Welcome to our May newsletter. After an extraordinary month of social and economic hibernation, there are positive signs that some of the restrictions on our everyday lives will soon be loosened somewhat. This is welcome news for households, businesses and our economy.
Data released in April provided an early insight into the impact of the coronavirus on the Australian economy. Inflation rose by an unexpected 0.3 per cent in the March quarter, lifting the annual rate from 1.8 per cent to 2.2 per cent. The biggest increases were food, alcohol and tobacco and health. The biggest falls were petrol, travel and accommodation.
Retail sales jumped a record 8.2 per cent in March as consumers stocked up on food and essentials ahead of the shutdown. New home sales fell 23.2 per cent in March while new vehicle sales were down 9.1 per cent in the year to March as Australians reassessed their finances. But consumer confidence rebounded in April, with the ANZ/Roy Morgan consumer confidence index lifting to 85 points, up from record lows of 65 points in March. National petrol prices fell to an average of 100.6c a litre in April, the lowest in 15 years. This follows a further 22 per cent drop in global crude oil prices in April as a result of a glut in supply.
Business confidence was also at record lows in March, with the NAB index falling from -2.4 points to -65.6 points. Unemployment rose slightly to 5.2 per cent in March but Reserve Bank Governor, Philip Lowe said in a speech that he expects the rate to climb to 10 per cent in the June quarter and remain above 6 per cent for the next few years. He also expects inflation will fall significantly in the June quarter as our economy contracts but said: “We can be confident that our economy will bounce back”. The Aussie dollar rose over 6 per cent in April to over 65 US cents, perhaps due to Australia’s success to date in dealing with the coronavirus.
The recent sell-off on global sharemarkets due to the economic impact of COVID-19 has highlighted the risks of depending too heavily on a single asset class. Even before the current crisis, the ATO was concerned about a minority of self-managed superannuation funds (SMSFs) with up to 90 per cent of their money in a single asset class.
Invariably that single asset is an investment property for which the SMSF has borrowed money through a limited recourse borrowing arrangement (LRBA). While property has historically provided good returns over the long run, this is not always a good recipe for providing income in retirement.
The ATO is so concerned about this trend, that last year it wrote to 17,700 SMSFs warning them about the dangers of concentration of risk and suggesting they should perhaps consider greater diversification.
One of the foundations of prudent investing is diversification. By putting your money in a range of investments and asset classes you effectively spread your risks.
Have a written strategy
Diversification is important for all investors, but especially so for those with an SMSF who are ultimately responsible for their own investment strategy. That’s why SMSFs are required to put their investment strategy in writing.
This is your plan for making, holding and realising assets consistent with your investment objectives and retirement goals. It should explain how your chosen investments will help you meet your goal.
If you have 90 per cent of your fund’s money in a property, you need to document that you have considered the risks associated with this lack of diversification. You need to state why you think the investment will meet your fund’s investment objectives and cash flow requirements.
This document can be attached to your strategy as a signed and dated addendum. If you cannot justify your heavy weighting in property, then you need to change the fund’s portfolio mix otherwise each individual trustee may face a fine of $4200.
Of those SMSFs that have focused heavily on property, a disturbing fact is that many of those funds have lower balances of between $200,000 and $500,000. This makes them even more vulnerable to a market fall. In 2017 the average borrowing under a LRBA was $380,000 and the average value of assets was $768,600.i
With an LRBA, the asset is held in a separate trust. Any investment returns earned from the asset go to the SMSF trustee. If the loan defaults, the lender’s rights are limited to the assets in the separate trust so there is no recourse on any other assets held in the SMSF.
That’s all very well, but if those other assets represent less than 10 per cent of a fund where the balance is $300,000, then having around $30,000 left in your super should you come a cropper clearly will not provide adequately for your retirement.
The banks require a personal guarantee from the members when setting up an LRBA so if you default on the loan then any shortfall must be met personally which could further undermine your retirement planning.
How to diversify
How you achieve diversity in your SMSF will depend on the risk profile of the fund’s members. For example, there’s no harm in being skewed towards more conservative investments if the members have a low tolerance for risk, but the trade-off is lower returns in the long run.
The type of investments in the fund may also depend on the age of members. If retired, then you probably need two years’ cash readily available. However, the remainder should be in a balanced portfolio of growth investments, bonds and fixed interest. That way the capital can still grow even in retirement, which will help ensure you don’t outlive your fund.
In contrast, younger fund members might skew their portfolio more towards growth assets such as domestic and international shares. This is because there is plenty of time to recover from market falls such as the one we are currently experiencing. Alongside these growth assets you should also have some fixed interest and bond exposure.
If you would like to discuss your SMSF’s investment strategy and make sure that you are not exposing yourself to unnecessary risk, then give us a call.
- RBA using low interest rates & easy money
The Morrison Government’s mind-bogglingly large support packages to get Australians through the COVID-19 shutdown have dominated headlines, and rightly so. Only months ago, the Australian economy was in relatively good shape and headed for a Budget surplus.
Behind the scenes, the Reserve Bank of Australia (RBA) has also pulled out all stops to keep the economy moving.
RBA monetary policy is the yin to the Government’s fiscal policy yang. During the current crisis it’s designed to complement and to some degree pay for Government spending which already exceeds $320 billion.
On March 19, RBA Governor Philip Lowe announced a package of monetary support policies to “support jobs, incomes and businesses”. These policies included maintaining the cash rate at 0.25 per cent, the creation of a $90 billion funding facility to support business lending, and the purchasing of government bonds.
Rates as low as they will go
After two rate cuts in March, the cash rate is currently at a new all-time low of 0.25 per cent. The RBA has promised to keep it there until “progress has been made towards full employment and it is confident that inflation will be sustainably within the 2-3 per cent target range”. With unemployment expected to hit double digits we could be waiting for some time, although inflation jumped to 2.2 per cent in March.i
Increased funding for SMEs
While low interest rates traditionally encourage individuals and businesses to borrow and spend, there’s less inclination to do either while the Coronavirus shutdown continues. So the RBA has provided a three-year funding facility for the banks at a low fixed rate of 0.25 per cent. The banks will be able to access this funding if they increase lending to businesses.
Bond buying bonanza
In its March statement it also set a target for the yield on 3-year Australian Government bonds of around 0.25 per cent, in line with the cash rate. This was a signal to the market that the central bank is serious about keeping rates lower for longer. At the time 3-year Government bond yields were around 0.85 per cent.
The RBA set out to achieve this target by buying Government bonds in the secondary market. This is a monetary policy lever it has never used before, known as quantitative easing (QE).
How does quantitative easing work?
QE is where central banks print money to buy government bonds. A government bond is a low risk investment product whereby investors lend money to the government for a set period at a predetermined rate of return referred to as the yield or interest rate.
When the RBA enters the secondary market to buy billions of dollars of government bonds, it effectively gives the Government a lot more cash to spend and this money flows through the economy.
To date, the RBA has spent more than $36 billion in bond purchases and 3-year Government bond yields have dropped to around 0.25 per cent.ii So, by spending huge quantities of cash the RBA eased monetary policy, which is a roundabout way of saying it used quantitative easing.
What does it mean for me?
The prospect of low interest rates for the next few years creates opportunities and dilemmas for borrowers and investors.
As banks pass on some or all the cuts in official interest rates to their home loan customers, first home buyers are well-placed to secure a good deal. Existing homeowners might also take the opportunity to refinance.
According to Canstar, by shifting from the average variable interest rate of 3.52 per cent to the lowest rate on offer of 2.39 per cent, a borrower on a 30-year, $400,000 loan could save more than $240 a month or more than $87,400 over the life of the loan.iii
Retirees and others seeking income from their investments are not so lucky, but there are some good rates on offer if you are prepared to shop around. The best 12-month term deposit rates and bonus savings account rates are as high as 2 per cent.iv, v
These are undoubtedly difficult times, but the decisions you make now could put you in a good position when markets recover. So give us a call to discuss your financial situation.
With many people now working from home because of COVID-19, some of the expenses your employer normally covers – such as electricity, heating and cooling – are coming out of your pocket instead.
Some employers provide a daily allowance to help with these additional costs, but if not it’s important to claim your extra expenses at tax time.
To simplify things, the ATO has announced shortcut rules if you find yourself working from your kitchen table or sofa for the first time.
New shortcut rules
Under these temporary measures, if you are working from home due to COVID-19 you can claim a simplified tax deduction of 80 cents per work hour for your running expenses.
Your running expenses include things like lighting; heating and cooling; cleaning; and office supplies like printer paper and stationery. The shortcut rate also covers the cost of your internet, phone and computer equipment.
The decline in value (or depreciation) of the furniture and fittings you use in your home office is covered too.
Items such as tea, coffee and toilet paper, can’t be claimed. Neither can expenses such as rent, mortgage interest, property insurance, rates and land tax.
Substantiating your claim
Before you get too excited, you are only entitled to a deduction for expenses related to earning income. You must have actually spent the money and not been reimbursed.
Fortunately, the shortcut method only requires you to keep a record of the number of hours you worked from home as evidence of your claim. This can be in the form of a time sheet, or an Outlook calendar or diary entry.
If you are audited by the ATO, it’s likely you’ll also be asked for supporting evidence from your employer.
The shortcut arrangements are in place for running expenses incurred from 1 March to 30 June 2020. The ATO intends to review the arrangement for the next financial year as the COVID-19 situation progresses.
Eligibility for the shortcut rules
The simplified rules are only available to employees working from home. If you are a sole trader or run a small business from home, you must use the normal business deduction rules. The shortcut rules allow multiple people living in the same house to claim the new 80 cents rate, so both members of a couple can claim a deduction at tax time. You’re not required to have a dedicated work area, which is a requirement under the normal rules.
If you normally work from home a few days a week, you need to keep two sets of records – one covering the period from 1 July 2019 to 29 February 2020 and a second one covering the period from 1 March to 30 June 2020 if you decide to use the shortcut method.
Current rules for working from home
Although the simplicity of the shortcut method is attractive for claiming your running costs, you can choose to use the pre-existing rules if you prefer.
Currently there are two ways to calculate your running expenses: claiming a fixed rate of 52 cents per work hour, or calculating your actual expenses.
Under the fixed rate method, you claim 52 cents an hour for your running expenses. You then work out separately your costs for phone and internet usage, computer consumables and stationery, and the depreciation on your computer. To claim, you need to keep records of actual hours worked, or a four week diary to show your usual working pattern.
Dedicated home offices
If you have a dedicated work area at home, you can choose to calculate your actual running expenses. These costs (plus depreciation on your equipment, furniture and furnishings over $300) need to be apportioned into personal and work related amounts.
For your phone and internet expenses, you can claim up to $50 with limited documentation, or calculate your actual expenses and apportion them.
Before opting for the new shortcut, it’s worth having a chat, as the best method depends on your individual situation. Although there is less administration with the shortcut, it may not provide you with the biggest tax deduction.
Call us to discuss how working from home will affect your tax preparations this financial year.