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The importance of a nest egg

15 October 2020

Author: Ryan Francis

It’s hard to believe that we are already in October of 2020, a year that has been so challenging in so many ways since the global outbreak of COVID-19. As far as health consequences, Australia has fared a lot better than many countries around the world, however we have experienced significant economic impacts from this pandemic - both in the national economy and for many of us personally. It's expected that the economic impacts will last a year or more, with parts of the country still moving in and out of varying levels of restrictions, state borders closing and opening, stimulus packages due to wind up in early 2021 and confirmation the economy is now in recession.

For many, the pandemic has resulted in job loses or job insecurity, cuts to income, falling house prices, the failure of their business or even a combination. Prior to the pandemic Australia had enjoyed a very long period of economic growth, 29 years to be exact. Our last economic recession was in the March and June quarters of 1991. Even the Global Financial Crisis, which had major economic impacts around the world, did not put Australia into recession. We have lived through reasonably prosperous times for three decades, resulting in complacency for some about the importance of having savings to fall back on.

If you started work age 18 in 1992 you would now be 46 years old and would not have experienced an economic recession until now. Around 60% of the Australian workforce is aged under 45 years old, and those employed in the industries most impacted by COVID such as hospitality and tourism tend to be younger and as such will be suffering more from financial strain.

If there’s one thing COVID-19 has shown us, it’s the importance of having a “nest egg” to keep us resilient when unforeseen events strike. A telling sign that a lot of people do not have any or limited savings to rely on is the fact that as of the 13th September 2020 APRA reports $33.3 Billion has been paid out under the governments early release of super scheme. Recent hardship has even seen some setting up a “go-fund-me” page to help pay their mortgage or the car registration. Neither option is a reliable fallback mechanism.

The good news is that COVID-19 has highlighted the need to be more prudent with spending and to increase savings to build a nest egg. In a recent Bankwest national survey 47% of respondents said they were trying to save more money than usual, with respondents reporting they were more than twice (2.2 times) as likely to be saving than spending.

But what is the best way to build a nest egg or rainy-day fund? Most people initially think of an interest earning bank account as a good way to save and while it does have its advantages, such as very low investment risk, easy access to cash when needed and easy set-up - with record low interest rates the effect of compounding interest returns is doing little to grow savings.

Another possible solution is using a mortgage offset account, which will provide a return in the form of an interest saving on your home mortgage. Again, this is low risk, provides easy access to the funds when needed and is easy to setup. However much like the interest earning bank account, record low mortgage rates means the return on investment you receive in the form of interest savings is relatively low.

An alternative strategy could involve using an investment bond to accumulate your nest egg in a tax efficient manner. Investment Bonds (also known as Insurance Bonds, tax paid bonds or Friendly Society Bonds) are a tax effective investment structure very similar to superannuation in concept, but without the restrictions and complexities regularly associated with superannuation. Earnings are taxed within the investment bond at a maximum of 30%, and investors do not have any personal tax liability while the funds remain invested inside the bond. This means investment bonds are an attractive option for those with a close eye on their personal tax liability.

When held for the long term – for 10 years or more – withdrawals from the investment bond carry nil personal tax liability, and taxable withdrawals prior to the tenth year receive a 30% tax rebate as earnings are tax paid by the bond issuer. This is particularly important as whilst the most tax effective term to hold an investment bond for is 10 years or longer, should the need arise to access funds within the 10-year period, this can still be achieved in a tax effective manner owing to the 30% tax rebate received. If an unexpected event such as the current COVID pandemic was to result in income being significantly reduced or even lost all together, it’s possible that the personal tax consequence of a withdrawal from an investment bond within the 10 year period is very negligible or even none at all.

Investment bonds also offer a wide range of investment options ranging from cash and capital guaranteed for those investors with a defensive outlook, right through to growth assets like Property, Australian or Global share exposure for those investors with a more aggressive outlook.

While Australians typically take a DIY approach to their investment strategies, it is often best to seek professional advice to establish the most suitable strategy for your financial situation, goals and objectives. Many Australians are now realising the value of advice in helping build financial resilience, with advisers reporting a 20% jump in new-to-advice clients.

If there is one positive we can take from the COVID-19 pandemic, perhaps it has shown us the importance of having a nest egg to fall back on when times get tough.

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