Younger GPs are interesting economic propositions. Just out of training, they usually have high incomes but low assets relative to their age peers in other occupational groups. The 30- year-old accountant or computer programmer probably has a higher income and more assets. And if the GP is married with kids the gap may be even greater.
The gap is greater again if the GP’s training included a year or two overseas. Boston or London are great life experiences, and should not be missed. But expect the credit card to take a hiding, and the asset accumulations to be put on hold while life is experienced.
But don’t despair: as the young GP finishes training this is all about to change…
The investment dilemma
Young GPs without dependants usually have after tax cash flow well above their living costs. It comes mostly from being paid as a doctor while you are still used to living like a student. The excess cash has to be invested somewhere. Young GPs with dependants usually have more claims on their cash flow but still tend to have excess cash that needs to be invested somewhere. (This phenomenon tends to disappear as the kids get older and morph into private school students with teenagers’ lifestyle tastes. More about this below under the heading: “Middle Age. The peak-cost years”.)
Three investments should get particular attention from young GPs. These are buying into a private practice, the family home and superannuation.
That’s an expensive tax return!
Let’s start with a word of caution. Medical students and registrar GPs are often offered “free” tax returns.
Sounds like a great idea, an offer you cannot refuse. But there is a catch… you have to take out life, income and trauma insurances through the accountant. And those insurances usually pay first year commissions of up to 120% of the first year premium, and trailer commissions of up to 20% a year forever (based on annually increasing premiums.
When you add it all up that tax return will probably cost you more than $50,000.That’s what we call an expensive tax return.
The first big decision is whether, when and to what extent the young GP should own a practice or work for someone else. Generally, owning a practice is financially more rewarding so most GPs will be better off owning a practice as soon as possible once they complete their training and feel comfortable with their experience and expertise.
The family home
Buying and paying for a family home will usually be a top priority for young GPs. Our advice is almost always “buy as much home as the bank will lend you, and then pay it off as fast as you can”. The reasons for this include:
- home prices increased significantly over the last two decades. History shows consistent returns (including rent) of more than 9% a year. The population is growing faster than ever and the experts agree houses will cost a lot more in 2037 than 2017, particularly in the major capital cities. It makes sense for younger GPs to buy as much house as they can as soon as they can;
- interest on a home loan is not tax deductible. This means that paying off the home loan early earns the equivalent of 9% pa or more and is, effectively, capital guaranteed. It is unlikely any other investment will come close to this sort of return;
- use an interest offset account rather than paying off the home loan. This allows equity to be transferred to a new home down the track, and the old home to be kept as a negatively geared investment. Most young doctors will move house at some future stage;
- increasing equity in the home, by paying off the home loan and from price increases, lifts the GP’s ability to acquire other investments including, for example, a practice or rental. Using the home as security for investment loans minimizes interest costs and is a great way to expand the GP’s asset base; and
- the home generates another, better kind of ‘income:’ the ambience of a pleasant place to be and the peace of mind of knowing that you have somewhere to live are significant benefits even though they cannot be measured in dollar.
The family home is discussed in detail later in this book.
Super is a vexed question for young GPs. Some say the rules are forever changing and retirement is too far away, so super should be left for now and the cash instead used for other things. Others say that you cannot start too early and that the power of compound interest demands a maximum effort as early as possible.
We say have a bet each way. Make super contributions up to your personal limit (for your spouse as well if they are a genuine employee) and at the same time pay off the home loan and, possibly, get started on a negative gearing strategy for other investments.
Being a member of the highest paid profession in Australia certainly helps here! Most young GPs can afford to do it all. Carefully.
Life partners and practice partners
Think of two doctors who have taken their life partnership to a new level. They are partners in another type of partnership – they share a 1/3 interest in a large city practice.
They co-signed a contract whereby they combine to work full time in the practice. Any extra time is paid as if they are not owners (ie a 60% fee split).
This works well, giving each of them a proprietorial motivation, and flexibility. The kids are toddlers so they both work a three day week. They spend a lot of time together, and with their kids.
The income is over $400,000 a year for a combined six-day week, which is plenty for now.
Life is good.
What if you are married to another GP?
It’s amazing how many young, and not so young, GPs are married to another GP or other high-income earner.
This presents a special case, financially speaking. Even with just one GP the household income is statistically high, but with two GPs the household income is sky high. Combined incomes well above $400,000 a year are not unusual. Add in an almost unique stability and longevity, and you have a mini-economic powerhouse on your hands.
Quite often each spouse works part-time, say 80%. This allows child-care roles to be shared and external child-care costs to be minimized.
This augurs well for household harmony since both mum and dad can get the work and family balance they really want.
This augurs well for economic harmony too. Twice the number of GPs means twice the income, but not twice the living costs. This more than doubles the potential savings. Often all the second income, or more, is saved and invested. This is something we recommend: live on one income (or less) and save all of the other income (or more). You will be wealthy before you know it.
Being married to another GP (or other high income earner) does not change the basic concepts and goals for younger GPs. It just makes them easier to achieve: the idea should still be to own a home debt free as soon as possible, get started on super and perhaps add a few rental properties to the portfolio. Perhaps the home should be bigger, and better located, the super more ambitious and the rental properties more numerous. As a general proposition, the two-GP household can take on more debt than a one-GP household, and those that do tend to reap the benefits with larger capital gains over time. And the un-taxed unrealised gains coupled with the immediate tax deduction for interest and other holding costs drags down the average rate of tax on all income. This in turn creates more space for future investments, setting the stage nicely for what comes next.
The solo GP
The demographers say that up to one third of people never marry and a similar proportion may never have children. There is no reason to expect that these proportions are any different for GPs. In fact, anecdotally, they may be higher; a reflection of the long years of study and training needed to become a GP and the demanding lifestyle once the training is complete.
Certainly it is not uncommon for a 35 year-old GP to be solo, happily or otherwise.
Does our advice differ for a solo GP? Well, in short, no, it doesn’t. The idea is the same, although the home is more likely to be a city town house than an outer suburban ranch with a huge back yard complete with sand pit and swings. A service entity is more likely to be a company than a trust, unless there are family members other than a spouse who can receive low tax trust distributions (such as younger siblings). This is so profit and cash can be kept in the service company and taxed at just 30%, with the possibility of a franking credit refund down the track.
Lest we forget
Older GPs will recall financial ‘planning’ and ‘accounting’ firms that actually specialized in selling trees, films and avocado tax schemes to GPs.
The amounts involved were huge: the GPs were told the ‘investments’ would be great, and self-funding. Just borrow $300,000 from us, invest that $300,000 back with us (“the money hardly even seemed to change hands”), and your tax bill disappears and your retirement is taken care of.
Of course, it did not turn out that way. It ended in tears. The trees all died but the debt did not.
The worst case we saw was a NT foreign-trained GP who lost $300,000 in the first six months he was in Australia, all because of his Alice Springs-based accountant. Fifteen years on he is still paying off the loan. He is philosophical: he is glad he learnt his lesson at age 35, and not age 55 when recovery would have been much harder.
One gender issue merits specific reference. This is the tendency for female GPs to be under-superannuated. Women have less super than men – which is perverse: super is more important for women since they live longer, and have greater retirement needs.
Historically women, including GPs, have been under-represented in the superstakes. They have lower incomes and spend less time in the paid workforce. This means less super at retirement.
The OECD estimates that Australian men are in the paid workforce for 38 years before retirement, which is almost twice the women’s equivalent of 20 years. There are also significant differences in pay rates (in 2012 women were paid on average only 82.4% of male salaries). This pay difference appears in general practice too: female GPs obviously face the same prices and costs that male GPs face, but the reality is they have lower incomes, and the statistics show the average female GP sees fewer patients per hour than her male counterparts. Anecdotes say this is at least in large part because female GPs see more people with mental health needs.
The Australian Bureau of Statistics (ABS) says 49% of women expect super to be their main retirement income, compared to 56% of men; 18% of women expect to rely on their partner’s income, compared to just 4% for men; and 27% of women expect the old age pension to be their only retire income, whereas it’s just 25% for men.
The federal government has tried to balance the gender super bias with special rules for spouse contributions, contribution transfers and co-contributions. These have not had a significant effect to date.
It is critical that younger female GPs do not repeat the mistakes of their predecessors. Their super contributions should start as early as possible and be as big as possible, ideally the
maximum allowed each year. The earlier the super snowball starts, the faster it rolls and the bigger it gets. That’s the magic of compound interest.
Significant miles stones for Australian Women, 1902 to 2009
- 2017 Susan Kiefel becomes the first female Chief Justice of the High Court of Australia.
- 2008 Quentin Bryce is the first woman to be appointed Governor-General of Australia.
- 2007 Julia Gillard MP is the first woman in Australia to be appointed Deputy Prime Minister.
- 2000 Margaret Jackson becomes the first woman to Chair a top-50 listed company – Qantas.
- 1999 The Equal Opportunity for Women in the Workplace Amendment introduced into Parliament.
- 1987 Mary Gaudron became the first woman Justice of the High Court of Australia.
- 1986 The Affirmative Action (Equal Employment Opportunity for Women) Act was passed in Federal Parliament.
- 1984 The Federal Sex Discrimination Act was passed, based on the United Nations Convention on the Elimination of All Forms of Discrimination Against Women.
- 1980 Women were admitted to the Surf Life Saving Association of Australia.
- 1976 Pat O’Shane was admitted to the Bar, becoming Australia’s first Aboriginal barrister.
- 1975 The Federal Family Law Act introduced a no-fault divorce system and legislative recognition of the economic value of women’s traditional work in the home was given in the division of assets on divorce.
- 1973 Elizabeth Reid was the first Women’s Adviser to the Prime Minister: the first woman to hold such a position in the world.
- 1966 The bar on married women as permanent employees in the Federal Public Service was abolished.
- 1961 The first oral contraceptive pill became available in Australia.
- 1921 Edith Cowan was the first woman elected to an Australian Parliament.
- 1902 Non-indigenous Australian women gained the right to vote in a Federal election.
Source: Office for Women, www.ofw.facsia.gov.au
A GP’s middle years, say from age 35 to age 55, are typified by high incomes and even higher living costs. Profits peak, but so do living costs, so much that we label these years “the peak-cost years”.
Sometimes the peak-cost years just make it too hard to do any significant investing. Family goals come first and this is fine. The kids are kids for such a short time that it is foolhardy to sacrifice the desired family lifestyle in the pursuit of long-term riches. There is plenty of time to get the investments going later once the kids are off mum and dad’s hands.
It can seem that no matter how hard the GP works and how much cash comes in, the cash goes out faster. There are a virtually infinite number of claims on the family budget. The money just goes. Sometimes it seems investing is just a pipe dream, just another thing that might happen one day – if the kids let you!
Despite all this, some GPs, probably less than a third, invest significantly during the peak-cost years. They tend to be those who have invested well in the earlier years, and, in particular, those who bought homes and paid off their home loans as soon as possible. This leaves them with the cash required to invest. GPs who invest in practices and practice premises do particularly well. Large super balances and good quality negatively geared property strategies feature too.
But most GPs are not able to do much investing in the peak-cost years. That’s OK: there is good news before and (if before is too late) after these years.
The credit card champion of the world!
An excess of demands for cash over possession of cash can lead to problems.
The record credit card debt goes to a forty year old GP in an outer suburb of Perth.
He and his wife happily clocked up over $250,000 of 16% non-deductible consumer debt. The interest bill was $40,000 a year: they had to earn nearly $80,000 in pre-tax income just to cover the interest each year.
There was an interesting psychology at play: as far as they were concerned it was not a real loan because “they never have to pay it back”.
The good news is that with some careful budgeting (and scissors for the cards) the $250,000 was paid off in just three years, and they are now well back on track, and using only debit cards. They have learned their lesson well.
Fred and Wilma have three kids. The eldest two are in their secondary years at a private school, and the youngest one is at a state public school.
Let’s look at the family’s annual cash payments budget that led them to that situation:
|Home loan principal and interest payments on $600,000||$60,000|
|Investment loan principal payments on $270,000||$30,000|
|School fees and related costs||$50,000|
|Entertainment and holidays||$15,000|
|Rates, repairs and maintenance and so on||$5,000|
|Total Cash Costs||$286,000|
You do not need to be a CPA to see the problem. Cash costs of $286,000 are greater than available cash of $260,000. There is a shortfall of more than $26,000 cash each year, or about $500 cash a week.
This shortfall may surprise you, but it is normal for most middle-aged GPs with families.
The solution is to work harder and longer and/or spend less. But this does not really help: new costs present and what’s saved somewhere is quickly spent elsewhere.
The real problem is that it costs at least $250,000 cash a year to live a normal slightly upper middle class lifestyle, pay off the home loan and pay some extra into super. So, unless you have prepared for this (basically by paying off the house a bit earlier), things can get really tight.
Obviously, if a GP has followed our advice and bought as much home as possible as early as possible, got the tax planning right, developed their practice as a business (and enjoyed at least an extra $100,000 a year every year) and started to invest excess cash in other investments, then the cash shortfall described above is effectively avoided. In fact, some GPs invest so well in the early days that they are insulated from the financial rigors of the peak cost years, and go on adding to their net wealth each year.
All the good family stuff is enjoyed while at the same time the family’s financial fortunes get better and better.
A common advice
We often find ourselves explaining that the peak cost years are a normal financial phenomena and that do not last forever. GPs do not need to do anything drastic. The peak cost years will pass. Kids do grow up. There will be plenty of time to build wealth later. The family’s immediate priorities should prevail.
The key is to:
- own a home in a fashionable suburb, or soon to be fashionable suburb, that rises in value at a rate greater than the average home;
- keep up the super contributions, ideally at the maximum allowed each year, so that you are in the top 1% of savers;
- look after your health; and
- enjoy yourself and your family.
The growth in the home’s value and the super accounts are creating a firm financial base, and you do not have to do much more, for now at least.
Should you borrow to pay for the peak cost years?
Ideally you will not borrow to pay for the peak cost years.
But sometimes there is no choice. For example, what if Dr Fred in our example above had another child, and a fourth lot of school fees, and Wilma could not work for a salary: she was too busy maintaining the home, particularly with Dr Fred working such long hours?
This is, of course, a common presentation.
It can make sense to borrow to fund the peak cost years. This increases debt during those years, and pushes back the point in time when all debt is repaid.
The position can be graphed like this:
Fred and Wilma have about $2,000,000 in assets now, and about $1,000,000 in debt. If they don’t borrow any more and continue the expected debt repayment plan (green line) they will pay off their loans at age 68.
If Fred and Wilma decide to borrow to help pay their peak costs they move to the adjusted debt repayment plan (red line) and will pay off their loans at age 73.
Fred and Wilma can relax a bit financially, borrow to pay for school fees and family holidays, and still achieve their family goals, very confident that once the peak cost years pass there is plenty of time and opportunity to build the assets up. Basically they swap a little more relaxation in their late 60s for a an extra dollop of fun right now with their kids.
Most people can’t do this. Most men at Fred’s age of 43 have only 15 years left in the workforce. But Fred at age 43 can keep working on a high income for another 30 years. The height, stability, scalability and longevity of Fred’s income make borrowing in the peak cost years a sensible financial strategy.
Up to one third of marriages end in divorce. It’s more for GPs, probably reflecting the stress and long hours away from home and hearth.
It’s normal for a newly divorced GP around age 50 to be bereft of assets, worried about the future and feeling that, financially at least, being a GP is not all it was cracked up to be.
The good news is that if you are going to be relatively bereft of assets and worried about the future being a GP is great occupation to be in. Most fifty year olds face seriously uncertain financial futures. There is an age prejudice and a youth bias in many workplaces.
For most workers retrenchment means forced retirement, with no second chance to establish a firm financial base.
There is a shortage of GPs and experienced GPs, divorced or not, can take their pick of practices and work almost wherever they want whenever they want. There is no age prejudice or youth bias in general practice.
The solution for a newly divorced GP, age circa 50, with few assets is simple. It boils down to:
- keep working. But do so at a pace and in a space you are comfortable with. The idea is to keep working as long as you can, but on a progressively reducing basis until, say, age 75 (or whatever age you, and your patients, are comfortable with). That means you have 20+ more years to build up wealth and that’s more than enough time;
- paying the maximum super contributions each year, ideally on a monthly basis using automatic payments. Over two decades this will grow to be a very sizable sum, more than enough to get you through to a comfortable retirement;
- buying a comfortable home. It does not have to be a four bedroomed four-car garage mansion. Think small. A three bedroom townhouse is all you need, and this comes at up to half the price of a larger house;
- using a GP friendly lender so you can borrow more than otherwise, and then pay off that expensive non-deductible loan as fast as you can (using an interest offset account). Rapid non-deductible debt reduction is the key to getting ahead at all ages, and age 50 is no exception;
- having appropriate income protection insurance in place, without over-insuring;
- potentially investing in a medical practice: most owners make an extra $100,000 or more a year, and this is the safest and least risky way for a GP to build up new wealth;
- tax planning, including making sure you get the best structure for your circumstances.
Over the years we have seen countless GPs down on their luck at age 50 achieve financial success by age 60. Once again, it’s all down to the characteristics of a GP’s income. Its height, stability, scalability and longevity mean, GPs recover financially from divorce a lot easier for GPs than it is for most other people.
It’s part of being a GP. It is the payback for all the hard work you have done so far.
Our view on how and when a GP should retire is simple. It boils down to “start your retirement early and never finish”. Most GPs warm to this idea once it is explained. So let us explain it.
Once the peak-costs years have passed and the kids are off mum and dad’s hands, attention focuses on the next phase of life and, morbidly, mortality. This often happens at around age 55, or perhaps a little later, as the kids finish their education and (finally!) become financially independent.
Mum and dad can spend money on themselves for the first time in perhaps 30 years.
By age 55 most GPs have accumulated a reasonable amount of wealth, even if it is tied up in the family home and super, or maybe the practice’s goodwill and/or premises. The 55 year- old GP is probably at their professional peak: years of experience grounded in extensive training and professional development mean most patient presentations are handled competently. This converts to a high level of employability: most 55 year old GPs can get as much work as they want anywhere in Australia. Provided health is ticked off, there is no reason why this is going to change for at least another fifteen years, or even more.
So, with a reasonable amount of wealth, a guaranteed high income, a full waiting room stretching inexhaustibly into the future, but only so many days left on earth, the rational GP often makes a smart decision. They cut back the working hours and spend more time on other things, like travel, sport, exercise, reading and further learning.
Obviously the more wealth a GP has, the more they can do this. But even GPs who have not accumulated that much wealth can cut back their working hours confident that they are not condemning themselves to an impecunious old age. With careful health management the working years can be spread out and blended with early retirement so the GP gets the best of both worlds.
We often suggest the 55-year old GP to cut back to four days a week for 10 months of the year. Over the years this trend continues so by age 70 the GP is working say four sessions a week for eight months of the year.
The other days are spent at the beach house or some other place where work cannot interrupt life, and the other months are spent in northern Australia or even the northern hemisphere.
This retirement strategy has numerous advantages:
- the GP (and usually a long suffering spouse) can enjoy the time out while still (relatively) young and healthy. Travel gets hard after about age 70, so why not go now at age 60 while you can still enjoy yourself?
- tax-planning strategies remain effective, particularly if a spouse has stopped working and is not getting any income;
- a longer working life creates a triple whammy that radically improves the economics of retirement. More particularly:
- the GP continues to add to their capital base, usually through continuing super contributions and possibly other forms of saving;
- the draw down and consumption of capital is deferred, compared to earlier retirement; and
- a longer working life means a shorter (fully) retired life, which means the capital does not have to last as long compared to earlier retirement. Less capital is needed because retirement is shorter;
- medical work has a high social utility, so working longer is fundamentally good;
- medical work is good for GP’s sense of ego and id. GPs are happier and healthier when they work longer; and most importantly,
- spouses cannot stand the retired GP hanging around all day with nothing to do. This is serious: (typically) the husband’s retirement can be a flash point in the marriage, and often causes great stress for all.
It’s a paradox that, from an economic point of view, the GP who starts to retire early will probably end up earning more than the GP who does not. The tortoise beats the hare, particularly if the hare has a heart attack from too much work. But there is a further paradox: if this is not so, and the tortoise has a heart attack as well, wonderful. Thank goodness the GP started to enjoy his or her retirement before the health event occurred. It is most unlikely that anyone would rue the years of early part retirement if this were to happen. More likely one would celebrate them!
Having established it is a good idea to retire early, and never stop, how do you do it?
Investing early and well means the GP can retire early and well. If things are done properly then as the kids come off the GP’s financial hands the investment income starts to exceed the practice income. This is a great position to be in, particularly if the income consists largely of unrealized, and hence un-taxed, capital gains.
Interestingly, most GPs continue to practice even at this point. But thankfully they work sensibly, and take more holidays and long weekends. There is a huge difference between the 55 year old driving to work because she wants to, and the 55 year old driving to work because she has to. One is much happier than the other.
The major problem relates to the costs of general practice. Many costs do not fall when the GP does fewer sessions. Many costs, for example, rent, some wages, depreciation of equipment and so on, stay the same regardless of how many sessions are completed each week. These costs are called “fixed costs”. This is because they are fixed irrespective of how many sessions are completed each week. A common mistake is to assume that this is not so.
A GP completing, say, 10 sessions a week and making $240,000 a year may reason that his income will fall to, say, $140,000 a year if he cuts back to 5 sessions a week. Sadly this is not so. More probably, because fixed costs stay the same, profit falls by more than this, say down to $70,000, if not less. The high fixed costs mean that any drop in the sessions worked each week will produce a more than proportionate drop in profit.
Something has to change. The GP has to stop practising solo or in a group practice where costs are shared equally irrespective of the number of sessions. This can happen in a number of ways but they all get back to the same theme: the GP has to make changes to a practice structure where all costs (or virtually all costs) become variable costs not fixed costs. This means if the number of sessions falls by half, profit should only fall proportionately, i.e. by half, say from $140,000 pa to $70,000 pa.
There are a number of ways of doing this but they all get back to the same idea. The GP should leave their own practice and join another practice as an assistant on the standard fee split of, say, 40% to the host practice and 60% to the GP. This 40% is all variable cost.
GPs in group practices may have to re-negotiate their co-ownership agreements to facilitate the older GP reducing their hours and retiring gradually over time.
Often, older GPs will sell the practice (or their share in the practice) to younger GPs. Sometimes, if there are no buyers, the older GP simply shuts the doors and walks away. In some cases they can sweeten the deal by getting a ‘better than market’ fee split in their new place of work, say 30% to the host practice and 70% to the GP. The extra 10 percentage points are really a form of goodwill, an extra payment recognising the GP’s contribution over the years.
This is a good deal for the host practice too. Good GPs are in short supply. Having an established local GP join the practice without cannibalizing the patient base is great for profit. Even 30% of the extra billings is well above the cost of the extra GP, so it’s a guaranteed profit.
Patients win too: their beloved doctor is still there and has made sure other good GPs will be there to take over as the older GP finally retires completely.
Tax planning in the retirement years
It’s not uncommon for a GP in retirement to pay virtually no tax. That is not a misprint and it is most certainly not a scam.
Let’s take Dr Barney as an example. Dr Barney is 65, and works four days a week for nine months of the year in his old practice. He sold it to his younger colleagues five years ago and has been working there ever since. He is busy when he is there, and bills about $210,000 a year.
Barney pays a 35% fee to the practice, and has about $16,500 of other deductible costs (insurance, CPD, registrations and memberships) leaving about $120,000 a year. He employs his wife Betty, age 60, and pays her an arms length salary of $12,000 a year. He also pays $35,000 of super for Betty, and $35,000 of super for himself.
Barney and Betty own their home: its worth about $2,000,000 and its debt free. They have about $2,000,000 in their SMSF, and are paying pensions of $40,000 a year each.
The good news is a combination of tax laws and government policies combine to naturally create an incredibly efficient income tax profile.
Their tax position is as follows:
|Deductible car costs||$15,000||Nil|
|Total income from the practice||$120,000||$9,150 or 7.6%|
The position is even better when we take into account the capital gains tax free increase in the value of the home: at say 5% a year they are making another $100,000 a year tax free, and the tax free income in the SMSF: at say 9.8% (ie the average for Australian shares in the two decades to December 2012) they are making about another $200,000 a year tax free. That is, they are making about another $300,000 a year tax-free every year.
Investment planning before the retirement years
Barney and Betty are not unusual. It’s quite common for 65 year old GPs to have $4,000,000 in quality assets, be working at a comfortable 50% of normal full time work, and, have plenty of time for other activities, such as travel, sport, charities and grandchildren.
The key is found in the advice provided previously. That is:
- invest in your home, buying as much home as the bank will lend you as early as you can;
- invest in your practice, and use the extra cash flow to pay for lifestyle and further investments; and
- pay the maximum amount of deductible super contributions every year.
The magic of compound interest does the rest.
This is all Barney and Betty did. It was simple and it worked.
The theme is to migrate assets to the super environment from say age 50 on, to be taxed on very concessional basis until age 60 and tax free after age 60 (or in some cases 55). This may mean selling investments: be mindful of stamp duty and capital gains tax as the migration is planned. The ultimate goal is to have all your investments tax free from age 60 on: the home is tax free and the SMSF is tax free.
Remember, men are living on average until about 80 and women until about 84, and hopefully you will live longer than this. If a female GP starts a super pension at age 55, and lives to age 85, that’s thirty years of tax free investment. Looked at more wholistically, that’s more than one third of a life and about one half of a post graduate working (and investing!) life.
What about non-concessional super contributions?
Non-concessional super contributions are super contributions that are not tax deductible and are not taxed in the hands of the fund.
Non-concessional contributions are a great way to increase super account balances, particularly as age 60 approaches. Age 60 is special because it’s the first age that a GP can start to receive a super pension without stopping work and:
- the pension income is tax free in the GP’s hands; and
- the investment income from the pension assets is tax free in the super
There is a good argument that most investments made after about age 45 should be made through a SMSF if at all possible, and be funded by non-concessional contributions if needed. The long-term tax benefits create a compelling financial argument. The only downside is the investment cannot be accessed until the GP is age 55, at the earliest. But this is rarely a problem in practice.
There are limits on the amount of non-concessional contributions. These limits should be checked before any non-concessional contributions are paid each year.
What about expected inheritances?
It’s common for GPs aged 50 or more to have a parent or two aged 80 or more.
It’s a morbid topic, but obviously the parents do not have long to go, are not spending much and in a way are holding their assets as stewards for the next generation. Inheritances of $500,000 or more are not uncommon. We recognise these expected inheritances as virtual assets owned by the GP, and factor them in to all financial plans.
It can be smart to immediately transfer the inheritance to a SMSF as a non-concessional contribution to be invested in a concessionally-taxed environment up to age 60 and tax free after age 60 once the GP starts a pension.
We try to spend a little extra time with new clients finding out a bit more about the person, their life views and their relationships with friends and family. Our purpose is not completely social. Often the extra time reveals important facts, hopes and attitudes we can then blend into our advice and strategies, making them better than ever.
The social glimpse allows us to filter our advice and make sure it is relevant and pertinent. An increasingly common glimpse reveals a GP supporting elderly parents or young (and sometimes not so young) adult children, and sometimes both. This immediately raises the question of whether this help can be synthesized into the GP’s overall financial plan.
As income and wealth levels grow, as the track to financial maturity lengthens, and as parents live longer, more GPs are viewing the extended family as the relevant economic unit, not just mum and dad. They want to maximize the utility across that whole economic unit. We are not slow to suggest this: wealth creation and retention philosophies once limited to the very wealthy now find fertile ground with most GP clients.
Inter-generational financial planning is the game’s name and it has incredible potential for most GPs. Mediterranean, Middle Eastern and Asian families pick it up quickest: its part of their culture. Anglos take longer to get it. Entrenched beliefs hinder the process: the old age pension has a sacred spot in many older psyches. But it is a very limited spot – $20,000 pa is not much cash to live on. Grandma and Grandpa may be better off skipping past the Centrelink office and jumping into their children’s financial planning strategies. Salaries, super, car fringe benefits and trust distributions create a better lifestyle for all concerned.
Super grants for super clinics
Most GPs will be aware of the Department of Health’s Super Clinic program.
Not all GPs will be aware that the $5,000,000 plus grants are usually tax-free under the tax law. Their close cousins, the Primary Care Infrastructure, grants are usually tax-free too.
The grants do not come without strings attached. There is an onerous obligation to provide a diverse and extensive range of medical services to all sections of the community for up to twenty years.
But the grants are real, and add to the GP’s wealth position over night, and properly invested create significant on-going future wealth.
Investing with the extended family in mind is the key. It does not matter who owns the investment as long as after tax returns to the family are maximized.
Investment time horizons are measured in decades, even generations, not years.
Trusts, companies and SMSFs each have a role to play, as does the careful creation of deductible debt, in the right place and at the right time.
Family fallouts can complicate things. Careful documentation is the key, but documents cannot substitute for the right attitude on the part of all concerned. Keeping control is a good rule of thumb: the GP should stay in the driving seat. Asset protection is enhanced. Build up valuable assets in spouses, trusts, super funds and companies’ names and you will not go too far wrong.
Two directions: upwards and downwards
Intergenerational financial planning occurs in two directions: upwards, and downwards.
Upward financial planning looks up at older parents and accesses their favourable tax planning profile through super, trust based structures and, in particular, genuine employment relationships.
Downward financial planning looks down at children, particularly adult children, (ie children age 18 and over) and identifies ways they can be integrated into the GP’s financial planning strategies. On the surface many downward financial planning techniques overlap with the upward financial planning techniques, but the different age orientation makes them functionally different strategies.
When tough love is needed
I can recall meeting with a 60-year old GP some years ago. It was a Sunday because he would not take any other day off work. He worked 6 days a week 51 weeks of the year every year and that was that.
I could not believe his question: it was: “should I work Sunday’s too?”
Suppressing my immediate reaction I simply asked “why?”
He told me his 30-year old son wanted to buy a home for his young family, and did not have a deposit. He wanted to work Sundays, save up a deposit and give it to his son. Further suppression of my immediate reactions was needed. So I asked why could not the son work Sundays and save up that deposit?
He said his son was too busy playing cricket and football.
I could no longer suppress my immediate reactions, but I instead found myself instead calmly quoting St Paul and his letter to those Corinthians:
“When I was a child, I used to talk like a child, and see things as a child does, and think like a child; but now that I have become an adult, I have finished with all childish ways.”
Which in 2014 translates to “grow up and get a real job”.
Take care with financial planning assistance to children
As a general proposition financial assistance to children is not a good idea. The evidence that exists indicates that children who receive significant financial assistance from parents tend to under-perform in the income and the asset accumulation stakes. Most can intuitively see why: the knowledge and expectation of regular financial assistance takes away the imperative of working hard for oneself. The child is not hungry for success, and does not feel the need to work hard and generally plan for their own financial future.
Exceptions abound, of course, and for this reason generalizations are dangerous. Even in the same family assistance to one child can have a negative effect while the same assistance to a sibling has a neutral or even a positive effect. Nevertheless, our general proposition stands.
This is not an argument against downward financial planning techniques. But who said the children must get the dollar benefits of the strategy? The aim is to enrich the family as a group, not any one individual. Integrating your children into your financial planning strategies will not damage your child’s future income and capital accumulation costs on its own. Damage is only done if you give cash to them in an inappropriate way now, and this can happen with or without integrated financial planning strategies.
Significant direct cash assistance should not be extended to children except for:
- living costs while studying (working nights as a cleaner may be good for the soul but its not good for the academic record, or future employment prospects);
- living costs once children become parents themselves, ie when the GP becomes a grandparent, and its not about them any more, its about the grandchildren;
- over age 40, as parents move into their 70s the argument for a “living legacy” becomes stronger. Remember, if you live to 90 your kids will be in their 60s at your funeral; and
- unusual circumstances, such as illness or your beloved child working very hard in a career that pays poorly or not at all. (It is perhaps no coincidence how so many Olympians seem to have GPs as parents).
It’s a case-by-case analysis. You know your child better than anyone and can make up your mind when, how and to what extent they should receive economic assistance, including the extra wealth created by integrating them into your financial planning strategies.
Our thoughts on cash based benevolence to non-working kids are best summed up in the following article first published in Australian GP some years ago (dollar values up-dated).
The Five Adult family
“…It is not unusual to encounter a household made up of a fifty-something Mum and Dad and three or more university student children, still 100% funded by their parents, even to the extent of paying HECS and other uni fees, and annual holidays to the Gold Coast. That’s basically a five adult family. The cost is huge: family living costs may be more than $18,000 a month. It’s not that hard to spend that much: it’s an average of just $3,600 a month per adult for the mortgage, utilities, food, entertainment, (five) car costs, clothing, holidays, HECS or uni fees.
Dad and/or Mum working killer hours and rising overdrafts to fund it all are not uncommon. You have got take your hat off to Mum and Dad. They love their kids and want to give them the best possible start in life. But sometimes you find yourself questioning the whole strategy and asking at what age should parental financial responsibilities end? Age 18? Possibly, but probably not. Age 21? Probably, but possibly not. Age 26? Definitely. Does a parent financially supporting a 26 year old make sense? Is the parent really helping the child? Perhaps working weekends and uni vacations, or taking a year or two off to build up cash, is a wiser option. Let them do it themselves: they will value it more and their self esteem and their job prospects will be better. A few years work experience, doing anything, never hurt anyone’s CV, and can be the best possible motivation for never getting near that rut again.
In many cases Mum and Dad sacrifice their own financial future to create an inappropriately high lifestyle for the kids. In some cases the cost is even greater: health and relationships suffer as Dad pushes himself hard to live up to his adult family’s financial expectations.
It can be cruel.
GPs should generally be more demanding of their adult children, and less generous financially. It does not mean you do not love them. Treating your children as financially independent adults as early as possible is probably the best favour you can do for them.
At a more practical level, what can be done to take the edge off these new peak cost years? Multiple tax deductible company cars can be a good idea: you provide a tax deductible (safe but second hand) car as a fringe benefit from your family trust (your children are deemed to be employees for these purposes) and free up their cash to help pay their own living costs. The old, fully depreciated, practice lap-top or PC may be all that is needed for a student child’s IT requirements. And you buy the new one for your practice, and depreciate it appropriately in your tax return. Adult student children, or nephews and nieces, may be able to receive distributions from the family trust and take some of the sting out of mum and dad’s tax bills.”
Take care with implementing strategies generally
From a tax planning point of view, each strategy must make sense from a commercial point of view and must not be implemented for the sole or dominant purpose of securing a tax benefit for one or more family members. The ATO may challenge a strategy if on the facts it has been implemented for the sole purpose of securing a tax benefit.
There must be significant purposes other than securing a tax benefit. Genuine motivations abound: building up family wealth over the generations, asset protection in relationship breakdowns, succession planning, genuine retirement planning, caring for elderly parents and caring for needy children are all good reasons for intergenerational financial planning.
What techniques are available?
A range of techniques is available, and the exact mix depends on the GP’s circumstances.
- genuinely employing parents or children in the practice and paying them market salaries for the work they do;
- superannuating employee parents or children up to their age based limits to provide for their ultimate retirement;
- providing parents and children with concessionally-taxed fringe benefits such as company cars, whether as employees or as deemed employees under fringe benefits tax rules;
- distributions of net income to low tax rate parents and children from discretionary trusts, whether they be service trusts, investment trusts or practice trusts where permitted under the ATO’s public rulings;
- building up assets and generally investing via family trusts whereby the net income including net capital gains from the investment can be distributed efficiently;
- building up super benefits in the names of parents over the age of 60 where the earnings are tax free and pension and lump sum benefits are tax-free. Concessional contributions and non-concessional contributions both have a role to play;
- guaranteeing parent loans to facilitate reverse mortgages at a sensible interest rate;
- guaranteeing young adult children buying their first home or investment property;
- soft loans to parents or children to allow them to buy homes, thereby minimising non- deductible debt across the family group; and
- renting homes to parents or adult children from a family trust at an arms length rent under a standard residential property lease
In each case the maths show the extended family better off compared to otherwise, even if the GP is not better off personally. It’s a mindset. It’s a perspective. It’s what’s best for the family, not what’s best for the GP. Its financial planning for the generations and it makes a huge amount of sense.
Disabled children are treated as adults for tax purposes even if under age 18 and therefore can receive distributions of net income from family trusts and hybrid trusts. This income is not taxed under the punitive rules that typically apply to unearned income of minors. This can save more than $10,000 cash a year for the parents, which helps take the sting out of the extra costs of disabled kids.
A disabled child can be superannuated if they are genuinely employed (obviously this depends on the nature of the disability). This is as a general law employee (where they are engaged as employee – minimum ages apply) or as a deemed employee under the special rules applying to company directors (aged 18 and above).
For example, a 19 year-old daughter who experiences deafness can work in the surgery during uni holidays, and be paid an arms length salary. She can also be superannuated up to $25,000 a year, creating a tax benefit of $7,500 for her family. She can pay non-concessional contributions of $150,000 a year, or $450,000 in a 3 year-period, and these can be in effect paid for her by her family.
These strategies will help create a better financial future for the daughter later in life: SMSFs can pay pension benefits to disabled members under age 55, provided certain conditions are met, and she may well meet these conditions if her health deteriorates. If she does not, and the money is ‘locked in’ to superannuation, then the large contribution to her super fund at the age of 19, which then has several decades to enjoy the benefits of compounding, means that – even if she does little else in terms of deliberate financial planning – this daughter is unlikely to face the typical problem for women when it comes to retirement. (The average woman only has around half of the retirement nest egg when she leaves the workforce – a real problem given that she can expect to live longer in retirement).
The worried grandparents and the second hand Volvo
Dr Bill and his wife Joan watched dismayed as their 20 year-old daughter Lisa moved in with her boyfriend of 10 months to raise their new baby girl together. Not surprisingly, the young couple were flat broke. The daughter was forced to cart Bill and Joan’s precious grand-daughter around in a 20 year old bomb likely to blow up at any time.
The solution was a new second hand Volvo station wagon, a credit card, and stern instructions on what each was to be used for. The Volvo had all modern safety features, was owned by Dr Bill’s practice trust and was provided as a fringe benefit. Lisa is their daughter, and daughters of employees are defined as employees for these purposes. The costs of the car were therefore deductible for the practice trust, with just a little FBT payable each year.
Lisa sold her old car to buy extra things for the baby.
Lisa used the credit card as a convenient cost-capturing device addressed to the practice manager and paid by the practice trust. Lisa paid her car costs with the card, and the statements were sent to the practice manager who paid them each month before the interest kicked in.
This strategy reduced the family’s tax bill by about $8,000 a year, being the tax benefit connected to the $17,000 of car costs incurred each year, including $8,000 of depreciation. But the real saving was made 6 months later when the drop-kick boyfriend stacked the car at 80k an hour, and Lisa and her daughter crawled out uninjured. The real motivation was to make Lisa and her baby as safe as could be. The tax benefits were secondary.
This example highlights the point that there is no limit on the number of company cars able to be provided as fringe benefits, and relatives of employees are deemed to be employees for fringe benefits tax purposes. Company cars are a great way of supporting low-income relatives with a safe and reliable car.
Inter-generational financial planning is not just about helping low-income family members. It can work the other way too. GPs’ parents are often asset rich and income poor, in their sixties and seventies and not working full time, if at all. They do not pay tax: their super is all tax-free.
Take Dr Mario as an example. Mario was born and raised in Strathfield. He still lives there, and his parents live around the corner. They baby-sit the grand-kids every day, and they helped Mario get through university, set up his practice and buy his home.
Mario’s family are close, in that Mediterranean way. They share everything.
Mario’s parents are worth about $4,000,000. They have their home, their super and a couple of local investment properties. Life is good. Except they are bored: they previously enjoyed active professional lives and the Strathfield Bowls Club just doesn’t do it for them. Too many old people, they say.
Mario sold his Strathfield practice for $500,000 in early 2014. The $500,000 was tax free under the CGT small business exemptions.
Mario now wants to invest $500,000, but does not have the time to do this. His days are spent at his new practice and when he gets home he wants to be a good dad to his young family. So Mario forms a new investment trust with his mum and dad as directors and primary beneficiaries. Mario puts in $500,000 capital. The trust borrows another $1,000,000 at 5% interest and invests $1,500,000 in blue chip Australian shares.
Mario’s parents administer the trust, along with their other investments. The Medico Investment Trust expects to earn 9-10% per annum based on the last two decades (source ASX Long Term Investment Report July 2013, 2014, 2015 and 2016), which means it earns around $135-150,000 (including unrealised capital gains), less $50,000 of interest. The net income (excluding unrealised capital gains) will be about $50,000, and this will be distributed to Mario’s parents as a reward for their time and skill in managing the investments.
Mario’s parents do not have other income. Little tax is paid on the first $25,000 that each of them receives. Thus, Mario’s $500,000 is effectively invested tax free, with excess franking credits refunded.
This is a powerful planning strategy: it allows the family’s $500,000 to be invested virtually tax free, which compares extremely well with alternative strategies including superannuation. Remember: a tax dollar saved is an extra dollar invested, with an exponential compounding effect over time.
Parents of foreign trained GPs
Parents of foreign trained GPs often do not qualify for Australian social welfare payments until they have been in Australian for at least 10 years. This means they are a significant cost, particularly when the GP is usually re-establishing herself financially and has to look after a young family.
One GP couple in Queensland had two lots of parents living in the family home, his parents and her parents, plus their three young children. We identified that the new practice they were buying was a business for tax purposes under the ATO’s public rulings: it had four non- owner GPs. This meant it could be bought by a family trust and once a reasonable amount was distributed to the two GPs the remaining net income was distributed to the four grandparent beneficiaries under the ATO’s public rulings, particularly Income Tax Ruling IT 2639.
The family trust ran the business for the benefit of the family, and reinvested the profits back into other family investments owned in related companies, trusts and SMSFs.
A family of investors
Dr Sue’s parents always invested via their family trust, and this proved to be a very good strategy: net income including net capital gains were distributed to Sue and her sisters after age 18, effectively paying for their university educations.
Dr Sue and her husband have just bought a new home and have a non-deductible debt of $250,000. Dr Sue is not working as a GP much for the next few years, since her hands are tied up with her young family and her husband is employed as an ATO auditor. The interest on the home loan is $24,500 a year, and Sue’s husband has to earn about $40,000 in pre-tax income to cover this cost.
The ATO is cutting back staff and Sue fears her husband may be retrenched.
We discovered that Dr Sue’s parents’ family trust’s balance sheet shows unpaid distributions to Dr Sue of more than $200,000, dating back to her student days and later her back-packing
days. The solution was simple: the trust paid the $200,000 to Dr Sue and she paid back the non-deductible home loan.
The parent’s family trust can still distribute $18,000 a year tax free to Dr Sue, and $441 a year tax free to each of her children, saving the parents about another $10,000 a year in tax. These tax savings are invested in new investments and debt reduction reducing risk and improving future investment returns for the family, including Sue, her sisters and her kids.
And if Sue and her husband divorce the ex-husband will not be able to access these benefits. Real family trusts make real sense.
Help with a home
The child buying his or her own home incites strong emotions for parents. For a variety of reasons parents can be anxious that the child buys well and gets a good home in a good location. If ever there will be financial assistance, it will be now (even if the parents are not doing that well themselves).
But we still say “don’t do it”. Let’s use a recent example to explain why.
A GP’s wife was delighted to tell me about her daughter’s recent wedding to a UK accountant. They were looking at buying nearby and had located a likely home for sale. My client was interested in adding $200,000 to the pot.
The major problem (apart from the GP’s own impecunious circumstances – the $200,000 would not have been the first large amount given to the daughter) was the likely effect on the new son in law. Financial assistance is rarely given without strings attached, consciously or sub-consciously. The effect is usually seriously emasculating. For the next two decades of his life the young son in law will be visited by the real owners of his home, not by friends with whom he stands as and equal and to whom he relates as an adult. It is most important that when the in-laws visit for the first time, and every time after that, he and his wife open the door to their home and invite them in as equal adults, not as indebted children.
A minor problem was what would happen to the gift if the young couple divorced. At least part of the $200,000 would go off to the now unloved ex-son in law. Not a good result.
Whenever possible, allow your children to buy and pay for their own homes. Even if this means living a suburb or two away from where they would live if you helped them.
If parental assistance is needed, consider a bank guarantee. This allows the children to buy more home and to buy that home earlier than otherwise. Assuming the home is substantially sound as an investment, ie they do not pay too much, the real exposure to mum and dad is minimal. But more importantly it allows children to stand as adults and to be proud of their own achievements, financial and otherwise.
And the studies show that they will end up earning more and owning more.
A child in every home
The world of work is changing, and it’s not a good idea to assume your children will enjoy safe employment with just one or two employer during their working lives. More probably, as Hugh Mackay tells us, they will have a “patchwork” of part-time and casual engagements, with nothing like the secure tenure that typified their fathers’ and mothers’ employment experiences.
A GP’s kids will be bright, that’s almost genetically guaranteed, and bright people tend to do well financially. But it is still not a safe bet that they will blitz their way in and out of university and then into the top echelons of the work-force. The competition is tough, and is going to get tougher.
And what about housing prices? Urban house prices have become astronomical in the last few years. One can understand why children are staying home well into even their late twenties. They have no choice: they cannot afford to leave. The entry price into most popular suburbs in capital cities (especially Sydney and Melbourne) is too high for most people under age 40, including GPs.
You would be amazed how often the new home is only afforded with a bit of discrete help from grandma and grandpa. It’s just not possible otherwise, particular if there are kids in the kitchen or on the horizon.
What will housing prices be like in two decades time? Who knows. How will your children afford to pay these prices? Who knows.
What can you do about this? Simple. “Buy” your child a home now. It does not have to be something they will live in when they are 50. But it should be in a capital city and have good growth prospects. You should not actually give the child the home (and in fact, as indicated above, we believe that this is actually a bad idea). The family retains ownership of it. But buying now in effect insulates the family against future home price increases and protects the next generation against the risk of runaway home prices.
If a GP’s home is worth, say, $1,500,000 and is paid off or nearly paid off, any of the banks will lend that much again for a second home at home loan rates without any fuss or bother. Make sure the interest rate is the same as the home loan rate: the banks may try to squeeze an extra percentage point or two here, and have been known to tell GPs that they have no choice but to charge that bit extra.
The tax maths show that a small after tax cost to mum and dad in the early years spares the child a large before tax cost in the later years. This sparing gives the child a real economic head start in life and, with a bit of luck, the child’s own efforts will amplify this head start many times over. The bottom line is that it’s almost cash-flow neutral to 100% gear a rental property if the interest rate is 7% and the rental yield is 5%.
Perhaps the homes are owned through a family trust and the children just live in them later on while saving for their own homes and investments. This has the added advantage of protecting your children against the risk of losing assets in divorce. Remember, the divorce rate is more than 50% for young marriages.
This strategy works with one, two or even three children. The maths becomes a bit daunting with four or more children, but perhaps here the idea can be modified by buying the homes a few years apart or buying lower priced homes and letting the children up-grade them later under their own steam.
Call us old-fashioned, but this is even more important for your daughters. Its a century since the suffragettes but we still do not have equal incomes or workplace opportunities. Most women have less than $30,000 of super on retirement. That won’t go far. Virginia Woolf wrote about a room of one’s own as a pre-condition for gender equality. We’d change that to a home of her own.
What happens if someone dies?
Death can be a problem.
It’s much easier to implement these strategies in one-child families. The sheer symmetry means nothing can go wrong: economically speaking, the parents and the child are perfectly aligned and what is good for one is automatically good for the other. Just keep your fingers crossed your 80 year old widower father doesn’t hitch up with a sexy 70 year old over at the Happier Daze Retirement Centre. Don’t laugh. It happens. But usually it does not.
One solution for multiple child families is to involve all the children equally: but this can be problematic if the children have different life circumstances and different attitudes to investment and taxation planning.
It’s fair to say the more kids there are the more complicated death is.
Careful documentation will reduce the risks connected to death. But, as always, nothing beats good faith, and the best documents in the world cannot guard against bad faith. So if there is no good faith there should be no inter-generational financial planning.
Careful documentation includes items such as:
- each parent’s will;
- each parent’s binding death benefit nomination form;
- powers of attorney;
- loan agreements;
- bank account access documents; and
- similar documents.
Each case is different and the exact combination of documents will differ from case to case.
What happens if there is a family fall out?
Family fall-outs can be a problem too.
The answer is essentially the same as the above answer. Nothing can replace good faith and careful documentation is the key. Do not implement these strategies if there is no good faith, that is, if you have any concerns that family members will not respect the substance and spirit of the arrangement as well as its strict legal form.