The best way to create wealth will depend on your personal and business circumstances – and the same is true when it comes to protecting that wealth for the long term.
There’s a lot to think about when you’re deciding on a strategy for building and managing your wealth. Here are the key topics you need to consider.
Business structures – protecting your assets
When you’re choosing the structure that’s right for your business you’ll probably be focused on minimising your tax liability. But it’s important that you also think about asset protection.
The four most common types of business structures are:
- Sole trader
From an asset protection perspective, a sole trader structure offers you the least protection. In fact, it provides no asset protection at all – if someone makes a claim against your business, all of your assets (including personal assets) could be at risk.
A company, on the other hand, is a separate legal ‘person’. This means that the company runs the business, owns its investments and can be sued in its own right. The owners of the company (the shareholders or members) are generally not exposed to any claims made against the company.
Trusts also make a very useful asset protection vehicle. A trust is a ‘relationship’, with the trustee holding assets on behalf of a group of beneficiaries. If someone makes a claim against the trust, the trustee will be liable, but the beneficiaries will not. And the risks to the trustee can be mitigated by, for example, having a company act as trustee of the trust.
Even if your business is structured as a company, all of your business assets could still be at risk in the event of a lawsuit. This is a common problem for business owners, and one potential way to mitigate the risk is to set up a ‘trading’ company to run your business and a separate ‘holding’ company to hold your business assets – for example the plant and equipment, which it would then hire to your trading company.
The good news is that you’re not locked into any one structure. You can restructure as you need, in response to changes in the size of your business or your asset protection requirements. In fact, Australian tax legislation incorporates a number of capital gains tax concessions, which can reduce (or even eliminate) the potential capital gains taxes you, or your business, may incur as part of a genuine restructure.
It is important that you speak to your accountant regularly, to check that your current business structure provides the level of asset protection you need.
Superannuation – your wealth management and protection vehicle
The superannuation system was created to allow Australians to adequately fund their retirement. Many people consider superannuation to be one of the best wealth creation and protection opportunities we have available.
But superannuation is widely misunderstood – it’s a common misconception that super is, in and of itself, an investment. Actually, it’s a specialised tax environment governed by its own set of rules and legislation. It’s only once you have contributed money to a superfund that you need to make decisions about how to invest it.
The superannuation tax legislation includes a number of valuable tax concessions for complying superfunds, which can make superannuation a very effective way to maximise and protect wealth.
- Income earned by a fund’s assets before any member draws a pension is taxed at just 15%. This is much lower than Australia’s personal income tax rates (21% to 47% (inclusive of the Medicare Levy) for individuals earning more than $18,200) or corporate income tax rates (27.5% to 30%).
- Capital gains on assets held in the fund for more than 12 months, and sold before any member draws a pension, are eligible for a 33.3% discount. This means they attract an effective capital gains tax rate just of 10%.
- Once a superannuation funds has begun to pay pensions, all the income it earns from its assets becomes fully tax exempt (up to $1,600,000 per member). Even more importantly, this exemption also applies the capital gains tax when the fund’s assets are sold.
One of the most common questions accountants are asked is whether a taxpayer (either an individual or a business owner) will receive a tax benefit by making a contribution to their super fund.
The answer is often ‘yes’. When either you or your business contribute money into superfund (within the cap limits) you may well able to claim a tax deduction for the contribution, because personal and corporate income tax rates are higher than the tax rate on superfund contributions.
Another important benefit of superannuation is that superfund balances are quarantined from your personal and business assets. This means your superannuation fund balance is protected even if you incur personal or business debts. As a business owner this gives you the peace of mind of knowing your superfund balance will be safe in the event of a lawsuit, or if your business runs into financial difficulties.
It’s wise to work with your accountant so you can make the most of all the opportunities superannuation offers you to maximise and protect your wealth.
Risk insurance – protecting your wealth
Another important aspect of your wealth management strategy is taking steps to protect your wealth in the event of an unexpected death, injury or illness.
There are several types of risk insurance available that can help provide financial security to you or your descendants.
- Life insurance provides a lump sum to your dependants if you die.
- Total and permanent disablement Insurance provides a lump sum if you suffer a serious injury or illness that leaves you unable to work.
- Trauma insurance provides a lump sum if you suffer a specified critical illness such as a heart attack, cancer or a stroke.
- Income protection insurance replaces up to 75% of your income for an agreed period of time if you can’t work due to sickness or accident.
The premiums you pay for your insurance will be based on a number of factors such as your age, sex, health (both current and historical), family medical history, occupation and lifestyle.
Premiums can also be stepped (meaning they start lower but increase with your age) or level (meaning they start higher but do not increase with your age).
In the case of income protection insurance, premiums will also depend on factors like the waiting period before benefits become payable, the length of time over which payments will be made, whether payments are indexed, and whether payments will be an ‘agreed value’ (based on your income at the time of application) or ‘indemnity value’ (based on your income at the time of claim).
As well as thinking about which types of insurance you may require, you also need to decide where you will hold your policy. Life insurance, total and permanent disablement insurance and income protection insurance can all be held either inside or outside of your superfund, but trauma insurance can only be held outside.
The tax treatment for both the premiums you’ll pay and the benefits you or your dependants may receive may be different, depending on whether you hold the policy inside or outside your superfund. It’s a good idea to ask the advisor who arranges your risk insurances to work with your accountant to formulate a strategy that is right for you.
When you’re busy running your business and building your wealth it’s easy to forget about the future. But considering these three wealth management strategies, and discussing your options with your accountant or financial advisor, will set you on track to protect everything you’ve worked so hard for.