financial management across a career in medicine 2007

Financial Management Across a Career in Medicine

2007

Before We Begin

• McMasters’ Independent Financial Planning is a licenced provider of financial services. AFSL 307248.

• The contents of this presentation constitute general advice only. They may not be relevant to your particular circumstances.

Good Financial Management = Good Financial Planning

• Good Financial Planning is:

– Consistent with other planning;

– Structural rather than schematic; and

– Based on common sense.

Elements of Financial Management

• Income

• Expenses

• Investment

• Wealth = (income – expenses) * investment

Income

• Two Types:

– ‘Employment Income’ – medical practice

– ‘Investment Income’

Employment Income

• Doctors and the Olympic Creed:

• Higher;

• Stronger;

• Longer.

Employment Income:Doctors and Non Doctors

Income Across the Lifespan - FTE Doctors vs Non Doctors

0

50000

100000

150000

200000

250000

1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52

Years in workforce

Do

llar

Valu

e (

2006 D

oll

ars

)

Points to Note

• Area under the doctor’s curve much greater:

– Doctor’s earn more;

– Their earnings are constant; and

– Their earnings last for longer.

• Therefore: trade being busy for being durable.

Investment Income


0

50000

100000

150000

200000

250000

1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52

Years in workforce

Dolla

r Val

ue (2

006

Dolla

rs)

Income Across the Lifespan - Investors Vs Non Investors

0200000400000600000800000

100000012000001400000160000018000002000000

1 6 11 16 21 26 31 36 41 46 51

Years in workforce

Do

llar

Va

lue

(2

00

6 D

olla

rs)

Investment Income: Benefits

• Not related to actual activity – earn it while you sleep, holiday, etc;

• Achieves compound growth;

• Reduces/removes reliance on employment income;

• Therefore: employment is on your terms.

Expenses

‘Typical’ Cost Curve

The Cost Curve across Forty years of Career

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39

Years in practice

Child 1 Born

Child 2 Born

Child 1 Primary

Child 2 Primary

Child 1 Secondary

Child 2 Secondary Child 1 Uni

Child 2 UniGrad 1

Grad 2

Leave Home 1

Leave Home 2

The Two Curves


0

50000

100000

150000

200000

250000

1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52

Years in workforce

Do

llar

Val

ue

(200

6 D

oll

ars)

The Cost Curve across Forty years of Career

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39

Years in practice

Two Curves Together

• Income generally exceeds expense:– Pre-kids;– While kids pre-high school;– Once kids graduate.

• Therefore, these are optimal times for enhancing wealth creation.

Major Areas of Expense

• Taxation;

• Cars;

• Loan interest; and

• Transactional Costs.

(Legitimate) Ways to Reduce Tax

• Deferring Consumption; and/or

• Spreading Income;

All Tax = Consumption Tax.

Superannuation• Deducted Contributions taxed at 15%;

• Age-Based Deductible Limit is per related employer.

• Earnings taxed at 15%;

• Capital gains taxed at 15%/10% or nil;

• Post 60 – withdrawals not taxed at all;

• Post pension, earnings and income not taxed at all; • Asset protected.

Self Managed Super Funds

• Maximum control;

• No commissions;

• Main cost often accounting and audit fee;

• Simple investment strategy = low cost;

• Automation adds simplicity;

• 15 minutes per month.

Case Study - Superannuation

• Doctor intends to invest $10,000 of pre-tax income;

• Marginal tax rate = 40%;

• Therefore, can invest:

• $6,000 in own name; or• $8,500 in superannuation.


• Assume investment earns income of 10%:

– Return in Dr’s name: $600 pa. Tax payable = $240. After tax return = $360.

– Return in SMSF: $850 pa. Tax payable = $127.50. After tax return = $722.50.

• Return on $10,000: – 3.6% in own hands;– 7.2% in SMSF.


• Investment value after year one:– Own hands: $6,360;– SMSF: $9,222.50.

• Investment Value after year ten:– Own hands: $10,745;– SMSF: $19,218.

• Investment Value after year twenty:– Own hands: $19,242;– SMSF: $43,452

Superannuation Makes More Sense for Doctors

• Preservation effect lessened due to higher cash flow;

• Asset protection;

• Saving for future generations.

Personal Services Income – How to Reduce Tax

• Superannuation;

• Employing Others; or

• Negative Gearing.

Business Income – How to Reduce Tax

• Superannuation;

• Share income between more than one person (no need for employment);

• Investment company;

• Negative gearing.

Cars

• Home to Work = Business Travel;

• No limit on number of company cars;

• Car no 2+ taken as fringe benefits;

• Oscar Wilde and Accountants.

Interest

• Deductible debt is generally good…;

• Non-deductible debt is generally not so good (but not necessarily bad);

• Maximise borrowings for business/investment;

• Direct all available cash onto non-deductible

debt.

Transaction Costs

• If it moves, tax it!

• Avoid commissions and excessive fees;

• Don’t sell good assets.

Investment

Types of Investment

• Property:– Own home;– Investment;– Commercial and Residential.

• Shares

• Cash

• Superannuation is a special case

Key Points - Investing

• Simpler than it is made to look;

• Long term time frame essential;

• Control the investment.

Optimising Investment (1)

• Maddison.

Optimising Investment (2)

• Australian Experience:

• Conclusion: Everyone Should be a Long Term Investor!

Growth in Australian Share Market Value versus Increase in Wealth Per Capita. 1901 - 2001

2% per year

7.5% per year

Property Investment (1)

• Example (residential)

• Cost of debt = 7%;• Net Income return = 3%;• Income loss = 4%;• Tax Break ~ 2%;• Net loss ~ 2%.

• If capital growth > 2%pa, wealth created. • 2% pa means doubling every 36 years.• Inflation = 2.8%.

Property Investment (2)

• Manage Risk: Avoid duds. • Poor quality/High maintenance;• Low demand relative to supply (caution

‘Seachangers’);• Aesthetic pleasures.

• Avoid ‘off the plan’*

• Consider a buyer’s advocate.

Shares (1)

• Two Ways to Invest in Shares:

1. Index Funds;

2. Direct Portfolio.

Index Funds

• Indices used to measure market;

• IFs invest in accord with the index;

• Automatic diversity;

• Obtains the gross market average;

• No ‘research’ = Lower fees;

• Little trading = lower fees;

• Provides superior net return.

The Maths of Index Funds• Distribution of returns before fees (individuals and managed funds)

• Distribution of returns after average active fees of 1%; index fees = 0.5%

0 1 2 3 4 5 6 7 8 9 10 11

Percentage return

-1 0 1 2 3 4 5 6 7 8 9

Average return =

5%

Average return =

4%

Index Fund

return = 4.5%

Humility Helps

• “Welcome to Lake Wobegon, where all the women are strong, all the men are good-looking, and all the children are above average.”

– Garrison Keillor, Lake Wobegon Days.

Strategy for Index Funds

• Dollar Cost Averaging;

• Buy and hold; and

• Reinvest distributions.

Dollar Cost Averaging – October 1987

Alternatives to Index Funds

• Listed Investment Companies (LICs);

• Exchange Traded Funds (ETFs);

• Same automatic diversity and efficiency;

• Not quite as tax advantaged;

• More manager risk – active management.

Case Study 1

• Doctor aged 35;

• Full time GP billing $300,000. Pays 35% mgmt fee;

• Taxable Income: $180,000. Tax rate = 45%;

• Employs husband as p/time administrator;

• Maximum deductible contribution 2007/2008: $50,000 each;

• Annual contribution: $100,000.

Case Study 1 - Solution

• Opens line of credit loan;

• Receives billings onto home mortgage;

• Borrows to pay:– Mgmt fee; and– Superannuation contributions


• Annual Contribution = $100,000;

• Therefore, monthly contribution = $8,333;

• Direct Debit 1st day of month:

– $8,333 from LOC to SMSF bank account.


• BPay 2nd Day of month:

– $7,000 from SMSF Bank Account to Vanguard.

• $7,000 = 84% of monthly contribution.

Case Study 1 – Key Elements

• Minimal fees: SMSF and Vanguard;

• Dollar Cost Averaging;

• No cash flow restriction;

• Immediate return of 30%: $30,000 tax saving for the family;

• Interest deductible at 30%; earnings taxed at 15%.

Case Study 2• GP in late fifties;

• Billing $400,000. Paying 30% mgmt fee.

• Taxable income: $250,000. Tax Rate = 45%;

• No personal debt;

• Wants to help children with home loan;

• Employs wife part time;

• Deductible contributions 2007/2008: $100,000 each.


• Opens Line of Credit loan;

• Contributes 1/12th of $200,000 into SMSF each month;

• Invests 84% into Vanguard;

• At age 60, withdraws money to finance home for children.

Case Study 3

• Dr in Mid 40s;

• Has principal and interest loan of $400,000 of deductible debt;

• Changes loan to interest only;

• Uses freed up cash to pay super contributions;

• This is effectively borrowing to pay superannuation contributions.

Case Studies 2 and 3 - Benefits• Debt must be repaid using after-tax dollars;

• Therefore, reducing tax payable reduces amount repaid.

• Eg: Loan of $400,000.

– If Dr pays tax at 45%, needs to earn $727,272 before tax to pay $400,000 after tax.

– If superfund pays tax at 15%, needs to earn just $470,588 to pay $400,000 after tax. Paid upon withdrawal from fund.

• Difference = $256,000 before tax. That is, virtually an entire year of full time work. $256,000 = 64% of the debt;

• Superannuation should precede debt repayment, especially if the debt is deductible.

financial management across a career in medicine 2007

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