Couples can have a distinct advantage when it comes to building wealth and achieving financial autonomy provided they maximise the opportunities available to them.
Here at Financial Autonomy we work to a proven framework that results in you being able to gain choice. We explore that framework in detail in the Financial Autonomy book, which incidentally is now available in audio version if that’s your preferred medium. If you haven’t yet read the Financial Autonomy book I encourage you to order yourself a copy.
In the Financial Autonomy framework we explore three pathways, and most of the posts that we produce look at one of those three pathways. They are investing in stocks, investing in property, and self- employment/entrepreneurship.
But before those three pathways there is an initial step that we cover in the framework and that is cash flow management. Now a lot of cash flow management is budgeting and controlling your spending. But at least as important is maximising income. It will surprise no one to realise that a higher income provides the opportunity for higher savings, and those higher savings provide the opportunity to build greater wealth more quickly, and in that way gain the choices in life that you’re chasing.
This week’s episode will therefore be exploring ways that we can maximise income, specifically for couples. Now I recognise that this will probably put some singles noses out of joint. However I looked at opportunities for singles back in this post, so I encourage you guys to check that one out instead.
I should also mention here in the intro that we’ve have created a 1 page checklist of these strategies that you might find helpful. You can download it here.
Before we jump in, a quick mention that many of these strategies, though not all, revolve around tax savings. That being the case it’s important you consult your tax advisor on any of the ideas presented here to ensure that they are relevant and helpful in your particular circumstance. As always, the information contained in this podcast is general in nature and by necessity of the medium, not specific to your unique circumstances.
Tax system quirk
A couple in which one person earns $200,000 whilst the other earns zero will have approximately $14,000 less to spend then a couple where each earnt $100,000. Although the total earnings in both households are identical, our marginal tax rate system means that the couple who split their income pay considerably less tax, and therefore retain more of the earned income.
In fact a couple who each earned $90,000 would have more money to spend than the couple where just the one person earned the entire $200,000, even though the first couple earned $20,000 less per year.
The tax system favours splitting income across a couple to maximise the after-tax income of a household.
Invest in your career
When it comes to maximising income for couples then, a focus on career development and earnings growth for both members in the couple should be a key consideration.
An example of a strategy I see commonly with clients is where one member of a couple goes back to study, perhaps for a career change, an MBA or a PhD. They are supported financially during this study period by their partner. Clearly household income is reduced during this period of study, but once the studies are completed the increased skills typically lead to increased earning capacity over very many years, providing great benefit to the household and both members of the couple. Such an approach could be done in a tag-team type way where once one member of the couple completes their studies and moves into a higher paying role, the other member of the couple can then work on increasing their skills.
Given the after tax benefits of splitting income, an optimal solution for households with young children could that each parent works three to four days per week, rather than the traditional arrangement of one member of the couple, usually the husband, continuing with full-time work, whilst the wife is full time at home. Not only does this traditional approach tend to stagnate the career of the stay at home parent, it’s also likely to be less than optimal from the perspective of maximising household income both in the short and long term.
An exception to this might be where one member of a couple has a considerably higher earning capacity. For example I have some clients where the wife works in the medical field and working full time can earn around $200,000. The husband working full time can earn around $70,000. In this scenario the wife cutting back to four days a week would mean the husband picking up three days of work just to balance things financially. In this particular couples case that’s what they did anyway, for reasons other than financial, which is relevant and interesting in its own right.
Self-employed and Family Trusts
For those who are running a business or are self-employed, there might be even greater opportunities to split income. Way back in episode 26 I spoke with accountant Shaun Farrugia about the options that family trusts can provide to maximise wealth creation opportunities. The ability to split income for self-employed people is determined largely by the application of the personal services income test. In the one page summary, I’ll put the web link to that so if this is relevant for you, you can read up on that some more. You can download it here. Ideally if you are self-employed, and you want to split income to your partner, you would get your partner actively involved in the business so that the income splitting is indeed genuine and reflects the contribution made by your partner.
Investments and Gearing
When establishing investments, consider in whose name the investment should be held. Ownership can help to minimise tax and therefore maximise income and growth. Assuming no borrowings, it will typically be most tax effective for the partner on the lower income to own the investments.
Gearing (borrowing to invest) complicates this matter somewhat. Traditionally for an investment involving borrowings, you would put that in the higher income earners name with the expectation that negative gearing would provide some tax benefits, and the higher income earner, being the one paying the most tax, would get the most benefit from those negative gearing tax benefits. There’s a couple of wrinkles to that approach however. One is that in the current climate of very low interest rates, strategies are often coming up as being positively geared rather than negatively geared. That is, the income the investment generates exceeds the costs of holding the investment (holding costs include not just interest but also things like council rates and insurance on an investment property). If the investment is positively geared then once again it makes more sense for the asset to be owned in the name of the lower income earner.
A second issue, which isn’t related to the current interest rate environment, is the fact that your hope in undertaking any investment is that it will grow in value over time. Assuming that is indeed what unfolds, at some point capital gains tax will be payable upon the sale of the investment. At that time it would be preferable for the investment to be in the name if the lowest income earner within the couple as that would result in the least amount of tax payable. The good thing about capital gains tax is you have a lot of control over when it’s payable, in that you decide when the investment will be sold, which is the point at which this tax liability is triggered. It could therefore be the case that an investment which is negatively geared and therefore held in the higher income earners name, is retained through until that high income earner retires or otherwise experiences a significant drop in their income. You sell the asset and trigger the capital gain at that point, thereby minimising your tax liability and maximising the gains retained by you.
Deciding on appropriate ownership of investments is a tricky issue and one that we regularly talk through with clients. The challenge is that in all likelihood you’ll be selling the investment 10 years or more down the road and a lot can happen between now and then. Often we end up simply putting the investments in joint names and in that way hedging our bets.
Superannuation and retirement
A final opportunity for couples to consider is within the superannuation environment.
Superannuation is a tax friendly environment in which to accumulate wealth, and then provide income in retirement. Our system provides most of the tax savings at the point when you commence drawing retirement income. For most of us, once we are over 60 years of age and drawing income from our superannuation, it will be completely tax free. There is however a limit as to how much you can put into a tax free pension and currently that is $1.6 million. This limit is per person. So a couple who can each grow their superannuation balances could potentially get $3.2 million into tax free retirement income streams.
Frequently what we see though is one member of the couple having a large balance and the other member of the couple having a considerably smaller balance. In this way the opportunity to maximise tax free income in retirement is somewhat wasted. There is a solution to this though and it’s known as superannuation splitting. The higher income earning member of the couple who will have the largest superannuation balance can request that their super fund shift their contributions from the previous financial year across to their spouses superannuation account. This is extremely helpful in equalising superannuation balances and thereby maximising the opportunity for tax free income in retirement. Beyond the financial benefits it also has some attractive psychological benefits for a couple. If you consider the traditional and common example of the husband having a larger superannuation balance due to the wife caring for children, using super splitting to direct the husband’s superannuation contributions across into the wife’s super fund so that they both have meaningful retirement savings not only makes financial sense but makes sense from an equity perspective too.
To summaries, here are 5 strategies you might like to explore to maximise your income as a couple:
- Career development with partner providing financial support through a period of study – career change, MBA, Masters, or Phd. Increasing your skills typically leads to increased household income.
- Parenting – it may be better for each parent to work part time rather than one remain full time and the other not work at all due to the workings of the tax system.
- For the self-employed – income splitting through a family trust. But beware Personal Services Income rules.
- Investment ownership – generally, hold investments in the name of the lowest income earner. Gearing strategies may complicate this.
- Superannuation splitting to maximise the amount of tax free income in retirement.
I hope you found those ideas helpful. As mentioned I’ve created a one page cheat sheet which you can download here.
Enjoyed these thoughts? Then you’ll love my weekly email GainingCHOICE. Subscribe for free here.
Others posts you might find valuable:
Back to All News