Financial planning in Australia : advice and wealth management [8th edition.] 9780409347609, 0409347604

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Financial Planning in Australia: Advice and Wealth Management 8TH EDITION

Financial Planning in Australia: Advice and Wealth Management 8TH EDITION

Sharon Taylor BCom (Accounting, Finance and Systems), MCom, FCPA Senior Lecturer, School of Business Western Sydney University Emeritus Professor Roger Juchau BCom, Bed, MA, Hon PhD, FCPA, FNZIM Emeritus Professor of Accounting and Management Western Sydney University

LexisNexis Butterworths Australia

2018

AUSTRALIA

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National Library of Australia Cataloguing-in-Publication entry

Author: Title: Edition: ISBN: Notes: Subjects: Other Authors/Contributors:

Taylor, Sharon (Sharon Maria). Financial Planning in Australia: Advice and Wealth Management. 8th edition. 9780409347609 (pbk). 9780409347616 (ebk). Includes index. Finance, Personal — Australia. Investments — Australia. Juchau, Roger H.

© 2017 Reed International Books Australia Pty Limited trading as LexisNexis. First edition 2005; Second edition 2007 (reprinted 2008); Third edition 2009 (reprinted 2010); Fourth edition 2010; Fifth edition 2013 (reprinted 2014); Sixth edition 2015; Seventh edition 2016. This book is copyright. Except as permitted under the Copyright Act 1968 (Cth), no part of this publication may be reproduced by any process, electronic or otherwise, without the specific written permission of the copyright owner. Neither may information be stored electronically in any form whatsoever without such permission. Inquiries should be addressed to the publishers. Typeset in Gotham, StoneSerif and Acaslon Pro. Printed in Australia. Visit LexisNexis Butterworths at www.lexisnexis.com.au

Preface Greater numbers of professionals are now offering financial advice, many of them with professional qualifications in accounting, law or financial planning, and there has been continued growth in managed funds and legislative changes in superannuation, including MySuper. This eighth edition of Financial Planning in Australia recognises the importance of the financial services sector as it continues to grow rapidly. The sector has been affected by increased regulation and education, especially the recent changes to the Future of Financial Advice reforms that were announced in 2012. The creation in 2015 of a ‘national register for financial planners’ under the oversight of the Australian Securities and Investments Commission adds a demonstrable outcome to the government’s appetite for continued reform. Combined with the findings of the Parliamentary Joint Committee on Corporations and Financial Services, which were reported in early 2015, these reforms continue to shape how the financial planning profession is likely to develop over the next decade.

Additionally, the new education requirements of a degree were introduced in 2017. The term financial planner/adviser will be enshrined in law. An independent standards setting body was established on 1 July 2017, to set the education standards, professional year framework and continuing professional development requirements, as well as developing a comprehensive code of ethics for financial planners. New financial planners from 1 January 2019 will require a degree, to undertake a professional year and pass an exam. All financial planners, both new and existing, will be required to undertake continuing professional development (by 1 January 2019), be subject to a code of ethics (from 1 January 2020) and pass an exam (by 1 January 2021). Existing financial planners who need to undertake additional study to meet the new education requirements will have until 1 January 2024 to meet the new standard. This edition — which incorporates recent changes in the law and in the provisions in social security, superannuation and financial services — brings to students, lecturers and other readers a comprehensive coverage of the language, concepts, vehicle and strategies required for providing financial understanding and advice. The content and chapters have been updated, reflecting key knowledge areas for successful wealth management. The textbook has been revised and updated to meet curriculum and

pedagogical developments in colleges and universities. For example, Parts 1 and 2 may be covered in one teaching term, with Parts 3 and 4 in another term. Each part may also be taken in modular form, with assessments given at the end of each part. Included are learning objectives and chapter summaries, along with numerous examples and exhibits, and a range of graded assessment items. New questions, problems and case studies have been added. The website accompanying the textbook will update the content in the event of post-publication changes to the law and professional regulations. As with previous editions, this textbook provides the necessary body of knowledge for courses run by associations, universities, colleges and professional bodies. It meets the needs of instructors and students in the subjects of financial advice, financial planning, investments and wealth management. By focusing on individual wealth-management problems, the textbook also supplies a guide for developing, implementing and monitoring strategies for successful asset accumulation and wealth management in Australia. Sharon Taylor Roger Juchau October 2017

About the Authors Sharon Taylor is Associate Professor in Accounting at Western Sydney University (WSU). She has worked at the Australian Taxation Office and is a Fellow of CPA Australia and a Registered Tax Agent. For many years, she was an academic supervisor in the School of Accounting, and also the Associate Head of School Engagement at WSU. Sharon is currently a member of the Financial Planning Academic Forum and Deputy Chair of the Financial Planning Education Council, and was a Foundation Fellow of the Association of Financial Educators. Additionally, she held the role of convenor of the Financial Services Discipline Team for many years, and was Chair of the committee developing both the Master of Commerce (Financial Planning) and Bachelor of Financial Advising degree programs. She has contributed

to

numerous

publications,

including

Australian Accounting Research Foundation, Financial Services Review, Financial Planning Research Journal and Australasian Accounting Business and Financial Journal.

Roger H Juchau is Emeritus Professor of Accounting and Management at Western Sydney University (WSU). He has held academic posts at Lincoln University (NZ), Macquarie University, Nepean CAE and the Queensland Institute of Technology, and was Commonwealth Foundation Fellow at the University of the South Pacific (USP). Professor Juchau is a graduate of the Universities of NSW, Queensland and Sussex, and a Fellow of CPA Australia and the NZ Institute of Management. He has been visiting Professor at the University of California, Davis, and Wye College, University of London. He initiated and led the development of financial programs at USP, Nepean, Lincoln and WSU. His scholarly and professional contributions have appeared in journals, texts and

monographs,

professional consultancies.

complementing

development

courses

his and

work

in

educational

About the Contributors Graeme Colley is currently the Executive Manager, SMSF Technical and Private Wealth at SuperConcepts, where he manages the SMSF technical program for clients, advocacy and assists in delivering the company’s education program to private clients. Previously, Graeme was Director of Technical and Professional Standards at the SMSF Association. Prior to that he was the National Technical Manager of ANZ’s financial services arm, OnePath Australia. At OnePath, he was responsible for providing

technical

advice

on

superannuation,

Centrelink, aged care and taxation strategies to over 2,100 financial planners and users of OnePath products. Dr Michelle Cull is a senior lecturer in Accounting and Financial Planning at Western Sydney University, where she has held various academic positions since 1999 and is currently the Director of Academic Program. She has contributed to the curriculum development for the Bachelor

of

Business

(Accounting),

Bachelor

of

Accounting (Financial Planning and Taxation) and

Master of Financial Planning. Michelle previously worked extensively in the areas of commercial, financial and

management

accounting

at

ASX100-listed

companies and has also worked as a consultant. She has completed a PhD on the role of trust in financial planning and contributed to numerous publications, including Accounting Education – An International Journal, Australasian Accounting Business and Finance Journal, Economic Labour Relations Review and Financial Planning Research Journal. Ray Griffin holds an Executive Master of Business Administration, a Diploma of Financial Services and is a graduate of the Australian Institute of Company Directors. In 2017, he commenced a PhD with Griffith University researching the efficacy of Australian financial planning legislation. Mostly under his own Australian Financial Services Licence, he has operated his business for more than 28 years, and is a Director of Baiocchi Griffin Private Wealth Pty Ltd. He has been a regular commentator for magazines, radio and television, and is a past winner of Money Management’s Financial Planner of the Year award. In 2003, Ray chaired the International Council of Certified Financial Planners’ Strategic Planning Task Force, and was a key contributor to the

development of the global standards-setting body, the Financial Planning Standards Board (FPSB). He cofounded the annual Corners for Kids Motorcycle Rally, and in 2007 instigated the establishment of Future2 Foundation, the charitable foundation of the Financial Planning Association of Australia. Robert Monahan is the principal lawyer at Monahan Estate Planning. Robert was first admitted in 1976 and has been accredited by the Law Society of New South Wales since 1998 as an accredited specialist in the area of wills and estate law. Robert’s career has taken him from private practice to a corporate environment followed by a consultancy at Maddocks Lawyers. Robert has now returned to private practice since establishing his boutique estateplanning firm where he now works with his daughter, Julia. Robert is the general editor of the Estate Planning Service, published by LexisNexis, and a regular contributor to Retirement & Estate Planning Bulletin. With Michael Perkins he co-authored the book Estate Planning: A Practical Guide for Estate and Financial Service Professionals, the fourth edition of which was published in 2015. Robert lectures in Estate Planning at the University of Technology, Sydney, and is a regular

speaker at conferences for lawyers, accountants and financial advisers. Michael Perkins is a partner at Perkins Fahey Rosenblum, a boutique private client firm in Sydney. He has over 30 years’ experience in private client practice. Michael assists his clients to create and manage multijurisdiction

and

multi-generation

focused

wealth

management and succession strategies. He also assists family groups with their operations and governance and business owners with meeting their succession and wealth-extraction objectives. Michael has been teaching estate planning for over 10 years. With the support of Charles Sturt University, he has created online estateplanning subjects for its Master of Accounting and Finance program. He is a practitioner member of the Academic Community of the Society of Trust & Estate Practitioners (STEP). Elen Seymour is a law lecturer at Western Sydney University, specialising in tax and financial services. Prior to becoming a lecturer, Elen worked for the Australian Taxation Office as a graduate and then as an auditor with the International Tax Transfer Pricing team. Later, Elen worked for PricewaterhouseCoopers as an international

tax consultant in Sydney, before transferring to become a Senior Associate with the international tax team with PricewaterhouseCoopers in Ottawa, Canada. Elen has been lecturing in tax and commercial law since 2003, and held various positions in the university including Acting Director Academic Program, Chair of Learning and Teaching Committee. Elen is a Fellow of the Tax Institute and a member of the Tax Institute’s Membership Committee.

Guide to the Book

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Contents Preface About the Authors Guide to the Book

PART

1 — Introduction: Setting the Scene

Chapter 1

The Financial Planning Environment

Chapter 2

Ethics and Compliance

Chapter 3

The Client–Adviser Relationship

Chapter 4

Constructing a Statement of Advice

PART

2 — Building Wealth

Chapter 5

Cash Flow and Budgeting

Chapter 6

Securing and Managing Credit

Chapter 7

Asset Allocation and Managing Risk

Chapter 8

Investing in Shares

Chapter 9

Investing in Fixed-Income Securities

Chapter 10

Investing in Property and Collectables

Chapter 11

Investing in Managed Funds

Chapter 12

Investing in Superannuation

PART

3 — Managing Wealth

Chapter 13

Taxation: An Overview for Financial Planners

Chapter 14

Tax Strategies

Chapter 15

Insurance — Life

Chapter 16

Insurance — Income Protection, Health and General

PART

4 — Using Your Wealth

Chapter 17

Superannuation and Retirement

Chapter 18

Social Security

Chapter 19

Estate Planning — Core Principles and Practice

Chapter 20

Keys to Successful Financial Planning

Appendix A — Time Value of Money Appendix B — Present and Future Value Tables Index

[page 1]

PART 1

Introduction: Setting the Scene Chapter 1

The Financial Planning Environment

Chapter 2

Ethics and Compliance

Chapter 3

The Client–Adviser Relationship

Chapter 4

Constructing a Statement of Advice

[page 3]

Chapter 1

The Financial Planning Environment Focus This introductory chapter sets the scene for the subsequent technical chapters. In many ways, financial planning is a product of the circumstances that arose in the early 1980s when it became apparent that such issues as an ageing population, poor levels of domestic savings and substantive changes in government policy relating to the funding of an individual’s retirement created the need for holistic financial advice. This chapter attempts to define and explain the term ‘financial planning’, followed by a discussion of the factors which have contributed to the emergence of this new profession/industry. Finally, the chapter briefly considers the historical framework of the industry and the role played by the major professional bodies and other industry participants.

Learning Objectives After studying this chapter, students should be able to: have an understanding of the difficulties associated with

defining the term ‘financial planning’ and the elements it incorporates; appreciate the impact of the external environment in which the financial planning industry operates; understand that many economic factors have played a role in heightening the importance of obtaining good financial advice; appreciate the history and development of the financial planning profession/industry as we know it today; have an understanding of the roles of the professional bodies in maintaining codes of conduct, ethics and standards generally; understand the role of the government in relation to both fiscal policy and regulation, and how this impacts on the giving of advice; and have an appreciation of the roles of other stakeholders and how these impact on the future development of the financial planning industry.

[page 4]

Introduction What is financial planning?

In this chapter, we discuss the impact of the factors mentioned in the ‘Focus’ above, and how their combined effect necessitated investors’ seeking professional financial advice, which, in turn, has resulted in the emergence of a new industry in Australia: financial planning. History continues to show us the ongoing volatility in financial markets over time. This fact, combined with factors affecting the Australian domestic scene, has led to numerous lessons being learned, as well as providing data for reflection. In 2008, for the first time, many investors experienced loss of their capital and they were keen to ensure there was no repeat of such losses. Hence, many investors sought financial advisers to give advice in relation to risk and return, market volatility, portfolio construction and diversification, as well as ongoing management of their investment portfolios. Before we can discuss the process of financial planning, it is important to examine a fundamental yet complex question: What is financial planning? There is no single answer. One possible response is: Financial planning: A holistic process whereby a client’s total position, both financial and non-financial, is examined and a set of actions or a plan is put in place which, once implemented, will assist in meeting the client’s ultimate goals and objectives.

As previously mentioned, the concept of financial planning as a discrete discipline is somewhat new. Until the early 1990s, financial advice was given by a multitude of different professionals. For example, accountants typically gave advice on investments, superannuation and tax issues, whereas lawyers were concerned with estate planning and superannuation. Then there were the insurance agents giving advice on insurance products, and real estate

agents recommending strategies incorporating negative gearing and direct property — for example, purchase of residential units or homes rather than property trusts. Consequently, there was no all-encompassing approach to an individual’s wealth creation. This fragmented approach often left clients with no clear plan as to how their overall financial goals and aspirations were to be met, and whether, given their circumstances, the goals were realistic and/or achievable.

A brief history of the financial planning environment The financial planning industry as we know it today plays a drastically different role to the one it played in the early 1980s. At that time, Australians lived in an economic environment of high inflation and high interest rates. While the Labor government of the time sought to engineer the economy to make it generally more robust and internationalised, it was apparent that many domestic issues relating to savings and retirement needed to be addressed urgently. Australia’s government recognised that the nation’s declining birth rate, combined with the ageing baby-boomer population and a poor savings record, required drastic action. In the early 1980s, the government introduced rollover provisions in relation to superannuation to ensure that employees who left one employer to work for another could transfer (‘roll over’) their superannuation benefits to the new employer. Taxation laws were changed to encourage this practice, rather than having individuals withdraw their lump-sum superannuation benefits. In 1985, capital gains tax (CGT) was introduced and, with this, came the

development of new investment products, which, in some cases, were CGTexempt. Additionally, many investors for the first time sought professional advice as to how to best structure their investments to minimise tax effects.

[page 5]

Another government initiative in 1987 was the introduction of dividend imputation or franking credits. Previously, dividends were taxable in the hands of the company but then also formed part of the shareholder’s taxable income, with no recognition of the tax paid by the company. In effect, this was double taxation and did not provide any incentive for investors to buy shares in companies that paid dividends. The introduction of dividend imputation removed this disincentive and recognised that the shareholder was entitled to a credit for the tax paid by the company on the dividend. Internationally, events were also causing a ripple effect for the financial planning industry. In 1987, the share-market crash saw share prices fall by anything up to 50% in a few days. For many advisers in the financial planning sector, it was the first time both they and their clients had experienced such a drastic market correction. Many brokers and fund managers went out of business during this period. As the 1990s approached, dramatic changes were evident in the financial environment, both in Australia and overseas. In Australia, the property trust freeze and the collapse of financial institutions, such as the Pyramid Building

Society, saw investors withdrawing funds and an overall climate of panic in the investment market of dividend income. Internationally, the 1990s were extremely volatile, with the crash of the Japanese stock market in 1994, followed by the United States governmentbond crash in the same year. In 1997, world currency markets were severely impacted by the Asian crisis, when the World Bank and the International Monetary Fund combined to draft a rescue package for many Asian countries. Closer to home, in 1992, the introduction of the Superannuation Guarantee (SG) charge heralded a new era for Australians, with the introduction of a compulsory superannuation scheme. Since its introduction, there have been many changes within the superannuation arena, which, today, provides potentially trillions of dollars ($2.05 trillion as at the end of March 2015)1 in funds to the Australian investment markets. Initially, the contribution by employers was 3% of their employees’ earnings to a superannuation fund. Currently, the rate is 9.5%, which will rise progressively over the years and, by 2022, the SG charge will be increased to 12% of employee earnings. In 2000, the beginning of the new century, share-market volatility was again evident, with sharp falls recorded in the value of share markets in many of the world’s developed countries. In the early part of the new decade, corporate collapses, such as HIH Insurance Limited, created a climate of instability and a lack of confidence that permeated the investment markets in Australia. This was exacerbated in 2007–08 with the subprime loan collapses in the United States and the ripple effect on world and Australian financial markets. Early 2008 again saw huge volatility on the world’s share markets,

and this continues to the present time. In terms of the Australian share market, some of the market losses that occurred early in 2008 were initially, and to some extent, recouped, but an environment of uncertainty remains and is reflected in investors’ current behaviours. In late 2007, Australia underwent a change to a Labor government. In May 2008, the new government brought down its first Budget, signalling that taxation and financial services issues were firmly on the agenda. This focus has continued, with several inquiries being set up and reports released, such as the Ripoll Inquiry reviewing financial services, the Henry Tax Review considering taxation reform, and the Cooper Inquiry into superannuation. Findings from the Ripoll and Cooper inquiries were released in late 2009 and the report from the Henry Tax Review was handed down by the government in May 2010. Although the economic environment continues to improve in Australia, the same indicators are not present in other OECD (Organization for Economic Cooperation and Development) countries. By mid-2012, a sustained international recovery was still difficult to predict with any real confidence. In early 2012, concern was raised about the true state of the Australian economy. For example, many people working in the retail sector reported they could not remember a pre-Christmas period quieter than what had occurred in 2011. Similar sentiments were expressed about the housing and construction sectors, along with manufacturing and other businesses. Yet the official figures for the period January to March 2012 showed the Australian

economy was growing much faster than expected — up a full 1% compared with the same period for

[page 6]

the previous year, and amounting to economic growth of 2.5% for the year. This was perhaps due to what had been referred to as a ‘two-speed’ economy: the mining sector continued to boom, but the same could not be said of other sectors in the Australian economy. The ‘situation’ fuelled domestic instability, which was compounded by the fact that continuing uncertainty in Europe failed to provide confidence globally — thereby adding to the considerably volatile domestic sentiment and beliefs about the robustness of the Australian economy generally. In May 2012, the Reserve Bank of Australia (RBA) opted to cut interest rates, giving households some mortgage relief, which, it was hoped, would have the result of stimulating the economy. Overall, however, while the Australian economy has performed better than many other Western economies over the last decade or so, economic growth in Australia was slow, which has led to further cuts to interest rates, along with changes to fiscal policy, especially in the area of spending. At the time of writing, the RBA continues to review interest rates on a monthly basis; the Australian cash rate reached an all-time low of 2.0% in May 2015, and subsequently rates have remained on hold. The 2012/13 federal Budget, handed down in May 2012, sought to reduce

government spending substantially, with the aim of securing a small surplus for 2012–13. This action, combined with the interest rate cuts during May and June, sought to support the predicted growth of 3% for the Australian economy for 2012. Also during 2011–12, the government was very proactive in the financial services area, with the introduction of the Future of Financial Advice (FOFA) reforms, which, it was hoped, would lead to increased trust and confidence of Australian retail investors in the financial planning sector. The reforms were designed to tackle conflicts of interest that had threatened the quality of financial advice provided to Australian investors. The reforms were also the government’s response to the Parliamentary Joint Committee on Corporations and Financial Services’ inquiry into financial products and services in Australia. The legislation was to commence from 1 July 2012. Then, in 2013, a coalition government took office in Australia. The new government embarked on a platform of strong fiscal policy and foreshadowed substantial changes to the FOFA legislation. In January 2014, the then Assistant Treasurer, Arthur Sinodinos, announced:2 The Government is progressing reforms to deliver affordable and accessible financial advice … Consistent with the Government’s announcement on 20 December 2013, key amendments include: removing the opt-in requirement; streamlining the annual fee disclosure requirements; amending the best interests duty to allow for scaled advice; exempting general advice from conflicted remuneration; and

amending grandfathering to allow for adviser movements.

In June 2014, the government announced that amendments to the FOFA reforms would occur, using regulations to implement the majority of its proposed changes on 1 July 2014. A media article3 reported Acting Assistant Treasurer and Minister for Finance, Senator Mathias Cormann, as confirming, ‘This will provide certainty to financial advisers and consumers while the changes are considered in detail by Parliament’. The article went on to report that: The regulations will bring about the following changes, which will subsequently be progressed through legislation: Removal of the ‘opt-in’ requirement Removal of the catch-all provision of the best interest duty to provide clarity and certainty on how a financial adviser has to comply with the best interest duty

[page 7]

Better facilitation of access to scaled advice Removing the requirement for fee-disclosure statements to be sent to pre-1 July 2013 clients. In addition, the regulations will implement the: Balance scorecard incentive payments which do not conflict advice are permitted Improvements to the FoFA grandfathering provisions to address unintended consequences and to facilitate competition in the financial advice industry.

These reforms hit more hurdles due to the political environment in the

Senate; however, a last-minute deal with the Palmer United Party saw the amendments pass in the House. Senator Cormann on 15 July 2014 stated:4 I’m pleased to inform the Senate that the Government has reached agreement with the Palmer United Party and that I have written to Mr Palmer about a range of additional measures that the Government will pursue, by way of further regulations, in order to take on board the positive suggestions that were made by Mr Palmer on behalf of the Palmer United Party.

The regulations became effective from 1 January 2015.5 Detailed discussion of the FOFA (amendments) is provided in Chapter 2. Additional issues also arose with the announcement of cost-cutting measures in the 2014/15 federal Budget. The government has sought to reign in the deficit using strong fiscal measures and including spending cuts. At the time of writing, much of the legislation is being held in abeyance. Also in 2014, the government set up the Murray inquiry to scrutinise bank deposits, insurance, retirement savings and home loans. The Treasurer, Joe Hockey, called it a ‘root and branch’ inquiry.6 The Murray inquiry, better known as the Financial System Inquiry (FSI), released an interim report on 15 July 2014. In an article published in The Sydney Morning Herald, authors Clancy Yeates and James Eyers stated that, although the interim report did not make recommendations, it provided a clear signal on the panel’s thinking on a wide range of topics, including the banking system, superannuation, and the role of technology and regulation.7 The final report was handed down on 7 December 2014. In the final report’s executive summary, the committee stated that:8

The Inquiry has made 44 recommendations relating to the Australian financial system. These recommendations reflect the Inquiry’s judgement and are based on evidence received by the Inquiry. The Inquiry’s test has been one of public interest: the interests of individuals, businesses, the economy, taxpayers and Government … The Inquiry identified two general themes where there is significant scope to improve the functioning of the financial system: 1.

Funding the Australian economy.

2.

Competition.

The report concentrated on five main themes: 1

resilience;

2

superannuation and retirement income;

[page 8]

3

innovation;

4

consumer outcomes; and

5

regulatory system.

Additionally, in late 2014, the Parliamentary Joint Committee on Corporations and Financial Services (PJC) released the final report of an inquiry into proposals to lift the professional, ethical and education standards in the financial services industry. The PJC report’s recommendations include the following:9 a minimum degree qualification for all new financial planners; the Finance Professionals Education Council (FPEC) to become an

independent body and gatekeeper of minimum education standards and requirements, setting the curriculum for the audit of education providers; the FPEC to be controlled and funded by professional bodies approved by the Professional Standards Councils, which are required to establish codes of ethics which are compliant with the requirements of a Professional Standards Scheme and are approved by the Professional Standards Councils; mandatory ongoing professional development for financial advisers; completion of a structured professional year as a prerequisite to being registered as a financial adviser; mandatory membership of an approved professional body; a co-regulatory model that recognises the role of professional bodies in maintaining and enforcing codes of conduct; the term ‘general advice’ should be replaced with ‘product sales information’, and the term ‘personal advice’ replaced with ‘financial advice’; the terms ‘financial adviser’ and ‘financial planner’ to be enshrined in the Corporations Act 2001 (Cth), and only those individuals registered as a financial adviser may use these titles; and a national competency exam for financial planners as a prerequisite to being registered as a financial adviser. The full report can be viewed at: