One of the most useful elements of this quarter’s update is the release of an online quick estimator of your retirement lifestyle cost.

To estimate how much you need to save in order to make work optional (“retire”) on your terms you need to define your retirement lifestyle target. If you have no idea of how much to set for your retirement lifestyle target then use the quick estimator to get a feeling of what current retirees are spending. I recommend you shoot for the “comfortable” lifestyle target.

You may also enjoy these related articles:

1. Dec 2010 qtr retirement cost statistics
2. How much super you need to fund a comfy lifestyle
3. The annual cost of retirement

In truth no-one knows what will happen.

The great news is that the actions which prepare you to survive a massive change also position you to thrive if instead a boom arrives. So irrespective of your personal forecast it is worth implementing these suggestions.

What could happen

If massive change arrives it probably won’t be pretty. You may experience some of the following:

• You lose your income, maybe for an extended period.
• Just to keep food on the table you have to sell assets, maybe including your home, cheaper than what you paid for them.
• Your loved ones lose their income and assets and move in with you.
• Your investment values go sideways or even down.

It’s all about cash flow

To keep food on the table and a roof over your head you need cash flow. Your best bet to keep money flowing in is to keep your job.

Even in the Great Depression seventy per cent of Australian men remained employed, so if you play your cards right there’s a good chance you’ll stay employed.

To protect your employment income you need to maintain expertise of value to your employer, your industry and to the country.

One way to achieve this is through ongoing professional development. Another way is by being more productive – work smarter, not longer.

For some people though, reskilling and reinvention will be necessary. This will likely apply to those working in retail and other consumer discretionary industries. Don’t despair – these days changing careers is the new black.

Contain your expenses

Borrowing to the max seemed normal while wages and asset prices grew steadily. But it’s now evident many financial houses were built on unsuitable foundations. To survive and thrive avoid over-committing to large debt repayments that are reliant upon two incomes.

Make like a squirrel

It’s time to make like a squirrel and save up your nuts for winter. Build a reserve of emergency funds you can use to fund your expenses if the worst happens.

The best emergency fund is cash you can access within about 1 to 2 days’ notice. The cash can take a number of forms including:

• Actual cash in a high interest online bank account
• Available redraw on your mortgage because you are way ahead in your repayments
• Withdrawal capacity in a personal line of credit secured against your home

Don’t rely solely on your investments

You may be thinking your investments are your backup plan.

If massive world change arrives it may be the worst time to sell your investments. In fact for lumpy assets like property you may not even be able to find a buyer. I know people who during the Global Financial Crisis couldn’t find buyers even after cutting prices.

In a “crisis” companies may slash dividends to preserve cash, leaving you empty handed.

And if people start bunking together to save costs your investment property may be without tenants. Or you may have to slash rents just to get a tenant.

So don’t rely on living off your investments if you lose your job for an extended period.

When the sun shines

Of course doomsday may never arrive and instead we’ll re-enter years of prosperity.

In that case, having invested in your professional development you’ll be in demand and may experience significant pay increases.

As a diligent debt repayer you won’t care as much when interest rates go up (to curb inflation) because you’ll have much less, if any debt.

Couple the higher income with contained expenses and you’ll have plenty of surplus income to invest in funding your early and luxurious retirement.

Chill out

Follow this timeless, common sense approach and you can confidently keep a “she’ll be right mate” attitude no matter what happens.

You may also enjoy these related articles:

1. Time for tax planning
2. How to reduce your tax
3. An example of how DIY is costly

I recall that being an often expressed goal around the traps twenty years ago.

Back then the median gross annual income was just $17,056* so the millionaire goal was quite a stretch. It was also before the explosion of free information on the internet.

Since then there’s been an endless stream of information published to show you how to wisely manage your money and become rich. Most of the information is dirt cheap or even free.

So despite all of this information why still do only 5% of Australians have net wealth in the millions? (Excluding the value in their principal residence.)*

That is the question I often ask participants in my seminars and courses.

The common reasons they suggest are:

• It’s easier to spend now than save. We don’t have the discipline.
• We make bad decisions.
• We don’t know what is the right or wrong decisions so we don’t make a decision.
• We get sucked into glamorous marketing and don’t know how to evaluate if the investments are any good.

All of those reasons are spot on. What do you think? Are there any other reasons you’d add?

Choice overload is a big problem

We’ve had an explosion of choice but our ability to make wise choices has not kept pace. So we hit information and choice overload.

In such circumstances often we either:

• Throw our hands in the air in exasperation and do nothing.
• Grab at something close that gets our attention and seems easy and do it whilst hoping for the best.

The problem with that is delay is the greatest cost in wealth creation. And bad choices can be just as costly.

This applies to all lifestyle goals

You may not have the goal to be a millionaire but I bet you have other lifestyle goals like a dream house, holiday, car, children’s education or retirement lifestyle.

Money is one of the resources that helps fund your important life experiences.

If you’ve ever said “I’d really love to do that but I just can’t afford it” then this probably applies to you. I bet the reasons you didn’t have the money for what you really wanted when you wanted it include those reasons listed above.

What to do about it

The elusive delayed gratification

Applying discipline is tough.

In the financial context I suggest you:

• Get clear on what matters most to you in life
• Save for the significant
• Automate as much as possible

Last Thursday one of my cash flow coaching clients said to me:
“I’d rather have lunch in Venice than buy lunch at work every day.”

She was getting clear on what was more important to her and then changing her habits to ensure she achieved her dream of lunching in Venice with the love of her life.

What about you? What experiences matter most to you in life?

Once you know what you really want next I suggest you harness recent technological advances to do the heavy lifting and protect you from your impulsive self. In the old days they used envelopes or jars and manually topped them up. Now you can have multiple online high interest bank accounts and set up automatic transfers to coincide with your pay cycle.

Learn how to make smart choices

You don’t need to know everything. You just need to know what you need to know.

You can save yourself a lot time, indecision headaches and stress if you learn how to filter the information overload.

The big time saver comes from learning how to quickly filter out things are not appropriate to you right now.

The big financial kick comes from knowing how to choose actions that are right for you and will boost your net wealth. You can avoid procrastination and inaction and get on with doing.

To have enough money for what you really want when you really want it I strongly recommend you invest time in learning how to make smart choices.

Stop scouring the internet and media for tips on the best shares, suburbs and other investments to buy into.

Rather than learning more about all the possible investments out there instead learn decision making models and frameworks you can use to filter every new thing you hear.

The knowledge of how to choose stays with you for life and can be frequently reused. Learning how to choose therefore pays you dividends for life.

You gain clarity from knowing how to identify what are right and wrong decisions. Therefore you’re much less likely to get overwhelmed and either do nothing or follow the next hot tip you hear.

Here’s the plug

My observation is that there are plenty of books telling you what you can do but not many teaching you how to choose.

So I created a course DIY Wealth Creation for Busy People that teaches you how to make the right choices for you right now. In the course I share many decision making models you can apply for the rest of your life.

They’re decision making models I’ve created so you can only get them from me.

If you want to learn how to make smart choices I recommend you check out my course DIY Wealth Creation for Busy People.

Interested but can’t make it?

If you’re interested in the course but the time or location does not suit you please e-mail me and let me know (including interstate folk). That will help me make smart choices about other formats for effectively sharing the knowledge.

Article sources:

• ABS 1301.0 – Year Book Australia, 1991
• ABS 6554.0 – Household Wealth and Wealth Distribution, Australia, 2005-06 (latest release)

You may also enjoy these related articles:

1. An updated wealth creation rule of thumb
2. How to make smart financial choices
3. Ruth Ostrow’s tip on how to discover what matters

Perhaps the most interesting aspect of this release are the projections of how much superannuation you need to accumulate to fund that lifestyle.

To fund that comfortable lifestyle ASFA estimate you need to accumulate $510,000 in superannuation (combined, in today’s dollars.)

However, ASFA project that if your household has a combined income of $100,000 earning 9% superannuation contribution over thirty years will accumulate just $366,000 (in today’s dollars).

The moral of the story is a familiar one: 9% p.a. compulsory employer superannuation is not enough to enable you to retire on your terms.

Regular readers of The Money Guide hopefully have received that message loud and clear and have taken steps to boost their Financial Independence Fund.

Sadly we observe that most Australians only get the message in their 50s when it can be too late to make a big enough difference.

You may also enjoy these related articles:

1. Retirement lifestyle costs quick estimator
2. The annual cost of retirement
3. Dec 2010 qtr retirement cost statistics

To help you achieve that outcome one key practice I recommend is to

 ”save for the significant and minimise the insignificant”

Obviously you first need to know and identify what life experiences are significant for you.

In Ruth Ostrow’s column today in The Weekend Australian she writes about how her jealousy of a friend revealed a life experience which really mattered to her that for various reasons was missing from her life at the time.

If you occasionally catch yourself resenting others for what they have then head on over and read Ruth Ostrow’s tip on how to embrace jealousy and turn it into something useful.

Then head back here to The Money Guide to learn how to ensure money is not the obstacle to you achieving what you really want in life.

You may also enjoy these related articles:

1. Not So Average Wedding Cost
2. Take The Financial Pressure Down
3. What to do if massive world change is coming

Hello Matt

My partner and I would like to buy shares for my son’s birthday. He will turn 21 on 9 November and we want to buy him something that he will have for a very long time. Eventually we came up with the idea of starting him off with his own share portfolio, but we have absolutely no idea how to go about this. We also don’t know if it is possible and whether it is a viable, long-term plan.

Regards, Jane (name changed for privacy)

My instinctive thought of  a gift that would last him a very long time is that of financial literacy. The knowledge on how to make smart, appropriate financial decisions will last a life time and will both make and save him hundreds of thousands of dollars. However, it’s hard to gift financial literacy for a birthday as you can’t force a horse to water let alone force them to drink.

A really useful gift

Following the financial theme my next instinctive idea was to gift him an opening balance in a First Home Saver Account. I think this is a great idea for the following reasons:

• It’s likely that he’ll want to buy a house some time
• A house and a mortgage is something he’ll have for a very long time
• The Government gives you some free money when you contribute to the account
• Giving him a boost on saving for a house will improve his financial position
• You can’t easily withdraw the money and blow it on indulgences

When I spoke to Jane she said they’d also considered buying a gold bar.

The problem with giving shares

Buying shares, a manged fund or a gold bar all have a certain novelty factor. But there’s no guarantee your 21 year old will have any of them for a long time. They all can easily be sold.

In fact once your child finally leaves the nest and buys their own home it would make good financial sense to liquidate all other financial assets to reduce their mortgage.

If giving your child a financial gift like shares, managed funds or gold bars has a spin-off effect of increasing their interest in managing rather than just spending their money then terrific. But I suspect that is luck and not something you can manufacture. Opening a First Home Saver Account could have the same affect and be more aligned to what they foresee in their future.

As it turns out Jane’s son is already diligently saving to buy a house, but not using a First Home Saver Account. So I suggested she investigate that route as fitting her criteria of a viable, long-term plan.

How to give the gift of financial literacy

For those parents whose adult children live in Perth you can give them a gift of financial literacy by enrolling them in my course: DIY Wealth Creation for Busy People. In fact two of the current participants who are aged in their 20s told me they are attending because their Auntie raved about the course, insisted they attend as “it would set them up for life” and even paid their course fee.

You may also enjoy these related articles:

1. It’s time in the market that counts
2. Over 10 years they’ve never lost
3. Find Ten for Wealth

With tongue firmly in my cheek I suggested my top tip was “to slap yourself in the face for leaving it that late.”

Fortunately he laughed, agreed with me, and also agreed not to quote me.

June is not the time to start thinking about how you will reduce your tax that financial year. Often it is too late to implement the most tax effective strategies.

June is the time for implementing the final tactics of the tax strategy you planned well in advance.

Right now is the time for tax planning

Most Australians are employees so they have reasonably predictable incomes, even when you include investment income and debt.

Therefore your tax position for the financial year can be estimated close enough to give you a good insight into key tax management factors including:

• Your taxable income
• Your marginal tax rate
• Your tax payable
• Your surplus income after lifestyle expenses

Knowing those factors you can review strategies to decide how you will manage and hopefully reduce your tax.

How to reduce your tax

Tax management should be considered in the broader context of how you manage your money.

The ultimate purpose of managing your money is to ensure you have enough for what you need when you need it.

Yes, reducing your overall tax will increase the money you have.

However many tax effective strategies have significant impacts on your cash flow. Some tax strategies can increase your investment risk way above your risk tolerance and risk capacity.

So tax should not be looked at in isolation. More importantly for most people tax reduction should not be your primary driver in selecting financial strategies. In my experience most people have much bigger financial fish to fry.

I have published a detailed introduction to key ways to reduce your tax. Read the article and consider the strategies that may be appropriate to you this financial year.

What you can do right now

My top tips for the tax effective financial strategies you can implement right now include:

• Salary sacrifice a regular amount to superannuation based on what you have estimated you need to save in order to achieve your financial independence goal
• Purchase an income protection insurance policy (if you don’t already have one)
• Contribute a regular amount after-tax to superannuation related to your eligibility for the spouse contribution tax offset and/or the Government co-contribution.
• Shift your cash savings into the name of the lowest income earner (or better still onto your home mortgage)
• Submit a PAYG Variation form to your employer considering the expected net taxable income loss from your geared investments (e.g. property). This strategy is better for your cash flow and avoids giving a large loan to the Government.

What you do in June

In June you make tactical tweaks to your strategies. For example:

• Advise your employer of how much of your anticipated annual bonus you want to salary sacrifice to superannuation.
• Adjust the after-tax amount you contribute to superannuation that month now you can closely estimate your eligibility for the co-contribution and tax offset.
• Pre-pay interest on investment loans
• Self-employed people can make their annual deductible contribution to superannuation based on what they earned that year.
• Extra charitable donations from your surplus

Guidance on which strategies are right for you

Not sure which tax effective strategies fit your situation and goals?

If you’re in Perth I recommend you attend my next DIY Wealth Creation for Busy People course. You’ll discover how you can strike a balance between spending, saving and tax.

If you’re outside Perth or can’t make the course then call me to discuss financial planning.

You may also enjoy these related articles:

1. How to reduce your tax
2. An updated wealth creation rule of thumb
3. Defining TRUE financial planning

First a word of caution

Only tax accountants and tax lawyers are legally allowed to provide you with specific tax advice. This article is an introduction to some key concepts of reducing your tax from a big picture planning perspective. And of course at the fringes there are some special cases. Start by understanding the key concepts before delving into the fringes.

Speak to your tax accountant for personal tax advice. And if you don’t have one – maybe you should get one as part of your financial team.

Key ways to reduce tax

Four key ways to reduce your tax are:

1. Spend money in the production of taxable income
2. Spend money where the Government wants you to
3. Give money away charitably
4. Park your money in a lower tax entity (e.g. superannuation, company, trust, partner’s name)

Note that the first three ways listed above involve you giving away or losing money as a way to reduce your tax.

Key concept: you don’t get everything back

A common misconception is that a $1 tax deduction saves you $1 in tax. That is not correct.

You don’t get everything back.

For an individual tax payer you get back the equivalent of your marginal tax rate. The majority of Australians have a marginal tax rate of 30% (excluding levies). So they get back only 30% of what they spend on deductible items.

An example

You give away $10 to charity. At the end of the financial year you claim the donation as a deduction and the tax on your income is reduced by $3 (what you ‘get back’ when your marginal tax rate is 30%).

Your net cash flow has however reduced by $7. That’s $7 less you could repay off your mortgage, invest or spend.

Spending money in the production of taxable income

Spending money in the production of taxable income is probably the primary source of higher tax deductions and thereby a reduction in your tax payable.

Conceptually you can split it into deductions related to active (personal exertion) income and those related to passive (investment) income.

Save tax on active income

As you may already be aware you can claim some expenses relate to your job, including these common categories:

• Self-funded work-related education
• Uniforms
• Some travel
• Some car expenses (not a full deduction as it is subject to some fringe benefits tax)
• Retirement savings (i.e. before-tax contributions to superannuation often through ‘salary sacrifice’)

The Australian Taxation Office (ATO) publishes guides for specific industries and occupations. Check them out to see if there is a guide relevant to you and consult with your tax accountant.

One easy deduction you may not be aware of is that of your income protection insurance premiums. Most insurance is not tax deductible but income protection is because if you later need to claim then the benefit will be taxed as if it was your employment income.

Save tax on passive investment income

In general if your investments earn income each year you can claim a tax deduction for expenses related to those investments, including for:

• Interest paid on money borrowed to invest
• Expenses related to maintaining the investment

In Australia you can also use investment related expenses to reduce your taxable income from your job.

That aspect gets many people salivating so much that they overlook key financial principles.

• If through investing your investment income is higher than your investment expenses you will actually increase your taxable income and pay more tax.
• When your investment income is less than your investment expenses your investment is losing money.
• Your net investment loss may reduce your tax payable on your wages income but you don’t get all of the loss back (remember). So you still have an after-tax net income loss.
• When you’re making a net income loss on your investment you need to make it up in additional capital gain so that overall you get an acceptable return on investment.

Save tax on investment gains

When you sell your investment you realise your capital gain. In Australia the capital gain is included in your taxable income for the year.

You can reduce the tax payable on your capital gain through:

• Holding the investment for over 12 months so that only half of your gain is taxable
• Deducting capital expenses such as transaction costs and stamp duty
• Offset prior realised capital losses

Tax rebates and offsets

The Government really wants you to:

• Keep working and earning money
• Raise future tax payers (so they earn more tax)
• Look after yourself in retirement (so they spend less tax)

So the Government gives you an incentive to do that by rebating some tax to you for ‘expenses’ related to their goals. Current examples include:

• Child care rebate
• Education tax refund
• Spouse superannuation contribution tax offset

Along the way there are other rebates that come and go depending on what behaviour the Government wants to incentivise at the time.

The difference between deductions, rebates and offsets is the way the Government calculates what you ‘get back’.

The key is to stay aware of what is out there and then delve into the detail for those schemes that may apply to how you live your life. Your financial planner and tax accountant are a great help in keeping you aware.

Park your money in a lower tax entity

I believe tax management needs to be looked at broadly across the total tax you pay on all of your money.

In my opinion one of the best ways to reduce your overall tax payable is to reduce the tax rate that applies to the income you earn. Primarily you can achieve this by holding your money in different legal entities, since each class of legal entity can have a different tax rate. (Think of a legal entity as a big tank which can hold financial stuff.)

Examples of legal entities are:

• You
• Your partner
• Superannuation trusts (commonly known as ‘super funds’)
• Discretionary trusts
• Companies (e.g. Pty Ltd and Ltd)

The tax rate for individuals such as you and your partner is based on a sliding scale related to your taxable income. The top marginal tax rate is 45% (excluding levies). As mentioned earlier the majority of Australians have a marginal tax rate of 30%.

Companies pay a top tax rate of 30%, whilst superannuation trusts pay a top tax rate of just 15%.

So the majority of Australians could reduce their total tax bill by investing through superannuation rather than in their own name. Your individual tax payable may not reduce but your total tax will reduce and therefore your net wealth will increase.

Another simple way to reduce tax is to hold your investments in the name of the partner with the lowest marginal tax rate. For example keep your cash savings in a bank account in their name. (Better still keep your cash savings in a mortgage offset account – but that is another article.)

High income earning Australians (those with a marginal tax rate above 30%) could reduce their tax by investing through entities such as companies and discretionary trusts. But the tax saved could be offset by the cost burden of establishing and maintain the entities. Plus there are other really important considerations, which you should first discuss with your advisers.

Putting it all together

As I said earlier I believe tax management needs to be looked at broadly across the total tax you pay on all of your money.

More importantly for most people tax reduction should not be your primary driver in selecting financial strategies. In my experience most people have much bigger financial fish to fry.

The ultimate purpose of managing your money is to ensure you have enough money for what you need when you need it.

Yes, reducing your overall tax will increase the money you have.

But there are some non-tax saving strategies, like repaying personal debt, that will increase your wealth and lifestyle faster, easier and more sustainably. Learn about those strategies too.

You may also enjoy these related articles:

1. Time for tax planning
2. An example of how DIY is costly
3. How much you should spend on your next house

As I immersed myself in the insights there was one in particular, right at the very end that I read as a personal challenge. (page 285, 2009 revised edition, pbk)

Dan Ariely described how when he and his wife Sumi went to buy a house he asked some experts he knew “including a few finance professors from MIT and investment bankers” what seemed to him like a simple question.

It is a question you have probably considered too.

“How much should I spend on a house?”

Ariely describes how everyone told him the same thing – a way to calculate how much he could borrow based on his income and the interest rate. But that’s not the question he asked.

Ariely noted “when I tried to push for an answer, the experts told me that they had no way to help me figure out the ideal amount we should spend and borrow.”
(my emphasis)

Can you see why I read it as a challenge?

Well, I have the answer for you Mr Ariely (I hope one day I can call you Dan).

First, let me share Ariely’s behavioural conclusion from his experience:

“When we can’t figure out the right answer to the question facing us, we often figure out the answer to a slightly different question, and apply this answer to the original problem.”

Hopefully you can see the potential issues in that human decision making.

How much you should spend on your next house

The maximum price you should pay for your next house is the sum of:

• Your saved deposit
• Transaction costs
• The maximum amount you should borrow

The maximum amount you should borrow is a function of:

• the loan term
• the average interest rate over the loan term
• your maximum affordable regular repayment amount.

For definitions of the categories described in the formula below see my ‘Pay Yourself First (in practice)’ model I described in my recent article on better budgeting.

Maximum affordable loan repayment equals your net after-tax income, less allocations for:

• Regular saving for your financial independence goal
• Regular saving for pre-retirement essentials
• Repayment commitments on other existing debts
• Irregular expenses
• Regular essential and comforts
• Impulses and indulgences (presuming you’ll still want the occasional splurge)

Now you have estimated the ideal amount you should spend on repayments rather than some alternate rule-of-thumb like 30% of your income.

To estimate your maximum affordable loan amount you then plug that repayment amount into the free borrowing calculators provided by the lenders. Or you can do it yourself in a spread sheet using the present value (PV) function.

You can download an example calculation here.

Extra tips

By the way, don’t use what the lender says you can afford to repay each period. Their calculation ignores your need to save for eventual retirement and often assumes you can live a lifestyle equivalent to the Henderson Poverty Index (in Australia).

In completing the affordability calculation I recommend you:

• Choose your loan term to match the amount of years until your financial independence goal. That way your debt will be repaid by ‘retirement’.
• Add an extra 1% to the lender’s current interest rate to give you a buffer.

When you actually apply for the loan you can apply for the typical home loan term of 30 years and just plan to make extra repayments in line with your calculation. This technique also builds your buffer for if misfortune strikes.

In practice

Life is a balance between doing something that brings us immediate fulfilment and doing something else that is an investment in future fulfilment.

Exercise, healthy eating and study are often investments in future fulfilment.

If the type of home you really want to buy costs more than the above estimate you then need to make an informed trade off.

Are you willing to cut other elements of your current lifestyle? Or are you willing to cut your expectations of future lifestyle like holidays, car upgrades and retirement?

Please share your thoughts

What do you think of my recommended approach to this common dilemma? Please share your reflections in the comments below as I’d really like to know. (You can share under a pseudonym to protect your privacy.)

You may also enjoy these related articles:

1. Increase your cash flow by managing your debts
2. Qn: How do we get out of debt?
3. Six tips for choosing the best home loan

Previously I’ve written a more detailed article about retirement planning and this statistic – this article just advises you of the latest update.

The Westpac ASFA Retirement Standard for the December 2010 quarter shows that a couple wanting a comfortable lifestyle in retirement need to target to be able to afford to spend approximately $53,879 per year.

Those seeking a ‘modest’ retirement lifestyle need to spend $30,708 a year.

Download detailed budget breakdowns here.

The Westpac ASFA Retirement Standard assumes the retirees own their own home. It defines a modest retirement lifestyle as “better than the Age Pension, but still only able to afford fairly basic activities.”

A comfortable retirement lifestyle is defined as: “enabling an older, healthy retiree to be involved in a broad range of leisure and recreational activities and to have a good standard of living through the purchase of such things as; household goods, private health insurance, a reasonable car, good clothes, a range of electronic equipment, and domestic and occasionally international holiday travel.”

I suggest most people do their planning with the aim of a comfortable retirement lifestyle. Our lifestyle expectations only seem to be expanding with every generation.

You may also enjoy these related articles:

1. The annual cost of retirement
2. Latest retirement cost statistics
3. Retirement lifestyle costs quick estimator