Monday, November 8, 2010

Merry Christmas and here's your tax bill

My three liabilities at tax time
  • Tax payable
  • Medicare Levy payable
  • HELP/HECS loan, adjustable depending on income, early repayment possible
Every single year it comes around for everyone. Without fail.
Tax time and the need to dig into your pile of papers, bills, receipts and payment summaries.

I've completed mine. And unfortunately I've ended up with a tax payable. Because I've got investment income from various sources and I don't pay tax instalments over the year, it means that my liabilities accrue until I lodge my annual tax return.

Preparing for my tax liabilities

For every gross dollar of investment income that I earn, I have to deduct a percentage for my tax, a percentage for my HELP/HECS loan (a student loan from the government from uni days) and 1% for Medicare Levy. So pretty much, out of each dollar of investment income, approximately 50 to 65 cents reaches my account after all deductions and liabilities are paid.

It'd be crazy if I spent each $1 of gross investment income without accounting for the fact that practically 50% will be payable to the government.

Why don't I pay off my HELP loan??

HELP debt is only indexed to inflation and my latest statement shows that they indexed my balance with a 1.8% inflation rate. 1.8% per annum, charged the end of the year. I don't even have to try hard to invest my savings to exceed that measly 1.8% rate. It's a super cheap loan!

Besides the compulsory amounts, I can decide how much I wish to dump into it as extra repayments.

As long as I can earn at least 3.6% gross and more elsewhere, there is no incentive to pay my loan off early. It's like the cheapest loan around, unfortunately for the government. They know this, which is why they have dangled a carrot to spark some enthusiasm for people to pay it off early. You get a 10% discount on the amount you pay off above and beyond the compulsory amount.

Eg: You pay off an extra $500 in April (just before they index the amount to inflation in May, getting double bang for your bucks). If your loan is $10,000 then it will decrease to $9,450, a total payment of $550 with the discount.
[the maths: 10,000 - (500*1.1)]

So if you decide not to pay it off early, you will suffer death from thousands of little cuts (to borrow a phrase). The compulsory amount you have to pay has no discount applicable.

Paying off HELP/HECS in lump sums

If you can't handle the thought of carrying your loan indefinitely, ensure that you make lump sum payments of $500 or greater so that you qualify for the 10% discount.

Using our previous example: A $10,000 HELP/HECS balance with a $499 payment in April will mean that your loan will decrease only by $499 to $9,501 Sadly, no 10% discount.

The balance of my HELP/HECS loan

Working with percentages. I started off with 100%, currently out of that original amount, 49% has been paid off. By the end of this year, 57% should be paid off. It's always nice when the balance tips into my favour. It means that the loan will be eroded a lot faster due to the inflation amount shrinking.

Some of my goals

I have a lot of goals - at the forefront would have to be dabbling in a joint business and acquiring some more investments plus planning a massive trip to Europe(who doesn't have a few goals of some sort?). All these have a higher ROI than paying my student loan off, even the trip to Europe ^_* (a pyschological ROI!)

In terms of this HELP/HECS loan of mine that drags on, by the end of April 2011, I aim to make another lump sum payment and get 70% paid off.

Again, it's hard working up enthusiasm to pay off such a cheap loan. Mortgage rates are about 7.8%, calculated daily and compounded monthly while margin lending rates for stocks are around 9%, compounded daily... comparing this to my HELP/HECS loan being indexed annually at 1.8% ...soooo cheap!!

But alas, it has to be paid off eventually and rather than suffer death by a thousand cuts, I don't mind making lump sum payments every year and also qualify for the 10% discount.

If you've got a range of competing goals or loans/debts to pay, it really helps to sit down and calculate the interest on each of the liabilities so that you can sort out your priorities. Dave Ramsey's got the 'debt snowball' trend happening, which is pay off your smallest loan first, but technically, you're better off paying off the loan incurring the highest interest charge first.

Pyschologically, paying off the smallest loans first helps with clearing the headache of having multiple loans outstanding. It's also a source of motivation for some when they start to see some debts being paid off completely.

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