Using line of credit loans
LAST week I talked about tax deductibility of interest. Today we will take it a step further and think about strategies for borrowers who are using line of credit loans.
There is confusion about home loan accounts with a redraw facility and offset accounts. It’s worth taking the time to understand them because they are vastly different animals and getting it wrong can be very costly.
An offset account is simply a savings account with the interest being deducted from your loan interest instead of being paid to you as taxable income. At any stage, funds can be withdrawn from the offset account without tax implications.
In contrast, every time you make a withdrawal from a line of credit account, you are establishing a new loan.
Suppose a couple have a $400,000 loan on their home and have the goal of eventually upgrading to another home and renting the original out.
Over the years they have accumulated $350,000 in their offset account, which means they effectively owe only $50,000 on their property.
When they make the move they simply withdraw the $350,000 from the offset account and use that as a deposit on the new home. This leaves them with a $400,000 debt on the now tenanted original property and they can claim all the interest on it as a tax deduction.
Their neighbours once had a $400,000 loan but have worked hard to reduce the debt to $50,000. If they move out, the debt on the now rented property will be stuck at $50,000.
Certainly they could redraw funds from the original loan to buy their dream home but the interest will not be tax deductible.
They will have a huge non-deductible debt on their new residence, and will be paying tax on the rents from the original property.
An investment line of credit loan can be a particular trap if the borrowers do not keep their business and private expenses strictly separate.
Unfortunately far too many borrowers deposit their salary into the investment loan account and then withdraw funds each month for normal living expenses.
They do not realise that the deposit of the salary is treated by the tax office as a permanent reduction of the debt, and each redraw is a new loan. Because the redraws are used for a private purpose such as paying for groceries, the loan very quickly loses its tax deductibility.
The lesson in all this is that you should keep your investment and private borrowings separate and always use an offset account if you intend to rent out a property that is presently used as your own residence.
Noel Whittaker is a director of Whittaker Macnaught Pty Ltd. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. His email is firstname.lastname@example.org.
Question: My wife and I are in our mid 50's and have about $500 a week spare for making money. Neither of us has much super - we are both reluctant to pour money into super. What can we sink our money into that will give us the best return over the next ten years - super, an investment property, a property trust or syndicate, managed funds, blue chip shares, anything?
Answer: There are two important factors to consider - the type of investment to hold and the best entity to hold it. For a person in their mid 50s earning more than $35,000 a year the perfect investment is super because you can usually invest in pre-tax dollars using salary sacrifice. Because salary sacrificed contributions lose just 15% and money taken in hand loses at least 31.5% you are making big tax savings immediately. Once the money is inside super you and your advisor can decide what sort of asset mix is appropriate for you.
Question: I am unable to work and am supported by my 61 year old husband. We owe $39,000 on our mortgage. I will soon turn 55 and wish to use my super to pay off the mortgage, before any changes to access may occur. Are there any disadvantages you can see to this course of action? I have not made any prior withdrawals. Would I be liable for tax on the payment?
Answer: I am not concerned about changes to the access rules for people of your age but under the existing rules once a person reaches 55 and retires they can access their super and withdraw up to $150,000 of the taxable component tax free. But, while your proposed strategy is feasible there are other factors to consider. For example, if you had more than $150,000 in super you would pay 31.5% on any monies you withdraw prior to age 60 and if your husband is seeking any Centrelink benefits money withdrawn from super and invested could disadvantage you both because money in super is not counted by Centrelink until the member reaches pensionable age. In your case this is 65. Just make sure you take advice before you make any withdrawals.