FNCE20003 Introductory Personal Finance Lecture 11 PDF

FNCE20003 Introductory Personal Finance Lecture 11 Divorce / Family breakdown Course review Lecturer – Tony Cusack October 2024  Lecture 11 topics Consequences of divorce / family breakdown Course review Exam information October 2024 FNCE20003 Lectu...

FNCE20003 Introductory Personal Finance Lecture 11 Divorce / Family breakdown Course review Lecturer – Tony Cusack October 2024  Lecture 11 topics Consequences of divorce / family breakdown Course review Exam information October 2024 FNCE20003 Lecture 11 2  Negative impacts on RIS we know that several variables will determine the amount of lump sum accumulation that will fund RIS – recall the EAV calculation we also know that an adequate RIS is certainly not a guaranteed outcome circumstances that will have a negative impact on the lump sum: 1. failure to remain in the SG scheme – e.g. due to illness, accident, medium to long term unemployment, time out for family-rearing, starting your own business, travel, etc. 2. divorce / family breakdown we now turn our focus to the latter, given about 40% of first marriages end in divorce... October 2024 FNCE20003 Lecture 11 3  Financial planning for family breakdown in addition to the emotional consequences, divorce usually has a significant and negative financial impact a cautionary view of divorce is: “the wife gets the house, the husband gets the super; BUT if you bring the lawyers in, the wife might as well give the lawyers the house and the husband give them the super” whatever are the reasons leading to divorce, it is best if physical and financial separation can be arranged between the two parties evidence indicates that up to 95% of couples resolve differences without resorting to a court determination October 2024 FNCE20003 Lecture 11 5  Issues for Financial Planners in circumstances of marital breakdown, key issues for FPs are: – which member of a couple is the client? need to clarify and communicate – in whose name are assets purchased and retained? risk area: FPs (and lawyers) may be open to actions of negligence relating to lack of advice on estate and financial planning prior to or on marriage breakdown as usual, the best defense against such action is demonstrating that the FP has met the ‘know your client’ and ‘know your product’ rules October 2024 FNCE20003 Lecture 11 6  Binding Financial Agreements as previously noted, Binding Financial Agreements in the form of pre-nuptial agreements can be used to regulate the parties’ arrangements during the marriage, when they separate / divorce, and even on death BFAs outline the financial consequences to each of the parties on relationship or marital breakdown parties should consider signing BFAs at the time when they are most amenable to agreeing on everything – i.e. in advance of when they might be needed … if the BFAs are properly drawn up, they are legally enforceable and their terms will be put into effect (i.e. they will override court jurisdiction) October 2024 FNCE20003 Lecture 11 7  Property settlement couples are commonly involved in complex financial arrangements, especially those that have been together and pooled assets over a number of years often, each partner has brought a different mix of assets to the marriage their arrangements are likely to include, for instance: – shared household provision (living expenses) – asset acquisition (home, car, investments) – asset protection (life, health, car insurance) – each partner may inherit or otherwise acquire additional financial assets (e.g. gifts or loans from parents) October 2024 FNCE20003 Lecture 11 8  The Family Court property settlement under divorce is dealt with by the Family Court when the parties cannot come to agreement in terms of split (of assets) the powers of the Family Court are very broad, and its decisions are binding however, despite its wide powers, the Court will seek to find the best solution by following two principles: 1. It encourages financial settlement and other accommodation without resort to arbitration; 2. The Court (if required to act) aims to achieve ‘a financial clear break’ and strives to be as ‘fair’ as far as possible, to both parties (applying the ‘four step approach’) October 2024 FNCE20003 Lecture 11 9  The Family Court that is, in the first instance, the Court strongly encourages financial and other settlements be worked out by the divorcing partners themselves – essentially, they send the couple away to come to agreement themselves in this vein, if the Court is made aware of the general financial and other domestic circumstances of the couple, it may be prepared to signal the judgements that it would make if court action were to proceed – it would also indicate the expected cost of taking that route if children are involved, the Court will typically seek to examine (and may vary) financial arrangements determined between the couple October 2024 FNCE20003 Lecture 11 10  The Family Court in the event that the matter gets to proceedings, the Court will initially set out to ascertain the total asset pool of financial resources, including superannuation and tax liabilities if applicable one outcome is that assets brought to the marriage on one side are ‘watered down’ over time (this is why not all BFAs are held to be binding) next, the Court takes into accounts respective needs, which is the basis for the homemaker spouse typically being awarded the family home legislation enacted in 2009 formally applies the same rules to de facto and same-sex relationships that break down October 2024 FNCE20003 Lecture 11 11  Family Court’s four step approach 1. Identify and value the pool of marital property (including superannuation, tax liabilities, etc.) – property values as at date of hearing (or as near as practicable) are used – tax issues and the question of inheritances of each member or the couple are considered 2. Assess contributions that each of the parties has made to the accumulation of the pool – initial contributions, gifts and inheritances, financial contributions, non- financial contributions, home-making contributions, big-money cases October 2024 FNCE20003 Lecture 11 12  Family Court’s four step approach 3. Assess the ‘future needs’ factors of each party – based on s.75(2) of the Family Law Act 1975 – it takes into account the income-earning capacity of parties, health and age, care of children, standard of living to which parties were accustomed before the divorce, etc. 4. Justice and equity – this final step is for Court to stand back from the exercise it undertook in Steps 1 to 3 and examine whether the outcome will deliver justice and equity between the parties see: Property Settlement in Family Law - Process, Agreements, Time Limits (fgd.com.au) October 2024 FNCE20003 Lecture 11 13  Child support obligations it is important not to underestimate the complexity of marital breakdown, especially in the area of child support the government provides guidance in this area via the Child Support Agency (CSA), part of Services Australia that administers the Child Support Scheme information relating to child support payments is published yearly, outlining the formula that determines the level of support to be paid by a payer – its effect is that there will be a net payment from one spouse to the other the basis of the formula is that the level of support will vary with the number of nights that the payer has the children in their care (i.e. stay overnight), taking into account income earned by both parties October 2024 FNCE20003 Lecture 11 14  The child support formula the formula was introduced “to ensure fairer assessments, encourage shared parenting and recognise the costs of contact”, as the system was seen as unfair to working fathers who had minimum access rights under this system, child support payments are to be calculated on the basis of actual costs of children the combined income of both parents is used to calculate payments, treating both incomes equally in essence, contributions of both parents to the cost of their children through care and contact is recognised October 2024 FNCE20003 Lecture 11 15  Equal to number Child support care Equal to number Child support cost of nights a Care level percentage of nights a year percentage fortnight Less than regular 0–13% 0–51 nights 1 night Nil care 14–34% 52–127 nights 2–4 nights Regular care 24% 25% plus 2% for every 35–47% 128–175 nights 5–6 nights Shared care percentage point over 35% of care 48–52% 176–189 nights 7 nights Shared care 50% 51% plus 2% for every 53–65% 190–237 nights 8–9 nights Shared care percentage point over 53% of care 66–86% 238–313 nights 10–12 nights Primary care 76% More than 87–100% 314–365 nights 13–14 nights 100% primary care source - https://www.humanservices.gov.au/customer/enablers/working-out-child-support-payments-using-basic-formula October 2024 FNCE20003 Lecture 11 16  Dividing superannuation assets super is considered as property in divorce proceedings, so like any other asset it can be divided between partners by agreement or court order generally speaking, there are three options when deciding what happens to superannuation assets at the time of a divorce or separation 1. Split the super (most common) 2. Defer the decision until another time, such as retirement 3. Take super into account but leave untouched there are various approved methods for valuing super interests super fund trustees are bound by court orders and binding agreements super preservation rules will still apply, even if super is split October 2024 FNCE20003 Lecture 11 17  CGT and stamp duty under marital breakdown legislation, transfers between parties of certain marital settlement assets are exempt from both CGT and stamp duty the main exempt assets are: – real estate – shares – trust assets – motor vehicles October 2024 FNCE20003 Lecture 11 18  Lecture 11 topics Consequences of divorce / family breakdown Course review October 2024 FNCE20003 Lecture 11 19  Re-cap – theoretical basis the underpinning theoretical basis of this subject is work done by economists relating to consumption and saving, commencing with Keynes (1936) and later extended to life cycle hypothesis theories we find that in a broad sense, the objective of financial planning is to enable achievement of financial wellbeing, so life cycle theory is relevant as a starting point for examining financial decision making leading to wellbeing the principles of the life cycle model, modified for practical realities (e.g. uncertainty), result in an explicit recognition of different ‘phases’ of the life cycle, involving saving / investment strategies designed to meet varying preferences, needs, resources in different ‘phases’ of life October 2024 FNCE20003 Lecture 11 20  Example – phase (ii) issues to consider phase (ii) (partnering, starting a family) issues: – cost of having a baby, hospital costs, out-of-pocket medical expenses – what government payments are available? Do the couple qualify? – do(es) either or both partner(s) plan to take time off work? For how long? in this phase, it is likely that debt will be taken on (personal loans, credit cards, home mortgage, other) the use of debt to fund short-term consumption – e.g. nights out, meals, holidays, clothing – is considered financially irrational however, funding long-term consumption – i.e. depreciating assets with a useful lifetime, such as ‘white goods’, cars or furniture – is not as bad October 2024 FNCE20003 Lecture 11 21  Refinancing and debt consolidation we saw that paying off home mortgage loans (and other non-tax deductible debt) is a low-risk strategy that delivers a relatively high effective return in the form of the amount of the after-tax interest saved we also reviewed the benefits of re-financing home mortgage loans – the key issues to consider is what interest rate are you currently paying, and how does this compare to the rates now on offer in the market – net benefits can arise from what looks like a small drop in interest rates further benefits can be obtained by consolidating other debts into the mortgage loan – this is possible due to the net equity, where MV of the property > loan balance October 2024 FNCE20003 Lecture 11 22  Portfolio asset allocations constructing a diversified investment portfolio is a two-step process: 1. Asset Allocation (the ‘macro’ decision) – refers to the percentage of available funds invested in the different asset classes (i.e. equity, cash / fixed interest, and property) – studies have consistently shown that around 90% of portfolio return arises from asset allocation (which can be strategic, tactical and dynamic) 2. Security Selection (micro decision) – i.e. selection of, and investment in, individual securities within each asset class each step depends on investor risk tolerance, so there is currently no standard model for either October 2024 FNCE20003 Lecture 11 23  Investment categories the three broad classes of investment assets are cash, equities and property and each provide investors with a passive (investment) income cash (on deposit) and fixed interest securities (bonds) are debt securities – this is the lowest risk category, as interest is paid before dividends and debt is repaid before equity property is a medium risk investment, providing returns in the form of income (rent) and capital gains on average, equities are the highest risk category of investment assets, as their income return (dividends) is discretionary, capital losses are almost as common as capital gains, and return of equity ranks last in a liquidation October 2024 FNCE20003 Lecture 11 24  Selecting securities how do investors go about selecting specific securities from the vast range available in each asset class? there are different recognised methods, including: 1. Fundamental analysis 2. Technical analysis (also known as ‘charting’) 3. Random selection each of these methods has a finance theory implication – for example, random selection is consistent with portfolio theory / diversification there is a huge industry associated with providing stock selection services, typically based on 1. or 2. October 2024 FNCE20003 Lecture 11 25  Illustrative case study you are a FP and have been approached by Anne, who is retired, to provide financial planning advice Anne is aged 67 and is a single (widowed) homeowner with two adult children and three grandchildren her assets are an SGS lump sum of $447,500 and $75,000 other assets (no car) she ‘doesn’t understand numbers and finance’, but her objective is to ‘live modestly, but comfortably’; you are engaged to advise her in relation to: – generating a low-risk, tax effective RIS – Social Security entitlements (basis not covered, we’ll assume amounts here) – estate planning and insurance cover October 2024 FNCE20003 Lecture 11 26  Financial advisers’ duties due to the specialised and complex nature of FP, the financial adviser is compelled to act properly to safeguard the interests of clients this is the fiduciary duty, which is a legal/statutory (as well as ethical) duty to act in the best interests of the client the rule of fiduciary duty is also referred to the ‘best interest’ duty, in that it requires the adviser to act objectively and solely in their client’s best interest it embodies two key principles: (1) Know your client (2) Know your product October 2024 FNCE20003 Lecture 11 27  The ‘best interest’ duty to ensure that advisers have a reasonable basis for their advice, it is necessary to ‘know your client’ by following these steps: 1. Perform a detailed investigation of the client and research the client’s needs 2. Carefully record all relevant aspects of the client 3. Formulate clear advice for the client 4. Obtain the client’s decision and implement it further guidance is given by ASIC RG175 ‘know your product’ is based on similar principles October 2024 FNCE20003 Lecture 11 28  The ‘best interest’ duty in relation to Anne, we need to provide advice that maximises her RIS taking into account her personal circumstances, in particular: – no longer earning income determine what Social Security benefits apply – relatively modest lump sum to fund pension – homeowner, with no dependents – health and insurance – bequest motive? – travel or hobbies? October 2024 FNCE20003 Lecture 11 29  Addressing Anne’s RIS given Anne has retired and reached age 65, at least one condition of release has been met, which means she can access her super lump sum she can withdraw it free of tax, in full or in part, but we know from her stated objective that she doesn’t wish to take it as a lump sum rather, her key objective is the need to provide a RIS / pension, so we need to evaluate the different options available in attempting to meet this objective as her FP, you will need to determine if she has objectives relating to travel, hobbies, a bequest motive – how? ask her! October 2024 FNCE20003 Lecture 11 30  Main RIS options a RIS may be generated by earnings from two broad sources: 1. superannuation assets, e.g. accumulation to fund RIS by way of: i. draw a pension from a super fund ii. purchase a term certain a life annuity iii. some hybrid / variation of i. and ii. 2. non-superannuation assets – e.g. rental income from investment properties, interest and dividends from cash, bonds and equity investments, royalties, annuities, non-superannuation pensions in Anne’s case, as the lump sum is relatively small with few other assets, she would not be able to rely on 2. October 2024 FNCE20003 Lecture 11 31  RIS – indexed term annuity to re-cap, Anne has advised that she is very uncomfortable with investing and would prefer a stable, certain income stream (preferably fortnightly) accordingly, we advise her to use the super lump sum to purchase a term annuity payable fortnightly for 25 years, indexed at 3% p.a. (full annuitisation) – 25 years is consistent with her life expectancy (female, 65), i.e. ~23 years assume that the annuity provider calculates the annuity using 5.5% p.a. the unit cost of her purchased annuity (cost per starting $1.00 of annuity) is $18.5102, using the indexed formula previously covered this means she would receive $447,500 / $18.5102 = $24,149 for a year – equal to $24,149 / 26 = $928.80 per fortnight October 2024 FNCE20003 Lecture 11 32  Anne’s total income now assume that Anne’s level of income and assets mean that she can receive $586 p.f. of Age Pension (maximum is $1,144 p.f.) Anne’s fortnightly income is therefore: $929 + $586 = $1,515 ($39,385 p.a.) – far closer to ‘modest’ than ‘comfortable’ the income would be tax-free, as are earnings on her assets remaining in the super fund pension account, because: i. the $24,149 purchased income stream is more than 5% (mandatory minimum pension) of her opening account balance of $447,500 ii. the Age Pension is taxable, but $586 p.f. is $15,236 p.a. which is below $18,200 (the tax-free threshold in 2024-25) October 2024 FNCE20003 Lecture 11 33  Cost of poor advice to Ann assume now that Anne qualifies for the maximum Age Pension of $1,144 p.f., which equates to $29,744 p.a. (taxable, but tax reduced to zero due to SAPTO) Anne believes she could live on this and asks if she can draw a smaller pension from her super balance than you had originally advised, to leave some money in the fund ‘for safety’ assume you agree with this, and it is decided to purchase an annuity over similar period, using $325,000 of the available balance (leaves > $100k) the annuity factor of $18.5102 gives her $325,000 / $18.5102 = $17,558 p.a. BUT this is below the minimum pension withdrawal requirement of 5% x 447,500 = $22,375, meaning the pension is taxable (TI = 29,744 + 17,558) October 2024 FNCE20003 Lecture 11 34  Estate Planning key elements of an Estate Plan – will – appointment of executor – establishment of a trust? – Power of Attorney (PoA) a good Estate Plan should be: – administratively simple – inexpensive to maintain – a balance of life-time enjoyment and preserving wealth for bequests – reviewed regularly October 2024 FNCE20003 Lecture 11 38  Anne’s will – considerations recall that a will is a legal document that disposes of a deceased estate’s assets to the people intended we should advise Anne to ensure that her will specifies how her property is to be dealt with after her death, and provides: – directions as to who are the beneficiaries to the assets and income of the estate – directions in the event that a beneficiary should die before Anne (testatrix) dies – nomination of executor(s) to manage the deceased estate – nomination of guardians for minors (not relevant in Anne’s case) we know that she is widowed, but has children and grandchildren, so these are her likely beneficiaries (but they can be friends, charities, other entities) October 2024 FNCE20003 Lecture 11 39  Anne’s will – considerations based on her objective, we need to determine (and confirm) that her children are financially independent assume that Anne advises that she would like to ensure that her estate goes to her grandchildren the reality is that she doesn’t appear to have significant assets – the home (value?), other assets ($75,000) and remaining term annuity, if any the easiest way to ensure that these assets go to her grandchildren is for her to specifically state this in the will, including any specific bequests if that is her objective (otherwise, state that assets are to be received jointly) note that the non-account based annuity is now an estate asset October 2024 FNCE20003 Lecture 11 40  Possible use of a trust alternatively, you might advise Anne to consider the set-up of a trust to enable distribution of her estate, e.g. 1. a living, or inter vivos, trust (established during a person’s lifetime) 2. a testamentary trust (established after the death of the testator, by the will) which only comes into effect upon Anne’s death testamentary trusts can result in tax savings due to special income rules relating to minors, and also enable effective income splitting / allocation is the estate value large enough to justify the cost of setting up and administering the trust? in Anne’s case, it would appear not October 2024 FNCE20003 Lecture 11 41  Choosing an executor / LPR executor ensures that a testator’s instructions are carried out and associated duties are completed no special qualifications are needed, but consider if they are up to the task can be a natural person (principal beneficiary, relative), Public Trustee, trustee company or professional adviser in Anne’s case, the likely choice is one of her children, if they have the capability – consider appointing a substitute executor (the other child? lawyer? adult grandchildren?) October 2024 FNCE20003 Lecture 11 42  Powers of Attorney (PoA) a PoA is a legal document under which a person (Anne) appoints another person (her attorney) to act as her agent Anne must have capacity to execute a PoA for it to be valid (of sound mind) and any PoA would operate only during her lifetime can be general (non-enduring) PoA, enduring (financial or medical), or power of guardianship a general PoA would cease to operate if Anne loses her mental capacity to act you would need to identify whether there are any matters that Anne would like dealt with on her behalf before recommending a PoA October 2024 FNCE20003 Lecture 11 43  Insurance for Anne whilst insurance has many uses in estate planning, is it relevant to Anne? possibly, as it can provide: – provision for dependents – provision for self (income maintenance) in case of disability or trauma – equalising bequests to different beneficiaries Anne’s lack of dependants and relatively low lump sum would suggest life insurance is unnecessary but health / hospital / trauma cover would definitely need to be considered to cover future medical costs (note: focus on definitions in any policy) October 2024 FNCE20003 Lecture 11 44  What about other insurance? Anne doesn’t own a motor vehicle her main asset is her property, so we would discuss with her the protection offered by home and contents insurance private/public liability insurance? Unlikely October 2024 FNCE20003 Lecture 11 45  Final considerations ensure that you are meeting FP disclosure and other regulatory / statutory requirements implicit here is that you ‘know your client’ (Anne’s circumstances) and ‘know your product(s)’ all information gathered in the process of meeting each of these rules needs to be held on file all recommendations to Anne must be in writing and evidence of her approval of recommended strategy is also to be in writing and on file perhaps review your professional indemnity cover … October 2024 FNCE20003 Lecture 11 46  Lecture 11 topics Consequences of divorce / family breakdown Course review Exam information October 2024 FNCE20003 Lecture 11 47