• You have more money invested than if you money to invest:
hadn’t borrowed. 1. You can borrow against the equity
• You may benefit from a number of tax in your home. This approach offers the
concessions (see FAQs on page 30). benefit of a low interest rate and there are
no restrictions on which investments you
The downside is gearing can multiply your can buy.
losses if your investments fall in value.
2. You can take out a margin loan with
For gearing to be successful in the long-term, a lending institution. With a margin loan,
the investments you acquire with borrowed the investments you purchase are used as
money must generate a total return (income security for the loan. The lending institution
and growth) that exceeds the after-tax costs will typically lend you up to 75% of the
of financing the investment (including interest value of approved assets.
on the loan).
For example, if you have $25,000 and you
It is therefore generally recommended the want to invest in an approved asset with the
borrowed money is invested in quality share help of a margin loan, you may be able to
or property investments (either directly or via borrow up to $75,000, making a total
managed funds). investment of $100,000. It’s also possible
Shares and property have the potential to grow to gear on a regular basis by implementing
in value over the longer term and they typically what is known as instalment gearing
produce assessable income (which means you (see Glossary).
should be able to claim the interest on the 3. You could invest in an internally geared
investment loan as a tax deduction). share fund. These are funds that borrow
to leverage an investment in Australian or
global shares.

Strategy # To work out whether gearing suits you,

we recommend you seek financial advice.

08 20
The benefits
• Increase the amount of money you have to invest and potentially boost your returns.

• Reduce tax on your other income through negative gearing (see FAQs on page 30).
Case study
Tips and traps
Jenny has $50,000 invested in an Australian share fund and would like to use gearing.
She considers the following three options provided by her financial adviser:
• Gearing should be seen primarily as a
1. Maintain her investment at its current level of $50,000 wealth creation strategy rather than a
2. Double her investment by borrowing $50,000 (ie 50% gearing) way to save tax. If you invest in assets
that fail to produce enough income or
3. Increase her investment even more by borrowing $100,000 (ie 67% gearing).
capital growth over the longer term,
In options 2 and 3, Jenny will use an interest-only home equity loan with an interest rate of your losses could outweigh any
7.5% pa. The following graph illustrates the potential outcome of the three options after ten years. reduction in your tax bill.

• If you take out a margin lending facility,

Investment value after ten years you may need to meet a margin call
if your investments fall in value (see
$300,000 Glossary). To reduce the likelihood of
$255,439
$250,000
a margin call, you should maintain a
conservative loan-to-valuation ratio.
$200,000 $180,795
You should also hold significant cash
$150,000 (or other liquid assets) to meet margin
$106,152 calls if required.
$100,000
Borrowings $100,000 • To reduce your tax bill at the end of
$50,000
Borrowings $50,000 each year, you could consider pre-paying
$0 up to 12 months interest on a fixed rate
Option 1 Option 2 Option 3
No gearing 50% geared 67% geared
investment loan. This can allow you to
bring forward an expense that may
Assumptions: Investment return is 8.5% pa (split 3% income and 5.5% growth). The franking level on income is otherwise be tax-deductible in the
75%. Interest on the loan is 7.5% pa. Jenny’s marginal tax rate is 41.5% including a Medicare levy of 1.5%. following financial year.
These rates are assumed to remain constant over the investment period. With options 2 and 3, where investment • You should take out income protection
income and tax benefits are insufficient to meet interest payments, a portion of the investment is sold to cover
insurance to make sure you are
the shortfall. Otherwise the excess investment income and tax savings are reinvested.
covered if you suffer temporary or
Clearly, the higher the gearing ratio, the greater the potential gains. It must be remembered, permanent injury that doesn’t allow you
however, that Jenny still has an outstanding loan in options 2 and 3 of $50,000 and $100,000 to work and earn an income.
respectively. If she withdrew a portion of her investment after ten years to repay the outstanding • If the lending institution requires the
debt and pay capital gains tax (CGT) on the amount withdrawn, the value of her investment is entire loan to be paid back in the event
shown in the table below. of your death, you should ensure you
have sufficient life insurance.
Investment value after repayment of loan
No gearing 50% geared 67% geared
$106,152 $126,089* $146,027*

* After CGT on the amount withdrawn.

As you can see, Jenny’s financial position could improve by using a gearing strategy if the value
of her investments rise sufficiently.
Caution: If your investments fall in value, your financial situation could
be significantly worse than if you don’t use a gearing strategy.

21
 Use losses to reduce
capital gains tax
An easy way to help reduce your tax bill is to However, because some unit trusts make their
minimise the value of capital gains you receive. final distribution at the end of May each year,
One way to do this is to sell a poor performing this may give you (and your adviser) sufficient
asset that no longer suits your circumstances. time to review the size of the distributed capital
gains and the performance of the rest of your
By implementing this strategy, you can use the
investment portfolio.
capital loss you incur to offset a realised capital
gain from another asset in the same financial If necessary, you can then sell poor-performing
year – including capital gains received as part investments before the end of the financial year
of a unit trust distribution. and utilise the capital loss to offset some (or all)
of the realised capital gains distributed by the
How does the unit trust (as well as realised gains from
directly owned investments). You can also use
strategy work? the money you receive (including any potential
When you invest in a unit trust, the fund tax savings) to pursue more suitable
manager decides when to buy and sell the investment opportunities.
underlying assets, and usually passes on any
Note: Some unit trusts make their final distribution on
realised capital gains to investors via the 30 June each year. Given the timing, it can be very
final income distribution at the end of the difficult to implement this (or any other) capital gains
financial year. tax (CGT) strategy. Your adviser can help you to select
a unit trust that offers you enough time to do some
year-end tax planning.

Strategy #
The benefits

09
• Minimise your CGT liability by selling a poor performing investment and using the capital loss
you incur to offset a capital gain on a different asset.

• Free-up money for more suitable reinvesting opportunities.

• Manage your CGT liability more effectively by reinvesting in a unit trust that distributes
realised capital gains prior to the end of the financial year.

22
Case study
Tips and traps
Bob received a distribution consisting of $6,000 in realised capital gains from an Australian
share unit trust in the 2007/08 financial year (with all gains eligible for the 50% CGT discount). • While there is generally no problem with
Assuming Bob pays tax at a marginal rate of 41.5%*, he will need to pay $1,245 in CGT you selling an asset to crystallise a capital
on this distribution, as shown in the following table. loss, the Australian Tax Office may have
an issue if you seek to immediately
Before strategy repurchase the same asset (if the
dominant purpose of the transaction is to
Distributed capital gains $6,000 gain a tax advantage). You should
therefore seek professional tax advice
Less 50% CGT discount ($3,000)
before considering such an arrangement.
Taxable capital gain $3,000
• It is possible to crystallise a loss on the
CGT payable at 41.5%* $1,245 sale of units in a unit trust (either by
redeeming units in the fund or switching
However, Bob also has some shares in a company called XYZ Limited that he bought two to a different investment option). These
years ago for $10,000 and are now worth $5,000. By selling these shares and triggering losses can then be used to offset gains
on other assets as well as distributed
a capital loss of $5,000 before 30 June 2008, Bob will be able to make significant CGT
gains from the unit trust itself.
savings (see below).
• Capital losses can only be offset against
After strategy capital gains and not against any other
type of income.
Distributed capital gains $6,000 • Excess losses can also be carried forward
Less capital loss on XYZ Limited shares ($5,000) to offset against gains in future years.

Net capital gains $1,000 • If you have different classes of capital gains
(see FAQs on page 29), it's generally a
Less 50% CGT discount ($500)
good idea to apply capital losses against
Taxable capital gain $500 non-discount gains first (ie gains on assets
CGT payable at 41.5%* $208 held less than 12 months and gains where
the indexation method has been used) and
* Includes a Medicare levy of 1.5%. then discount capital gains.

By implementing this strategy, Bob has reduced his tax bill by $1,037! • Investment decisions should not be solely
driven by taxation outcomes. They should
always be considered in light of an
investment strategy designed to meet
your lifestyle and financial goals.

23
 Defer asset sales to manage
capital gains tax
If you need to sell a profitable asset, you But even if your taxable income stays the
should consider delaying the sale until after same, you may find your marginal tax rate is
30 June 2008. By implementing this strategy, lower in the 2008/09 financial year. This is
you can defer the payment of capital gains tax because, from 1 July 2008, the income
(CGT). Depending on your circumstances you thresholds at which the 41.5%* and 46.5%*
may also reduce your CGT liability. marginal tax rates apply will increase
significantly.
How does the It may also be a good idea to hold assets
strategy work? for more than 12 months to take advantage of
the 50% CGT discount. CGT is only payable on
CGT is generally only payable by individuals 50% of the capital gain if an asset is held by
after they lodge their tax return for the an individual for more than a year, reducing the
financial year in which an asset is sold. By effective tax rate on capital gains from 46.5%*
deferring the sale until after 30 June 2008, to 23.25% (for higher income earners).
you may be able to delay paying tax on your
* Includes a Medicare levy of 1.5%.
capital gain for up to 12 months – in some
cases longer.
If you expect to earn a lower taxable income
next financial year (eg because you plan to
retire or intend taking parental leave – see
case study), the marginal tax rate you have to
pay on realised capital gains in 2008/09 may
decline considerably.

Strategy #

10 24
The benefits
• Defer paying CGT for 12 months (or more).

• Minimise CGT by deferring the sale to a lower income year (eg retirement).
Case study
Tips and traps
Natalie (aged 32) works full-time, pays tax at a marginal rate of 41.5%* and is considering
selling shares that have increased in value by $10,000 over the last five years. By selling the • You may want to defer asset sales
shares before the end of the financial year, Natalie will need to pay $2,075 in CGT after when transferring assets into a spouse
applying the 50% CGT discount (assuming she has no capital losses to offset her gain or family member's name for income
– see Strategy 9). splitting purposes (see Strategy 5).

• Depending on your situation, you could

Before strategy consider selling a portion of a share or
unit trust investment in the current
Realised capital gains $10,000 financial year and the remainder after
Less 50% CGT discount ($5,000) this date. By spreading the sale of an
asset over several financial years, you
Taxable capital gain $5,000
may be able to reduce your CGT liability
CGT payable at 41.5%* $2,075 even further.

• Some unit trusts allow investors

However, Natalie plans to take 12 months maternity leave next financial year. As a result, to select which parcel of units they
she anticipates her marginal tax rate will decline from 41.5%* to 16.5%*. By selling her shares want to sell. For example, if you have
in the new financial year, Natalie will be able to take advantage of her lower marginal tax rate made several separate investments in
and reduce her CGT liability to $825 (see below). a unit trust (at different prices), you
don't have to sell the first parcel you
purchased. Selecting the right units to
After strategy
sell can also help you to minimise your
CGT liability.
Realised capital gains $10,000
• If you must sell a profitable asset this
Less 50% CGT discount ($5,000)
financial year, there are some other
Taxable capital gain $5,000 strategies you can use to save on CGT.
CGT payable at 16.5%* $825 You may be able to use capital losses
to your advantage (see Strategy 9).
* Includes a Medicare levy of 1.5%. If you are self-employed, substantially
self-employed or under 65 and recently
By implementing this strategy, Natalie will cut her tax bill by $1,250! retired, you could consider making a
tax-deductible contribution into a super
Note: Investment decisions should not be solely driven by taxation outcomes. They should always be considered
fund to offset your capital gains.
in light of an investment strategy designed to meet your lifestyle and financial goals.
Speak to your financial adviser to find
out more about this strategy.

25
Assets: the building blocks for
wealth creation
There are four main asset classes: cash, bonds, property and shares. These are the essential
building blocks for wealth creation. A diversified investment portfolio should contain a mix of
each asset class, in proportions that reflect your age, personal situation, financial objectives,
investment timeframe and attitude towards risk.

Asset class Investment timeframe

Cash Short term (1–3 years)
Includes bank bills, treasury notes, term deposits and
cash management trusts. Most managed investments
keep a small cash reserve to cover transaction costs
and withdrawals made by unit holders.

Bonds Short to medium term

Issued by governments and large companies to raise (3–5 years)
capital. When you invest in a bond you are lending money
to the issuer in return for interest and your capital back
at the end of the term.

Property Medium term (5 years)

Includes residential, commercial, industrial and retail
buildings and land, as well as tourist resorts, farms,
vineyards, roads and power stations.

Shares Medium to long term

(5–7 years)
Buying a share in a company means you become a part
owner of that company. Investing in shares indirectly
through a managed investment can give you exposure
to a portfolio of shares spread across different sectors
and markets. Global share funds also give you exposure
to overseas sharemarkets.

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The right asset mix for you should be determined with the assistance of a professional
financial adviser. Each asset class has its own unique characteristics as summarised below:

Benefits Risks
• Considered a safe investment, as there is • Relatively low returns.
little chance of losing your capital. • Buying power of your money may be
• Ease of access to your money. eroded by inflation in the long term
• Provides a convenient transaction account compared to other asset classes.
or a transitional account to park your • Sensitive to movements in interest
money while you consider longer-term rates.
investments. • Not tax-effective.

• Relatively secure as your interest is fixed • Relatively low returns.

and your capital is generally protected. • Buying power of your money may be
• Less volatile than other asset classes. eroded by inflation in the long term
• Capital gains can be made in a bond fund compared to other asset classes.
and these gains can be passed to you by • Sensitive to interest rate movements.
way of higher income distributions. • Capital loss may lead to no distribution
of income.

• Generates stable income and capital • High initial costs and outlay.
growth. Historically, property has • High transaction costs (eg stamp duty).
outperformed bonds and cash. • High maintenance.
• Protects against inflation.
Many of these disadvantages can be
• Income from direct property may be offset
overcome by investing in a property
by deductions (eg depreciation).
securities fund.
• Income from property trusts may also
qualify for tax concessions (eg tax
deferred income).
• In a managed investment (eg a property
securities fund), risk is reduced as your
money is spread across different property
sectors. You also have ready access to
your money.

• Best potential for long-term capital growth. • Volatile in the short term.
Over the long term, shares have • Uncertain income stream, as dividend
outperformed other asset classes (see payments can rise and fall over time.
graph on page 2). • Risk of capital loss if the company’s
• Can generate a growing income stream. share price falls and you are forced
• Tax benefits through dividend imputation to sell.
system (Australian shares).
• Relatively liquid as listed shares can be
sold quite easily.

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FAQs
How is income from a unit trust taxed?
A unit trust does not pay tax if all income and realised capital gains are distributed to unit holders each year. Instead, the distributions
are taxed in the hands of unit holders, after allowing for any related tax benefits. This is known as the flow through principle and it
ensures distributions are taxed in the same way as income and capital gains received from directly owned investments. The distributions
need to be included in your assessable income in the year they relate – even if they are reinvested to purchase more units.

How is income from Australian shares taxed?

Many Australian companies pay dividends from their profits after tax has been paid to the Australian Tax Office (usually at the
company rate of 30%). To ensure the dividends aren't double taxed (ie in the hands of the company and the hands of the investor),
the Government allows investors to claim a tax offset for the company tax already paid. This tax offset is called a franking
(or imputation) credit.
Regardless of whether you invest in Australian shares directly or via a unit trust, you are required to include the dividend and the franking
credit in your assessable income. The franking credit can, however, be used to reduce the amount of tax you are required to pay on the
dividend and other sources of income (see below).

How does dividend imputation work?

The following example illustrates how dividend imputation works, assuming shareholders on different marginal tax rates receive a fully
franked dividend of $70.

Marginal Tax Rate 15% 45% This, in very simple terms, is how dividend imputation works
Dividend $70 $70 ❶ A company pays a fully franked dividend*.
Franking credit $30 $30 ❷ You add the franking credit# to your dividend
➪
Assessable income $100 $100 to get your assessable income.
Gross tax $15 $45 ❸ Then you calculate the gross tax based on your tax rate
Less franking credit ($30) ($30) and subtract the franking credit
➪
Net tax payable nil $15 to get your net tax payable.
Excess franking credit $15 nil If your franking credit is larger than your gross tax,
the ATO will offset (ie refund) any excess (available for
certain tax payers only).
➪
Net income received $85 $55 Deduct your net tax from your dividend, or add your
excess franking credit to your dividend, to get your
after-tax income.

* This is the after-tax income distributed by the company.

# This is the tax already paid by the company at the company tax rate of 30%.
Note: Certain investors who are unable to use all their franking credits can claim a refund of these credits in their annual tax return.

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How is income from property trusts taxed? How are capital losses treated for tax purposes?
Property trusts usually distribute the following types of income: A capital loss occurs when the proceeds received on disposal of
1. Assessable income, such as rents received by the trust from an asset are less than the reduced cost base. A capital loss can
the tenants of the underlying properties. This type of income be offset against current year capital gains, but cannot be used
offers no tax advantages and is taxed at your marginal rate. to reduce other sources of assessable income (eg salary). Broadly,
if there is a net capital loss for the income year, the loss can be
2. Tax deferred income that arises from the property trust
carried forward and offset against capital gains in future years.
writing off the value of assets such as fixtures and fittings.
This income is not taxable in the year of receipt, but reduces
the cost base used to determine your capital gains or losses
What tax deductions can be claimed
when redeeming units.
when investing?
Certain expenses may be claimed as a tax deduction to reduce
How is interest income taxed? your assessable income. The more significant deductible
The interest you receive from cash accounts (eg term deposits) expenses include:
and bonds is fully taxable at your marginal rate. Interest income • Interest charged on money borrowed to purchase
can vary over time, depending on the Government's interest rate income-producing investments, such as shares and
objectives and economic conditions. investment property.
• Account keeping fees charged on bank accounts held for
What is capital gains tax (CGT)? investment purposes.
CGT is a tax on the growth in the value of certain assets or • In certain circumstances deductions including retainers and
investments acquired after 19 September 1985, and is generally fees paid for ongoing investment advice.
only payable when a gain is realised. This usually occurs when
an asset is sold or where there is a change in ownership. What are the current marginal tax rates?
However, when you invest via a unit trust, you may also receive The table below summarises the marginal tax rates in 2007/08:
realised capital gains via the distribution(s) if the fund manager
sells underlying investments for a profit. Taxable Tax payable (by residents)
income range
A capital gain will arise where the proceeds received on disposal
exceed the cost base of the asset. For assets disposed of on or $0–$6,000 Nil
after 11.45 am (ACT time) 21 September 1999, CGT is usually $6,001–$30,000 15%* on amount over $6,000
payable by individuals on 50% of the nominal gain (ie the $30,001–$75,000 $3,600 + 30%* on amount over $30,000
difference between the sale price and the cost base) where
$75,001–$150,000 $17,100 + 40%* on amount over $75,000
the asset has been held for more than 12 months. As only half
the gain is taxable, the effective tax rate for an individual on the $150,001 + $47,100 + 45%* on amount over $150,000
highest marginal tax rate (including Medicare levy) of 46.5% is
* These rates do not include the Medicare levy (see page 30).
reduced to 23.25%.
For assets acquired before 21 September 1999, certain How are minors taxed?
investors can choose between two methods when working A person under the age of 18 may be required to pay tax on
out their CGT liability: non-employment income (eg dividends and interest) at the
1. They can elect to be taxed on 100% of the real gain following rates, regardless of whether the income is derived
(ie the difference between the sale price and the frozen directly or via a unit trust.
indexed cost base as at 30 September 1999).
Amount of Tax payable
2. They can choose to be taxed on 50% of the nominal gain.
non-employment income
If an asset is held for 12 months or less, neither the 50% 0–$416 Nil#
discount nor indexation applies (ie the investor is taxed on the
$417–$1,307 66% on amount over $416
full nominal gain).
$1,308 + 45% of entire income

# With the low-income tax offset the tax-free amount is increased to $1,666.

If the minor is engaged in full-time employment at the end of the

income year, or for at least three months during the year, the
income will be taxed at normal marginal rates.

29
What is the Medicare levy? • If you invest the borrowed money in Australian shares directly
or via unit trusts (eg through an Australian share unit trust),
The Medicare levy is a levy of 1.5% that is payable on your taxable
the income you receive may have franking credits attached.
income on top of normal marginal tax rates. If you earn less than
These credits can be used to offset other tax payable, with
$16,741 pa ($28,248 pa combined for couples) you are exempt
any excess franking credits refunded to you.
from the levy. If you earn slightly more than these limits, the levy
is phased in. An additional 1% surcharge applies to singles with • You may claim a tax deduction for the interest expense in the
an income (including reportable fringe benefits) over $50,000 current financial year, but defer CGT until you dispose of the
($100,000 for couples) not covered by private health insurance. investment. The investment may also be sold in a low-income
year (eg post-retirement) to minimise CGT.
What is gearing? • Where the investment is held for more than 12 months, only
Gearing simply means borrowing money to invest. You can 50% of the capital gain needs to be included in assessable
benefit from gearing if the growth in the value of the investment income.
and the income you receive is greater than the after-tax cost
(including interest on the loan). • You may be able to pre-pay interest costs on fixed rate loans
up to 12 months in advance, giving you a greater potential tax
How does negative gearing work? deduction in the current financial year.
Negative gearing arises when the interest payments (and other • Negative gearing will reduce your taxable income, which could
costs) on your investment loan in a particular year are more than assist in minimising the Medicare levy surcharge and your
the assessable income received from your geared investment. CGT liability.
In this situation, the cashflow shortfall can generally be claimed
Note: You need to carefully consider in whose name the geared investment
as a tax deduction to offset other sources of assessable income.
should be held. It may be better to hold the investment in the name of a
For example, if you invest $100,000 of your own money plus higher marginal tax rate payer (to maximise the value of tax deductions in a
$100,000 of borrowed money (at an interest rate of 7.5% pa) negative gearing scenario). However, it could be equally advantageous to
have the investment in the name of a low marginal tax rate payer (to reduce
into an asset that produces an annual income of 3%:
the amount of CGT payable at the end of the investment period).
• Your interest bill for the year will be $7,500
• Your investment income will be $6,000
How are unit trusts treated for social security
purposes?
• The cashflow shortfall of $1,500 can be deducted from other
assessable income (eg salary) in your annual tax return. Assets Test
The capital value of unit trusts are fully assessed under
If you are on the top marginal tax rate of 46.5% (including Medicare
levy), this strategy will save you $697 in tax that year. the social security Assets Test.
Caution: Investors who negatively gear should ensure they can meet
Income Test
cashflow shortfalls during the year.
Unit trusts are included with a person’s other financial assets,
What is positive gearing? such as term deposits and shares, and are deemed to earn a
Positive gearing occurs when the assessable income from your certain rate of income for the purposes of determining eligibility
investments is greater than the interest and other costs you pay for Government income support payments.
on the borrowed money. As at 1 July 2007, a deeming rate of 3.5% applies for the first
For example, if you invest $100,000 of your own money plus $39,400 of an individual’s total financial assets ($65,400 for
$50,000 of borrowed money (at 7.5% pa interest), your investment couples), while amounts above these thresholds are deemed
income will be $4,500 (at 3% pa) and your interest bill will be to earn income at 5.5%.
$3,750, leaving you with a cashflow surplus of $750 pa.

How can gearing help you save tax?

Gearing not only increases your potential to make money, it can also
minimise your tax. The potential advantages of gearing include:
• Where the interest expense (plus costs) exceeds the
assessable income in a particular year (ie the investment
is negatively geared), the excess expense is generally
tax-deductible and can be used to reduce the tax payable
on your other income such as salary.
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Glossary
Assessable income – Income including capital gains, on which Margin call – With a margin loan (see below), the lender is prepared to
you pay tax (ie your total income before deducting allowable tax lend up to a maximum limit known as the loan to valuation ratio (LVR).
deductions). The LVR is usually the loan amount expressed as a percentage of the
assets offered as security. If you exceed your LVR, you will be required
Asset allocation – The process by which you select where, and into
to make a margin call, which means you must either repay part of the
what assets, you invest your money.
loan (via a cash payment or by selling assets) or provide additional
Balanced fund – A fund that invests in a mix of different asset classes, assets as security.
including shares, property, bonds and cash.
Margin lending – A means of borrowing money to invest in shares
Bonds – Bonds are issued by Governments and large corporations in and/or unit trusts where the assets themselves form the loan security.
Australia and overseas. The bondholder receives interest for the fixed
Marginal tax rate – The stepped rate of tax you pay on your taxable
term of the bond and the capital value is influenced by changes in
income.
interest rates.
Portfolio – A basket of investments. A managed investment contains
Capital gains tax (CGT) – A tax on the growth in the value of assets or
a portfolio of investments, which is managed by a portfolio manager.
investments that is payable when a gain is realised. If the assets have
been held for more than one year, the capital gain may receive Property securities – Includes shares in listed property companies or
concessional treatment. units in property trusts. They are an alternative to investing in property
directly and offer greater liquidity and diversification.
Cash Management Trust (CMT) – A managed investment that invests
in high-yielding money market securities. CMTs tend to provide a Real rate of return – The return from an investment after taking
flexible, better performing alternative to a bank savings account. account of inflation. For example, if your investment pays 5% and
inflation is 4%, your real rate of return is 1%.
Consumer Price Index (CPI) – A measure of inflation taken each
quarter based on the price of a basket of typical household goods Reinvestment – Using the dividends from shares or distributions from
and services. managed investments to purchase additional shares or units.

Disposal of an asset – Refers to the sale or transfer in ownership Risk – The chance of losing money or not having your expectations
of an asset. met. An investment considered risk-free because the capital is
protected (eg a term deposit) may still involve the risk of not keeping up
Diversification – Spreading your money across asset classes, sectors,
with inflation.
markets and fund managers to reduce investment risk.
Taxable income – Your assessable income after allowing for tax
Dividend – Distribution of part of a company’s profits to shareholders
deductions. Usually subject to tax at marginal rates plus the Medicare levy.
expressed as a number of cents per share. Companies typically pay
dividends twice yearly – an interim dividend and a final dividend. Tax deduction – An amount that is deducted from your assessable
income before tax is calculated. You can claim deductions in your
Dividend yield – The dividend expressed as a percentage of the
annual tax return or, if your total deduction is significant, you can apply
share price.
to the Australian Tax Office for a variation of PAYG tax.
Equity – The interest or value an owner has in an asset, over and
Tax-effective – The term given to a strategy or investment that
above any debt against the asset. For example, the equity of a
provides a return that may lead to a tax benefit, such as a tax deduction
homeowner is the value of the home less any outstanding loan.
or tax offset.
Franked dividends – Dividends paid by a company out of profits on
Tax offset – An amount deducted off the actual tax you have to pay.
which the company has already paid Australian tax. They entitle resident
You may be able to claim a tax offset in your end of year tax return
shareholders to a tax offset.
(eg franking credits). Sometimes a tax offset may be taken into account
Instalment gearing – Investing on a regular basis by periodically in calculating your PAYG rates.
drawing on an investment loan. Takes advantage of dollar cost averaging
Term deposit – An account that pays a fixed rate of interest over a
(see Strategy 4) and gives you the flexibility to make adjustments to
fixed term. A penalty can apply if funds are withdrawn before the expiry
your gearing and investment arrangements, should you need to.
of the fixed term.
Liquidity – The capacity of an investment to be readily converted into
Volatility – Refers to the fluctuating value of an investment. A share is
cash. Listed shares, for example, are relatively liquid because they can
said to be volatile if its price moves up and down frequently over a short
be easily sold on the market.
period of time.
Managed investment (or managed fund) – An investment which
Yield – The annual income from an investment expressed as a
pools your money with other investors to form a fund that is invested into
percentage of the current market value.
assets based on set investment objectives. A sector specific fund invests
in only one asset class (eg global shares) while a multi-sector (or
diversified) fund invests in a number of asset classes.

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 Notes

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Speak to your financial adviser about these solutions for building wealth with managed investments.

Strategies 1-10 Strategy 1, 4, 5

 How to contact us
MLC MasterKey Service Centre
For more information call MLC MasterKey
from anywhere in Australia on 132 652,
or contact your adviser.
Website
mlc.com.au
Postal address
MLC Limited
PO Box 200
North Sydney
NSW 2059

50900 MLC 11/07

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