Financial planning is really about… helping clients avoid common debt management mistakes

Exploring some of the common big mistakes adviser make regarding debt management helps explain how you can get better results for your client.

Some debt management mistakes we have seen over the last year include:

  1. an adviser suggested an insurance bond-based savings plan to fund school fees while the client had a large non-deductible home loan. Insurance bond net income is taxed at 30% in the insurer’s hands, and there is no CGT discount, so an insurance bond is never going to beat paying off the client’s home loan, which has a capital guaranteed effective pre-tax earning rate of about 9% pa. The best way to pay the new baby’s school fees is to pay off the home loan as quickly as possible;
  2. a similar SOA discussed what to do with a $50,000 cash windfall. It suggested a managed fund. The problem was the client had a home loan of more than $50,000. So the corrected SOA said “pay the $50,000 on to your home loan, and then borrow $50,000 to invest in the managed fund.” Same net assets, much better debt profile;
  3. failing to recommend $40,000 in a cash deposit be paid on to a large non-deductible home loan (via the interest offset account). When it was noted to the adviser he said “but that is outside the scope of the advice”. That’s like a doctor not bothering to mention the cancerous growth on your nose because you consulted her about your in-grown toenail. We suggested two simple paragraphs, as follows:

    I know it’s outside the scope of my advice, and you did not consult me specifically on this issue, but for completeness I suggest you transfer the $40,000 in your cash account on to your home loan (via your interest offset account so you can get it back easily if you need to).

    This will save you about $2,000 a year in non-deductible interest. In your 40% tax bracket this is the same as earning about $3,500 in pre-tax income, and only costs you $400 in foregone interest income. In other words, this is the same as increasing your salary by about $3,100 a year, every year.

    The feedback was positive. The client loved the advice and happily accepted the adviser’s other recommendations including the risk insurance recommendations.It really helped get the relationship going;

  4. failing to recommend a large credit card debt (ie about $15,000) copping a whopping 18% interest a year be consolidated into the client’s home loan which enjoyed a low 4.7% interest rate. Doing this saved the client $1,995 a year [ie $15,000 times (18% less 4.7%)] which at a 40% tax rate is equivalent to earning $3,325 a year in pre-tax income [ie $1995 divided by (1 – 40%)]; and
  5. similarly, failing to suggest the client re-negotiate a $500,000 NAB home loan at 5.2% when the adviser knew other clients in similar circumstances were paying only 4.8%. The difference of 0.4% is significant. $500,000 times 0.4% is $2,000. And at a 40% tax rate the client has to earn an extra $3,333 in pre-tax salary to get an extra $2,000 in after tax cash.

The adviser sent an e-mail that read like this:

I notice that a colleague in similar circumstances is paying 4.8% per annum interest on her loan, while I am paying 5.2% interest on mine.

Could you please reduce my rate to the same as hers? Or, if this is not possible, explain why I am paying a higher rate than her?

The second question was a hard one to answer. The bank manager dropped his interest rate to 4.8% without further ado.

So, suggesting the client e-mail the NAB bank manager asking for same interest rate as the NAB’s other customers (which took less than ten minutes) was the same as earning a $3,333 pa salary increase.

This will compound to more than $20,000 cash over the next ten years. 

A pretty good use of ten minutes.

The Dover Group