Friday 26 January 2024

Labor's proposed change to the legislated 'stage 3' income tax cuts

Having had two previous 'stages' of income tax reform legislation targeted mostly at low and middle income earners, the previously legislated 'stage 3' tax cuts were intended to finally provide some simplification of the rather complex range of 'tax brackets' used in Australia, and pushing the top tax bracket (45% income tax + 2% medicare levy, which, when you spend 'after tax' take-home pay on practically anything that isn't unprocessed food, will then have another 10% GST charged).

The 'stage 1' tax cuts were in response to the risk of a recession due to the Covid pandemic, and was a temporary tax offset targeted only at low and middle income earnings. Then 'stage 2' introduced a permanent tax offset of between $455 and $700 for low and middle income earners, cutting out for those earning more than $66Kpa.

The 'stage 3' tax cuts were intended to simplify the tax brackets by eliminating the 37% tax bracket and reducing the 32.5% to match the standard company tax rate of 30%. Instead of the 37% tax rate applying to income above $120Kpa, the new 30% rate would have applied up to $200Kpa. To a large extent this was simply bringing the tax brackets back in line with the multiples of average income that had applied before inflation and 'bracket creep' had steadily moved more and more people into the higher tax brackets.

However, although Labor made a 'pledge' to honour the 'stage 3' tax cuts if they won office at the last election, giving a tax cut to 'the rich' rather than the Labor support base was going to be politically appealing to a Labor government. Hence the last minute decision to 'adjust' the legislated 'stage 3' tax cuts less than 6 months before they were due to come into effect from 1 July 2024.

The 'adjustment' is actually quite politically savvy, as it provides a new round of significant tax cuts to a large group of low and middle income workers who are Labor's traditional support base, but still provides a tax cut to higher income earners -- so Labor can go with the catch phrase 'everyone gets a tax cut!'. The new 'stage 3' tax regime even comes at 'no cost' to the overall budget (compared to the original 'stage 3' plan), as it simply slashes the tax reduction that would have benefitted those earning over $150Kpa, and instead redistributes the tax saving to low and middle income workers.

Although I'm not in favour of governments breaking promises (especially ones that they had explicitly vowed to not break, in order to win an election), this change is actually not too bad. The worst aspect is that it will retain both the 30% tax rate and the 37% tax rate. One of the best results of the original 'stage 3' plan was that it would combine these tax brackets into one, and make the rate the same as the business tax rate.

MLC put out a nice graphic clearly showing who the 'winners' and 'losers' are going to be from this revision of the 'stage 3' tax reform:

Directing the tax cuts towards the lower income cohort will likely also provide a bigger economic boost, as it will provide a much larger relative boost to discretionary income at the lower income levels.

Personally I might even benefit from this revised tax cut by around $804pa, whereas I would have seen no benefit at all under the original plan, especially as my taxable income is considerably reduced by my negatively geared rental property investment.

In the long term it will also provide a boost to my retirement income - although the superannuation pension will be tax free, any significant income from investments or realized capital gains would have been taxable -- so a reduction in the tax rates applicable at lower levels of taxable income might be helpful.

The retention of the 37% tax bracket applying to taxable income above $135Kpa will also mean that my investment in an Investment Bond may be more tax effective in the long run that it otherwise would have been.

Even DS1, who recently gained a promotion and pay rise (to around $140Kpa), won't be adversely affected (in the short term) by this change. But a few more years of promotions and pay rises will see this impact him.

Basically the extra tax paid by someone earning $200Kpa will be used to fund the Labor tax cuts being handed out to five Labor voters on average wage.

Of course a successful professional can always either take their skills to an overseas job market where income tax levels are more reasonable. Or else use a business structure to ensure their personal taxable income stays within the 30% tax bracket and additional company income is taxed at the 30% company tax rate and used to invest in business property or grow the business. So a 'tax the rich' strategy can be counterproductive to long term economic development -- but most politicians never look beyond the next election cycle.

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Sunday 14 January 2024

Wealth Accumulation 'boiling point'

The Money Guys posted an interesting youtube video outlining what they call the 'boiling point' of an investment portfolio. The essential concept is that at some point in your wealth accumulation and investment journey the amount you save and invest will stop being the main driver of your wealth accumulation, and instead the returns (reinvested) provided by your existing investment portfolio will be doing more to build up your wealth (NW) than the 'sweat of your brow' (savings from your salary income).

For example, if your annual income was $60K and you saved 20%, your savings would be adding $1K to your NW each month. And when starting out your 'portfolio' would be very small and investment returns modest in absolute terms, so the main driver of your wealth accumulation is your salary and savings rate, rather than the rate of investment return.

But at some point your investment portfolio would have grown enough that the investment returns being reinvested are the same magnitude as your additional savings. eg. If your portfolio was worth $200K and made a 6% real return, your NW would have grown by twice the amount you are adding via savings from your $60K salary, so your investment portfolio is 'working' as hard as you are to build up your wealth. This is what the Money Guys call the investment portfolio "boiling point". I tend to view this as "critical mass" where the wealth accumulation process has 'gone critical' and become self-sustaining (like in nuclear fission).

At some stage your portfolio might grow sufficiently large than the portfolio return is the major contributor to your wealth accumulation, and how much of your salary income you save each month is basically a 'rounding error' ( or a minor boost to your overall rate of NW increase).

I did a quick plot of my monthly NW changes for the past 20 or so years (excluding a couple of months where there was a major jump in NW due to being 'gifted' a property, or where I did a real estate revaluation for a period of several years in one particular month. I also did a 7-mo moving average of the monthly NW changes (to smooth out the random monthly changes a bit and highlight the overall increase in typical monthly NW change over time) and added in a linear trend line.

This chart clearly illustrates the concept - when I was starting out, my monthly saving accounted for most of the monthly increase in my NW. So how much of my after tax salary I was saving (plus the pre-tax SGL and salary sacrifice) was the major determining factor in how quickly I could build up some wealth. But after a decade or so the average monthly change in NW was equivalent to my entire salary, so even at a 20% pre-tax savings rate my savings were only contributing about 1/5th of my overall monthly wealth accumulation. And these days my NW increases by about 2x my pre-tax salary (or about 3x my after-tax wage income), so my existing investment portfolio is the major source of wealth increase, and how much I save out of my salary is largely irrelevant (eg. saving 10% or 20% might only be the equivalent of adding 0.1% or 0.2% to my investment portfolio rate of return). From here on (barring any market crash slashing my investment portfolio value) the main benefit of my salary is to provide my required spending budget without having to siphon off part of my investment portfolio growth. Hopefully by the time I retire even drawing down my required retirement income stream from my investment portfolio will have a negligible impact on my rate of wealth accumulation. 

ps. The scatter in monthly NW changes, and even in the 7-mo moving average, highlights when investing has to be approached with a long term outlook. While it is a lot of fun to see your NW go up by your annual salary in a single month, it is not quite as enjoyable to see an entire year's salary disappear from your NW in one month! Taking the 'long view' helps you remain sanguine about such market gyrations, and stick with your long term asset allocation strategy.

pps. It also illustrates why you might want to move slightly more conservative with your investment asset allocation (at least with the part that is funding your retirement) as you get older and your NW increases. At some point increasing the rate of monthly NW increase becomes less important than reducing volatility of returns. You would be happy to see the rate of monthly NW increase plateau if instead the volatility (and number of negative NW changes over a year) was diminished. But you can really only afford to trade off returns for reduced volatility once your NW has grown to a sufficient level. If you go too conservative too soon, then your investment portfolio might never achieve 'boiling point'.

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Thursday 11 January 2024

2023 budget review - plan vs actuals

Back in January I switched from using my NAB credit card (paid off in full each month) for most daily expenditure to instead using a Debit card linked to my main bank savings account that receives my after tax wage income. This was due to the requirements of the mortgage for my investment apartment (I had to close my credit card accounts to reduce my credit utilization). I also make direct bill payments for utilities etc. from this savings account, so from 20 Jan onwards I had most of my standard income and expenses flowing through the one main account, making it easy to load the transaction data into a spreadsheet and categorize all the items during the year. I had estimates of various spending categories from previous years, so I did a budget plan and started tracking actual expenses vs. expected during the year. Now that 2023 has ended, I thought I would do a quick review of my budget 'plan' vs actual expenses for last year (since 20 Jan).

This review doesn't include all income (eg. rental income, superannuation income, share dividends, share trading gains, gig income from doing some Doordash etc.) or all expenses (eg. my financial planning business fixed costs, rental property expenses, income taxes etc) but does give a view of my after-tax salary income and bulk of my day-to-day expenses. The after-tax income was higher than usual during 2023 as I put in a withholding tax variation based on the investment property expense, rent income and depreciation data, so my income tax rate was adjusted to 11% (so I won't get much of a tax refund when I lodge my FY2023-24 tax return).

The main budget categories, estimated amount and actual amount (monthly averages) for 2023 were as follows:

budget item              budgeted     actual     % budgeted  Notes

                         (monthly)    (monthly avg)

salary (after tax)       $6,550       $8,287      127%       [1]

medical (out of pocket)  $  124       $  128      104%

entertainment            $   81       $   71       88%       [2]

eating out               $   36       $   40      112%       [3]

savings                  $  650       $  940      145%       [4]

GFP business (variable)  $  350       $  307       88%       [5]

DD business              $  320       $  556      174%       [6]

children (misc)          $  300       $  167       56%       [7]

fitness                  $   80       $   92      115%       [8]

council rates            $  365       $  314       86%       [9]

household items          $1,000       $  382       38%       [10]

gifts                    $   60       $    8       13%       [11]

utilities                $  220       $  406      185%       [12]

citibank                 $  550       $  535       97%       [13]

groceries                $1,097       $1,372      125%       [14]


[1] As mentioned, actual after tax income was higher than budgeted, due to putting in a withholding tax variation form in June. For 2024 I use to current after-tax monthly income as a starting point. I also didn't allow for the annual bonus, as this is not guaranteed and can vary significantly.

[2] entertainment was basically just the cost of the NBN internet and Netflix and Amazon Prime subscriptions.

[3] eating out is just the occasional takeaway when I have to go into the company office and buy lunch. I also included the occasional roast chicken bought for the family dinner (this is usually lumped together with groceries if bought during a shopping trip).

[4] doesn't include pre-tax retirement savings (SGL) but just my after-tax monthly deposits into an online savings account (theoretically an 'emergency' or 'holiday' account, but basically just an extra cash stash I can forget about until I need it for something unplanned/unusual). The actual amount was a bit higher than planned due to making a few one-off cash transfers to my share trading apps during the year

[5] this was misc annual fees (eg ASIC levy) and advertising, website renewal etc. The biggest regular (fixed) expense for AFSL fee and the software required by the AFSL comes out of another account that I setup with a lump sum. I hoping I actually get some paying clients so the business will at least cover running costs before all my seed capital is used up. Currently my business is effectively a very expensive hobby.

[6] As I mostly use my car for doing Doordash a few hours each week, the rego, insurance, and petrol can be claimed pro-rate based on mileage. I keep a logbook of mileage, so decide at tax time whether to claim actual expenses or the standard 'per km' deduction against the gig income. Petrol costs were higher than expected, and I also earned a bit more (but that gets deposited into a different account).

[7] this was just miscellaneous school expenses (books, pens, school excursions etc) and was lower than expected as Year 11 didn't do many excursions. I also didn't make some of the 'voluntary' contributions I had made in previous years. DW paid some uniform costs and DS2 paid for his own new computer (for gaming) from his part-time job earnings, so my expenses were lower than expected in this category during 2023

[8] club fortnightly membership fee went up, so cost more than I had budgeted. I also didn't go to the gym very often, so not very cost effective. I plan on going at least twice a week in 2024, so should be better value-for-money

[9] includes council rates for both our home and my lake house (holiday home). Was lower than expected as DW sometimes paid half of the rates on our home (as it is half hers and she is now working FT again).

[10] lower than expected as nothing major broke (eg washing machine, water heater etc) during the year. The unused budget should probably go into a sinking fund, as there are some items that will need fixing fairly soon (eg. rusting gutters, some defective light fixtures). We might just 'knock down and rebuild' in a few years though, so not sure it is worth spending a lot on renovations, non-urgent repairs, or remodelling.

[11] what can I say, I a cheapskate. The actual spending on gifts was lower than budgeted mostly because I earned some 'free' gift cards doing online surveys, shopping scanning etc. which I gave DW during the year in place of birthday, xmas, valentine's day gifts etc. We tend to stop 'exchanging' gifts amongst adults in my family, as it seems an inefficient xfer of funds with no net change in assets, and often the gift wasn't really wanted. so this amount was bascially just gifts for the kids.

[12] utilities cost a lot more than projected. Aside from electricity, water etc. all rising considerably, I also ran the pool filter continuously after cleaning it up for the summer. I need to buy a decent 'timer' to automatically turn the pool filter on and off each day.

[13] as expected, the 0% personal loan used for part of the investment property purchase continue to have the expected repayment automatically paid each month.

[14] grocery spending was a lot higher than I'd planned. Not sure if this is due to buying extra snacks/desserts etc, prices just going up in general due to inflation, or the fact that DS2 is a 17 year food disposal unit set on 'high'.

I'll tweak the budget for 2024 to reflect the actuals from 2023 and have a look every month to see if things are going more-or-less according to plan.

The budget doesn't include DWs income, or her eating out, entertainment spending, clothes etc. so isn't a reflection of 'household' income and expenses, although it does include some household spending used by DW, DS2  (eg. groceries, utilities etc).

The total expenses don't match the total income, as any surplus accumulating in the savings account get transferred out to my investment property loan offset account to save a bit of mortgage interest. This would probably be categorised as 'savings' if it was included as a budget line item.

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Tuesday 2 January 2024

Net Worth - DEC 2023

Chart updated to end of December in sidebar.

Stocks/cash increased $4,966 (+2.18%) to $233,101.

Retirement savings (SMSF etc) increased by $76,339 (4.84%) to $1,652,778 in line with the market trend and our asset allocation.

Est. valuation of our home (my half) increased by $30,161 (2.72%) to $1,139,571. The 'Other real estate' (my 'lake house' and the investment apartment) increased by $21,101 (1.02%) to $2,092,945.

The outstanding balance of the investment property mortgage remains at $999,993 during the 'interest only' period of the mortgage.

Other assets (my online depository bullion account at  Perth Mint, and the bullion value of my gold and silver proof coin collection) decreased by -$773 (-2.04%) to $37,074. Doing its job as an asset class that has low correlation with equities and real estate I guess.

Overall, NW increased by $131,794 (3.27%) to $4,163,476 during December.

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