Indian Ocean Financial Services https://www.ifswa.com.au Thu, 08 Nov 2018 03:31:09 +0000 en-AU hourly 1 https://wordpress.org/?v=4.7.2 What’s All This About Utmost Good Faith? https://www.ifswa.com.au/2018/11/whats-all-this-about-utmost-good-faith/ Thu, 08 Nov 2018 03:20:10 +0000 https://www.ifswa.com.au/2018/11/whats-all-this-about-utmost-good-faith/ An insurer and the policyholder must be honest with each other. It is the very basis of the insurance contract. Full disclosure - or the duty of utmost good faith - is so important that it is even enshrined in legislation.

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If you have a life insurance policy in place, or if you’re thinking of getting one, you have probably heard the phrase ‘utmost good faith.’

Put very simply, utmost good faith means the two parties to a contract will be entirely and absolutely honest with each other. In insurance, the two parties are the insurer and the policyholder.

The duty of utmost good faith is a statutory one. This means that it exists because of an act of Parliament. In this case, the relevant parliament is the Federal Parliament (Canberra). Section 13 of the Insurance Contracts Act 1984 (Cth) states the following:

13  The duty of the utmost good faith

(1)  A contract of insurance is a contract based on the utmost good faith and there is implied in such a contract a provision requiring each party to it to act towards the other party, in respect of any matter arising under or in relation to it, with the utmost good faith.

(2)  A failure by a party to a contract of insurance to comply with the provision implied in the contract by subsection (1) is a breach of the requirements of this Act.

(3)  A reference in this section to a party to a contract of insurance includes a reference to a third party beneficiary under the contract.

(4)  This section applies in relation to a third party beneficiary under a contract of insurance only after the contract is entered into.

As you can see from subsection 2, if one or both parties to a contract does not act in utmost good faith, they have broken the law and penalties can be applied.

For the policyholder (that is, you) the duty of utmost good faith basically means that you have to tell the insurer everything and anything that would relate to their decision as to whether to offer you a policy.

When you take out an insurance policy, the insurer assesses how likely it is that you will make a claim on the policy. Some things make a claim more likely than others. For example, if you have a history of serious illness, such as cancer, then you are probably more likely to become unwell in the future and therefore to make a claim on any insurance policy. When faced with an applicant who has a history of illness, an insurer might choose either not to offer a policy at all or to offer a policy with exclusions or loadings. (An exclusion means that the policy will not cover certain kinds of events; a loading is an increase in the premium payable for the policy).

Obviously, a situation like this can create an incentive for a person not to disclose their full health history to the insurer. They may be tempted to keep their medical history secret from the insurer. However, if they do fail to disclose this information, they will breach the duty of utmost good faith. This breaks the law and, usually, voids the insurance contract. This means that any future claim would not be paid because the policyholder has basically been dishonest when the policy was created.

The duty of utmost good faith can also apply to an existing policy. If you experience a health event, you should let your insurer know. Almost all insurances are guaranteed renewable, which means that an insurer cannot decide to stop providing you with an insurance policy because you have experienced some poor health after that policy commenced. Provided the policy was in place before you first became unwell, you can generally continue to renew the cover each year.

The basic principle when dealing with an insurer is ‘if in doubt, declare.’ That is, tell the insurer everything that might be relevant to your insurance policy. You will never get in trouble for telling the insurer too much. However, if you tell the insurer too little, you might breach the duty of utmost good faith and basically render your policy useless.

So, if there is something that you think might be relevant to the insurer, please feel free to discuss it with us. We will always be discreet and, of course, everything we do is confidential and governed by strict privacy standards.

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November 2018 https://www.ifswa.com.au/2018/11/nov-2018-newsletter/ Wed, 31 Oct 2018 13:00:04 +0000 http://www.ifswa.com.au/?p=7847 Well, we will almost say ‘we told you so.’ Last month we analysed the extraordinary growth of the US share market over the last ten years – and suggested that the main driver of that growth, the technology sector, may be in for a correction. And the correction happened: shares in one company alone (Amazon) fell by 18% across the first 26 days of October, while the (US) market fell 9% overall. Read on to see what this means for the Australian market.

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Franking credits https://www.ifswa.com.au/2018/10/franking-credits/ Wed, 24 Oct 2018 13:00:48 +0000 http://www.ifswa.com.au/?p=7849 The franking credit system is necessarily complex. But the idea underlying it is quite a simple one. A company’s profits are taxed at the applicable tax rate of each of its shareholders. This article explains exactly how.

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For many years, company profits were taxed twice in Australia. The first time was in the hands of the company when they were derived. The second was in the hands of the shareholders when and if they were paid out as dividends. There was no ‘imputation’ of tax already paid by the company on those profits when they were paid out to the shareholders. This meant there were very high effective rates of income tax on company profits.

The 1985 reform of the Australian taxation system identified this as a major inefficiency and, consequently, recommended a change to a partial imputation system of taxing company profits. This system started in 1987 and has now been extended to a full imputation system of taxing company profits. This system relies on a complex system of record-keeping to track income tax paid by companies and to allow their shareholders to claim a credit for that tax. This credit is called variously an ‘imputation credit’ or a ‘franking credit’ and, as the name suggests, provide the shareholder with a credit for tax already paid when they include those dividends in their assessable income computations.

The basic logistics of taxing franked dividends are as follows:

  1. The company pays tax on its taxable income at the company tax rate (currently 30%) and records this tax as a credit in a notional account called a ‘franking account;’
  2. When the company pays a dividend, it determines the extent to which the dividend is paid out of taxed profits, debits its franking account and advises its shareholders via a written dividend statement of the amount of the cash dividend and the attached franking credit;
  3. The shareholder includes both the cash dividend and the attached franking credit in their assessable income computation; and
  4. The shareholder claims a tax offset in their tax payable computation, equal to the value of the imputation credit; this tax offset, unlike most tax offsets, can generate a refund of tax.

This means that, ultimately, the amount of income tax paid on the company’s profits depends on the income tax profiles of its shareholders. If all of a company’s shareholders faced the 47% marginal tax rate, then all of its income would ultimately be taxed at that rate. If all of a company’s shareholders faced a nil tax rate, for example because they were super funds paying allocated pensions, then all of its income would be ultimately taxed at 0%.

This means that income derived through companies, like income derived through trusts, is ultimately taxed in the same way as it would have been had it been derived directly by the underlying owners i.e. the shareholders or unit holders, as the case may be.

This means that the level playing field identified as a major policy goal in the 1985 reform of the Australian taxation system has largely been achieved. This, and particularly the removal of the structural tax bias against companies through the imputation system, is recognised as a major factor fuelling Australia’s economic growth and, in particular, the strong growth in share market values since 1985.

Large investment trusts

Large investment trusts (also known as ‘managed funds’) invest in cash deposits (and similar facilities), properties and shares. This means that they derive interest, rent and dividends from holding investments, and capital gains when the value of those investments increases. ‘Net income’ is the phrase used to describe the equivalent of taxable income for trusts i.e. assessable income less allowable deductions. The trust’s beneficiaries or unit holders are said to be ‘presently entitled’ to a share of net income, usually in proportion to the number of units that they hold.

The character of the trust’s net income in the trustees’ hands determines its character in the hands of the unit holders. This is called the ‘flow through’ or the ‘attribution’ principle. This means that if the trust’s net income is made up of, say, 50% cash franked dividends, 30% rent, 10% interest and 10% capital gains, then a unit holder receiving a distribution of $1,000 technically derives $500 rent, $300 franked dividends, $100 interest and $100 capital gains.

Under special rules designed for trusts, the benefit of any franking credits, the benefit of any tax deferred amounts connected to depreciation and building allowances, and the benefit of any capital gains discounts flow through or are attributed to the unit holders. This way the trust’s net income is ultimately taxed in the same way as it would have been had it been derived directly by the unit holders. In practice, the details of the income distribution are made very clear to unit holders in the distribution advice statements provided by trusts to their unit holders.

This can all seem quite overwhelming, but the take home message is this: if you invest in shares in an Australian company, either directly or through a managed fund, then the ultimate tax paid on your share of that company’s profits will be determined by your marginal tax rate.

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Extra help when a child is disabled https://www.ifswa.com.au/2018/10/extra-help-child-disabled/ Wed, 17 Oct 2018 13:00:33 +0000 http://www.ifswa.com.au/?p=7852 Disabled children are treated as adults for tax purposes even if under age 18. This means that they can receive distributions of net income from family trusts and hybrid trusts. This income is taxed normally, rather than under the penalty tax arrangements that usually apply to the unearned income of minors. It can mean that the family pays much less tax.

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Do you have, or do any of your friends or family have, a disabled child? Is that parent self-employed? If so, please read on or send this article to your loved one.

Self-employed people can often distribute income to members of their family. By spreading the same amount of income across more than one taxpayer, the total amount of tax paid is reduced. However, distributions can generally only be made to adult members of the family – that is, family members who have turned 18. If distributions are made prior to a child turning 18, these are often subject to the penalty tax arrangements that apply to the only income of minors.

However, disabled children are treated as adults for tax purposes even when they have not yet turned 18. This means that they can receive distributions of net income from family trusts and hybrid trusts. This income is taxed normally, rather than under the penalty tax arrangements that usually apply to the unearned income of minors.

This can save a lot of cash each year for parents, and helps take some of the sting out of the extra costs of disabled kids.

A disabled child can also be superannuated if they are genuinely employed (obviously this depends on the nature of the disability). This is as a general law employee (minimum age rules 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 is vision impaired might work in the family business during Uni holidays, for which she is paid an arm’s 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 even pay non-concessional contributions of up to $500,000 across her lifetime, and these can also in effect be paid for her by her family. This allows wealth to be moved into the lower-taxed environment of superannuation. Less tax means more money available to enjoy the long-term benefits of compounding investment returns.

These strategies can 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. Disabled children, especially if the disability is degenerative, often meet these conditions well before the normal retirement age.

It’s remarkable how often advisers sit down with a new client and discover they have, say, a ten-year-old disabled child. If the client is self-employed, that’s usually ten years of unnecessarily high tax bills. We work hard to make sure there are not eight more yet to come.

Any questions? Give us a call. This is one area in which we really love to help.

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A life well lived https://www.ifswa.com.au/2018/10/a-life-well-lived/ Wed, 10 Oct 2018 13:00:35 +0000 http://www.ifswa.com.au/?p=8358 Too many people look back on their life with regrets. Far from being morbid, realising that our death is inevitable can inspire us to live a better life today.

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If you watched Australian Story earlier this week, you would have seen the inspiring story of young Samuel Symons. Eldest son of Red and his wife Elly, Samuel died last week at the age of 27. He was first diagnosed with cancer at the age of four – but managed to live an extraordinary life nonetheless.

If you haven’t seen the show, you can find it on ABC’s iview platform.

Samuel lived virtually his whole life with the inevitability of death very much in his face. That said, he didn’t let it dominate his thinking: “I was too busy trying to stay alive and keep living, that I really just didn’t care about death, and never have and never will.” What a great way to be in the world.

Would that we could all care less about the prospect of dying. Maybe a lesson we can all take from young Samuel’s life is that it’s okay to think about death. Indeed, perhaps thinking about the inevitability of death can help us all live a fuller, deeper and more satisfying life.

As financial advisors – and especially as life insurance advisors – we know full well that talking about death can be difficult for many people. Sometimes, it almost seems like people think that talking about death will somehow make it happen! So, at the risk of sounding preachy, and without wanting to be morbid at all, why don’t you take some time to think about the fact that one day all of us will die? We promise this won’t make it happen.

The American author Stephen Covey suggests that a great way to give focus and meaning to your life is to imagine the eulogy at your own funeral. What would you want people to say about you at the end of your life? If we accept that people will only say those things if they are in fact true, then you can see how this little thinking experiment can bring meaning and focus to our life. If that is what I want people to think, then that needs to be the way that I live.

Another great way to become less fearful of dying is to read Australian nurse Bronnie Ware’s wonderful book ‘The Top Five Regrets of the Dying.’ Bronnie worked in palliative care, nursing people in the last months of their life. As you can imagine, this gave her the opportunity to have a lot of very deep and thoughtful conversations with her patients. From these conversations, she was able to distill things that people most regret not having done earlier in their lives.

We won’t spoil the whole book by telling you all five of them. But here are two that stood out for us. Many people regret having worked so much during their lives. We guess when you are faced with dying, and realise that you can’t take your money with you, you realise that it did not make sense to keep working if you already had enough. Secondly, many people regretted that they didn’t stay in touch with more of their friends. Perhaps they were too busy working! Like the others, these are simple regrets – and often regrets the can be simply avoided.

So, again without being morbid, why not spend a bit of time thinking about your own inevitable death. Obviously, we hope that that death will be many decades away. But realising that it will come one day will help you fill those decades with many years of wonder.

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October 2018 https://www.ifswa.com.au/2018/10/oct-2018-newsletter/ Wed, 03 Oct 2018 14:00:52 +0000 http://www.ifswa.com.au/?p=7857 In this newsletter, we look at a very strange phenomenon. In 2008/2009, Australia was one of very few developed economies that did not enter recession as part of the GFC. Despite that, our share market fell by about the same proportion as the US share market. Since then, however, the US market has roared ahead, while the Australian market has grown at a much more gentle pace. Read on to find out the hows and whys of the difference.

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What happens to your super when you don’t need it any more? https://www.ifswa.com.au/2018/09/happens-super-dont-need/ Wed, 26 Sep 2018 14:00:59 +0000 http://www.ifswa.com.au/?p=7859 Superannuation benefits are not automatically subject to your will. That means the trustees may not send the money where you want it to go when you die. But there is a solution! Read on.

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Organised your will?

Yep.

Organised a binding death benefit nomination for your super?

What’s that?

Your super benefits are not automatically subject to your will. That is because your super benefits are held in trust. That means you are not the legal owner of the benefits – the legal owner is the trustee of the fund.  This means that, when you die, the trustees may pay your remaining benefits to either your estate or to appropriate dependants as they see fit.

In most cases there are no problems. The trustees give the money to the same people that you would have given it to yourself had the benefits been subject to your will.

But problems can arise. If there is any dispute as to who might have a claim on your assets, the trustee can find themselves in an awkward situation. What’s more, the trustee might resolve that situation in a way that makes sense to them – and your money does not end up where you want it to go.

Moral and legal factors which may influence a super trustee’s discretion to pay a benefit to a person include:

  • the relationship between that person and the deceased member;
  • the person’s age and ability to look after themselves financially;
  • the extent of the person’s dependency;
  • the person’s financial circumstances;
  • the history of the person’s relationship with the deceased member; and
  • the strength of any other claims made by other people.

There is a further general restriction.  Trustees can actually only pay benefits to certain people, known as “super dependants” of the deceased member. A super dependant is a person who is:

  • a spouse,
  • a child (of any age); or
  • a person who was financially dependent on the member at the time of death; or
  • the estate of the deceased member.

Binding death benefit nominations

Super fund members can override their trustees’ discretion by signing a ‘binding death benefit nomination’ (BDBN). This directs the trustee to pay death benefits to a particular person. This lets the member control the trustees’ discretion as to who gets the benefits on the client’s death. The trustee must pay the death benefit in accordance with the BDBN.

A BDBN may be used in conjunction with a ‘normal’ will to ensure consistency between the payment of the deceased member’s super benefits and their other estate planning strategies.

As long as a BDBN is valid, it will not usually be contestable. Some possible reasons for a BDBN not being valid include:

  • the fund’s trust deed does not allow BDBNs;
  • the BDBN was not signed properly;
  • the client was not of sound mind when the BDBN was executed;
  • the BDBN is the result of a fraud or emotional or physical duress; and
  • the BDBN is more than three years old.

Some common problems for self-managed super in particular

The ongoing control of a SMSF will be held by the remaining individual trustees or the shareholders of a corporate trustee.

One common problem arises where only one of several children is a member and trustee of a SMSF. The worry is that this child will control the SMSF on the death of both parents. This control may be exercised to the detriment of the other children.

Another common problem arises is where a member wants to leave their super benefits to a person who is not a super dependant, such as a parent, sibling or a friend. These people cannot receive a death benefit directly from the fund. A solution here is for the binding death benefit nomination to be drawn in favour of the estate, along with a will which specifically gives an amount equal to the super benefits to that person. Another option may be to give the super benefits to a super dependant and leave non-super assets to these other people.

Either way, the situation calls for intelligent and informed estate planning. Please do not hesitate to contact us if you, or someone you know, needs assistance in managing the connection between their super and their estate planning.

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Dollar Cost Averaging https://www.ifswa.com.au/2018/09/dollar-cost-averaging-2/ Wed, 19 Sep 2018 14:00:06 +0000 http://www.ifswa.com.au/?p=7862 Dividing an investment up into smaller amounts that are invested at different points in time can be an effective way to manage the timing risk inherent in the sharemarket. This practice is known as dollar cost averaging and this article explains all about it.

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One of the key risks in markets like the share market is timing risk. Prices at which equities are bought and sold change regularly, as any glance at the 52-week high and 52-week low columns in share tables will attest. Have a look at the share prices for Santos over the 12 months of 2015 (thanks, Google):

As can be seen, the price of the same asset – in this case a share in a particular company – fluctuates widely over a relatively short period of time. Because of this fluctuation, investors who buy into volatile markets such as the share market run the risk of making their investment at a price higher than could have been achieved had they made their purchase at some other point of time.

The simplest way to manage this risk is to use a buying technique called dollar cost averaging. Dollar cost averaging is where an investor buys several smaller parcels of investment assets at several different points in time. This is as an alternative to buying a complete parcel of investment assets at a single point in time.

For example, rather than buy $60,000 worth of shares at a single point in time, an investor might prefer to buy $5,000 worth of shares at twelve monthly intervals during a year. There will be times when the price of the share is high, and $5,000 will buy relatively few shares. There will be times when the price of the share is lower, and $5,000 will buy relatively more shares.

Over the entire purchasing period, this means that a greater proportion of the overall assets will have been bought at lower prices. This drags the average purchase price of the portfolio down – hence the term, dollar cost averaging.

Of course, you don’t have to take our word that dollar cost averaging is a good high. If you follow Warren Buffett, or if you follow Lebron James, you will see that they agree with us. Which we think is kind of cool.

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No two insurance policies are the same https://www.ifswa.com.au/2018/09/no-two-insurance-policies/ Wed, 12 Sep 2018 14:00:12 +0000 https://www.ifswa.com.au/2018/09/no-two-insurance-policies/ One of the most frustrating aspects of life insurance for clients is that not all policies are the same. This makes it hard for the ‘person in the street’ to ensure that the cover they take is the cover they need.

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One of the most frustrating aspects of life insurance for clients is that not all policies are the same. This makes it hard for the ‘person in the street’ to ensure that the cover they take is the cover they need.

One simple complication is the term ‘life insurance.’ While you may think that life insurance is insurance that pays out if you lose your life – that is, if you die – the term life insurance is actually used for a broader range of insurances. These include income protection insurances (which pay you when you are temporarily unable to work due to illness or injury), total and permanent disability insurances (which pay you if you are permanently unable to work due to illness or injury) and trauma insurances (which pay you if a particular health event occurs, regardless of whether you are prevented from working).

So, what most people think of as ‘life insurance’ is more accurately described as death insurance: insurance that pays money to your loved ones if you die while you hold the cover.

But this is just one complexity. Another is the fact that some life insurances can be paid for using super. Others cannot. Even more confusingly, some forms of a particular life insurance, such as total and permanent disability, can be paid for using super benefits, while other forms of the same type of cover cannot.

What’s more, using super can lead to other complications when the time comes for money to paid out. A few years ago we saw a potentially tragic situation of a father whose one year old daughter needed a liver transplant. Her dad, being a direct relative, was an obvious candidate as a donor. Even better, because she was so young, the liver did not need to be very big. That meant that her dad only needed to donate a part of his own liver.

It took Dad about three nanoseconds to make the obvious decision to save his daughter’s life by donating part of his own liver. But having part of your liver removed is no small thing. Dad needed to be off work for several months. Happily – he thought – he had an income protection policy with a 30 day waiting period. This meant that, once he was off work for 30 days due to illness or injury, he thought he would start to receive a payment of 75% of his income for the remaining months until he returned to work.

Unfortunately, the income protection was held through super. To receive a payment, he needed to withdraw benefits from the super fund. But the fine print on the policy prevented access to insurance funds in cases of ‘elective surgery.’ And the definition of elective surgery covered what was happening to this Dad: he would not die if he did not have the surgery (although his daughter would have).

Happily, in this particular case, the insurer found a way to allow the family to receive a payment. But that came after a very difficult period for the family and followed a dedicated media campaign to help them – as well as expert advice about insurance.

Expert advice like that is what we are all about. We can help you navigate your way through the complexities of life insurances and ensure that the policy you take up – and pay for – is the right one for you and your family. So, give us a call, and let us help you make sure you get what you expect.

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September 2018 https://www.ifswa.com.au/2018/09/sep-2018-newsletter/ Wed, 05 Sep 2018 14:00:55 +0000 http://www.ifswa.com.au/?p=7867 In this month’s newsletter we discuss the state of the share market and how it is measured – exactly what is the ASX 200? We also give you a good analysis of what may well become a problem in the future: tweeting now, paying later. Enjoy!

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