For many mining and resources professionals, relocation is often a consequence of progressing your career path. Purchasing a property in your new town or city may form part of your personal wealth accumulation strategy.
You may have equity in an existing property that you have retained as an investment, but limited cash available for purchasing a new property.
If you wish to purchase a property funded from debt, use of an ‘offset account’ may offer you significant benefits including a flexible way to accumulate wealth. The scenario below highlights how an offset account may help you.
What is an offset account?
An offset account is a bank account that can be linked to your home or investment loan. The credit balance of your transaction account is offset daily against your outstanding loan balance, reducing the interest payable on that loan. View our 2-minute video on offset accounts.
Scenario – Michael and Susan
|Michael and Susan, both resource professionals, live in Mount Isa where they own and occupy a residential property that was jointly purchased in 2013 for $350,000 and funded with $250,000 of debt. They also own an investment property in Brisbane that was purchased by Michael for $450,000 in 2005 and funded with $350,000 of debt. Michael and Susan are about to move to Perth where they will purchase a new residential property, retaining the Mount Isa house as a second investment property.|
Compare how the scenario unfolds in Option 1, where Michael and Susan focus on reducing their debt, and Option 2, where they use an offset account strategy. In both options, all loans are assumed to be interest-only repayments.
Option 1 – reducing debt
Since buying their first home, Michael and Susan have focused on reducing their debt.
When they move to Perth, their Mount Isa home has $0 of debt and is valued at the original purchase price, while their investment property in Brisbane has $50,000 of debt and is valued at $600,000. In addition, they have accumulated $100,000 in cash over the last 12 months.
In Perth, they purchase a home to live in for $700,000, funded with $600,000 of debt after using their $100,000 cash held. The Mount Isa and Brisbane investment properties are now positively geared, resulting in more tax to pay for Michael and Susan. They also have a non-tax-deductible loan of $600,000 against their new home in Perth, which means they have to meet loan repayments with after-tax cash flow.
Option 2 – using an offset account
Since buying their first home, Michael and Susan have used an offset account strategy to reduce debt by paying all surplus cash to their offset account and making minimum loan repayments.
When they move to Perth, the Mount Isa property has a loan of $250,000 with $250,000 in the offset account and the Brisbane property has a loan of $350,000 with $300,000 in the offset account.
To purchase their new home in Perth, Michael and Susan use the cash and funds in offset accounts combined with $50,000 of non-tax-deductible debt.
Michael and Susan’s total debt of $650,000 is the same in both Option 1 and Option 2.
|Income||Option 1||Option 2 – offset strategy|
|Mt Isa – rental income (4% of property value)||$14,000||$14,000|
|Brisbane – rental income (3% of property value)||$18,000||$18,000|
|Mt Isa – interest cost of (4.50% of outstanding debt)
Brisbane – interest cost (4.50% of outstanding debt)
Perth – interest cost (4.50% of outstanding debt)
|Tax* – Michael @ 47%
Tax* – Susan @ 21%
*Interest rate is an annualised figure. Tax calculations include assumed depreciation and capital allowances of $4,000 (Mt Isa property) and $6,000 (Brisbane property). Tax amounts include the Medicare Levy of 2%. Refunds are shown in brackets, cash flow deficits are shown as a negative. MRT+Marginal Tax Rate.
Outcomes of Option 1:
- Michael and Susan’s Mount Isa property is positively geared with actual net cash flow of $10,600 (assumptions: a net rental yield of 4% or $14,000; no interest cost and a depreciation and capital allowance of $4,000; marginal tax rates of 47% for Michael and 21% for Susan).
- Michael’s Brisbane property is positively geared with actual net after-tax cash flow of $11,168 (assumptions: net rental yield of 3% or $18,000; interest cost of 4.50% or $2,250; a depreciation and capital allowance of $6,000; marginal tax rates of 47% for Michael).
- They have to meet non-deductible loan repayments of approximately $27,000.
- Therefore, their net after-tax cash flow is approximately ($5,232).
Outcomes of Option 2:
- Michael and Susan’s Mount Isa property is positively geared with actual net cash flow of $3,175 (assumptions: net rental yield of 4% or $14,000; interest cost of 4.50% or $11,250; and a depreciation and capital allowance of $4,000).
- Michael’s Brisbane property is positively geared with actual net after-tax cash flow of $4,012 (assumptions: net rental yield of 3% or $18,000; interest cost of 6% or $18,000; and a depreciation and capital allowance of $6,000).
- Therefore, their net after-tax cash flow is $4,937.
Option 2 – characterised by an offset strategy – produces a result which improves Michael and Susan’s after tax cash flow by approximately $10,000 pa (ie. the difference between a deficit of $5,232 and $4,937).
Offset Account Strategies – Benefits
1. Offset vs savings
Many people make the assumption that it would be better to have your money earning interest in your non-working partner’s savings account rather than offset against a loan. The fact is that the interest you can save with an offset account will generally be worth more to you than the interest you could earn with a savings account. In addition, any interest you earn through savings is usually taxable, whereas any interest savings from an offset account isn’t (you should confirm this with your own tax adviser).
For example, let’s assume you have $20,000 that you want to earn interest on. Let’s also assume the variable rate on your home loan is 4.5% pa and your online savings account earns 3.00% pa interest. You could:
- Keep the $20,000 in your partner’s savings account and earn $50 a month in interest (which you may have to pay tax on); or
- Put the $20,000 in an offset account and earn $75 in interest over the same period.
That’s a difference of $25 each month, before you pay tax on your partner’s bank interest. Over a year, you’d be ahead by $300.
At tax time, you would also need to declare the interest you have earned. For example, if your partner was taxed at a rate of 21% on income, the difference over a year would increase from $300 to $426.
2. Flexibility to move cash from one offset account to another
An offset account strategy gives you the flexibility of being able to move cash from one offset account to another.
In Option 2 above, Michael and Susan could borrow for the loan against the new Perth property, and use an offset account to place cash from the other properties which are now investment properties. If at a later date, Michael and Susan decide to move from Perth, they can use the cash held in the offset account to purchase the next property.
3. Flexibility for unexpected events
You can access the cash in an offset account if your finances become tight. This shouldn’t be your long-term plan, but can be very useful for unexpected events such as redundancy.
Offset Strategies – Important Considerations
Offset accounts may be a flexible way to accumulate wealth, but not all loans and offset accounts are created equal.
- Some institutions do not fully offset the balance, so you will need to check with your bank or mortgage broker that you have a 100% offset account.
- You will benefit from maintaining a higher balance in your offset account. It’s generally advisable not to use your offset account as your primary bank account as it can be difficult to maintain control if all your banking goes through the one account. We would advise that you nominate a regular amount to transfer from your wages or your transaction account to the offset account, and move any surplus amounts there too.
- To benefit from this strategy, you must ensure that your offset account is linked to your home loan.
For more information about the use of an offset account strategy, or to arrange a complimentary and obligation-free consultation, please contact James Marshall on (07) 3007 2007 or email@example.com
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Stratus Financial Group and its advisers are Authorised Representatives of Fortnum Private Wealth ABN 54 139 889 535 AFSL 357306. This information does not consider your personal circumstances and is of a general nature only. You should not act on it without first obtaining professional financial advice specific to your circumstances.