What planners need to do to cope with 2000 changes

The last few years have seen many legislative changes which impact on financial planning, and 2000 was no exception. In 2000 we saw the introduction of the Goods and Services Tax (GST), major tax reforms, increasing globalisation and more takeover /merger activity. With so many major changes in a short time, it is difficult to consolidate all the issues into financial planning strategies for clients. This article outlines some of the major issues and strategies to deal with the changes.

GST

GST has been part of Australia's taxation system for eight months. This is long enough for us all to start feeling the impact through an increased cost of living. The annual CPI result to the end of December 2000 is 5.8 per cent. This is higher than the annual rate of 1.8 per cent for the previous 12 months to December 1999 and reflects the impact of GST.

Now is a good time to review client portfolios to ensure enough income is generated to meet their increased cost of living. This is especially important with the recent interest rate cuts. Also check that cash reserves have not been depleted.

When assessing a client's income needs you should take into account their estimated increase in the cost of living. But don't forget the compensation measures in the GST package which may increase the net income people receive.

For example: Bill and Kate are homeowners with investments of $250,000 and personal effects totalling $30,000. Before the introduction of the GST, they received total income of $20,195 which was comprised of $8,600 age pension and $11,595 investment income. They paid no tax. Compare this to their situation today. The social security compensation measures for pensions, along with the September CPI increase, increased their pension entitlement to $10,190. Investment income is maintained at $11,595 but they now receive a cash refund of franking credits equal to $1,000. Bill and Kate still pay no tax so this effectively gives them net income of $22,784 for the year. This is a 12.82 per cent increase in their income and they also received $2,000 one-off bonuses to top up their cash reserve.

If Bill and Kate's expenses only increased in line with the CPI, they are already well compensated for the GST impact and shouldn't need to adjust their portfolio to generate further income. However, not all retired people are so lucky. Many didn't qualify for income tax cuts or social security increases. The one-off bonuses will not adequately compensate them. They may need to make adjustments to their portfolios to generate more income or draw-down on capital.

Share attractions

Shares received a double bonus from tax reform, with changes to capital gains tax and the refund of unused franking credits.

While it is contentious whether the new 50 per cent discount on capital gains is better than the old indexation rules, it should prove to be an advantage for high performing shares in a low inflation environment. This is unless you hold the shares in a company or private trust structure, where the discount may not flow through. The decision on how to own assets now has different dynamics to be considered and questions the future of discretionary trusts. It is less desirable to purchase growth investments through a company or trust structure.

Commencing this financial year, unused franking credits will be refundable in cash. This should provide a benefit to low income earners, including superannuation funds and allocated pensions/annuities.

Social security clients are included in the group who should reconsider shares. As low income earners, they receive a cash bonus from refunding franking credits. Shares are income tested under extended deeming rules, so the refund is not considered assessable income. Clients receive more income without reducing their pension.

Future of trusts

Trusts have been hit from two angles - taxation and social security. The social security changes are legislation so we have some certainty there, but we are still waiting for legislation to effect the entity taxation proposals which now looks to be a problem for next year.

These changes do not spell the end of the discretionary trust, but do require a review to decide if the structure should be retained. Trusts are still viable for asset protection, continuity of ownership, income splitting and in many cases, as a vehicle for operating a business.

One common strategy which needs careful review is the inclusion of testamentary trusts in wills for social security purposes. Clients who included a testamentary trust in their will in the hope that their surviving spouse would retain social security benefits need to think again.

If a person dies after 31 March 2001, the assets transferred to a testamentary trust will automatically be assessed to the surviving spouse if he/she is the trustee or a beneficiary. This can create hardship if the planning is not right.

For example, consider Roland who is married to his second wife Siobhan. They both have children from first marriages. Roland is concerned to ensure Siobhan is looked after when he dies but wants residual assets to transfer to his children on her death. Roland was advised to set up a testamentary trust, with his children as capital beneficiaries and trustees while Siobhan is entitled to all income for her lifetime. This was written into his will five years ago. Roland dies on 31 May 2001.

Siobhan is a beneficiary of the trust, so under the new Social Security rules, she will be assessed to own all the assets of the trust (as well as all the income) from 1 January 2002. This may be enough to exclude her from eligibility for the age pension. However, she is not trustee and is not eligible to use any of the assets. If the income produced by the trust is not sufficient to meet her needs she may suffer financial hardship.

It is important for clients to review wills to reconsider how the surviving spouse may be affected. If the death occurs before 1 April 2001, testamentary trusts may still be captured from 1 January 2002 under the control test.

Globalisation

The world is becoming one big market as opposed to separate regional markets. Returns from one region are affected by developments in another. A financial planning implication of globalisation is the need to consider greater exposure to international assets for diversification in a client's portfolio, but there is less need to allocate funds to specific geographical regions.

Conclusion

Now is a good time to take a new year health check for client's portfolios. A checklist for financial planners to consider is:

ensure income is sufficient to meet client needs

ensure clients are receiving their correct social security entitlements, including concession cards

check the portfolio is balanced and diversified and if the risk profile is appropriate, consider international shares

consider the benefits of Australian share investments, particularly for low income earners

review wills which include testamentary trusts to determine if it is still an appropriate strategy

reconsider the use of trusts and companies and wind-up where they provide no further benefit.

It will be interesting to watch what further changes develop over the next year. But even without change, clients are becoming more sophisticated and better educated about investments. Planners need to think strategically to stay ahead.

Louise Biti is national manager of technical strategy at ING Financial Planning