Understanding Deductible and Non- Deductible Debt

Debt is often a scary term for many which is good but there are better ways to look at it as and better ways to structure it. Many are not aware of the real difference between deductible and non- deductible debt which play an important role in determining what is the best wealth accumulation strategy for you.

I had a very interesting case of someone who kept piling up her non-deductible debt as her lifestyle needs caught up with what she could actually afford. This is often the danger trap, too often. While trying to keep up a certain image, the credit card and personal loans become a favourite companion. In her case, Mrs A, debt had hit the $100,000 mark and alarm bells went off when most of her monthly pay goes entirely to paying off the interest on the credit card.

What happens next is very predictable- the tough talk with the family that led to the huge emotional rollercoaster for all of them and me as I sat and mediated them through the process. What is important is to educate them to understand that there are ways to take control of your finances again, there are ways to make sure that you are not drowning in repayments while taking a big hit emotionally – there is a fine balance between the 2 which is important to be achieved.

What I did next was to take charge of her financial life and set in place some rules that will force her to be disciplined with her repayments and focus on her goals. Depending on the goals, for her, I had established 5 different bank accounts that has no account keeping fee and linked to capital stable conservative investment product. As soon as she gets her pay, the funds are then directed to each of the bank accounts:

1. Pay off all her loans – the minimum repayments get in here – approximately $1600 each fortnight
2. Start a savings plan – $100 get in here each fortnight that gets invested in a capital stable conservative investment
3. Cash Buffer – $200 get in here each fortnight to build on a cash buffer – as the famous saying is, cash is always king after all
4. Day to Day – the balance is for her to utilize for the next fortnight to buy her groceries, pay her bills, money for day out with friends and any other expenditure -$160. That may seem like a small figure but realistically $160 is an achievable target for a fortnightly expense if you have a proper budget in place and be prudent with your spending – this is for a single person alone.

Any excess cash is then used to pay off her debt. The reason why I choose this instead of directing her pay entirely to paying down the debt is that having a cash buffer provides her with emotional stability as she now knows that she has a sum of cash that is available if she needs to in an event of emergency and not having to try and figure where it will come from.

With the investments, we sat and discussed what is important for her and what does she want to achieve in short, medium and long term. This will determine the most effective tax structure for her. There is no point me teaching you how to drive to Melbourne if you want to go to London. If you are going to London, I need to put you on an A380 with high powered fuel while I can put you in a car or a smaller Boeing 737 if you are going to Melbourne. There is only 1 CBA share on ASX, 1 WOW, 1 ANZ etc. but it is how I buy it for you that matters – be it in form of direct equities, warrants, in SMSF, in a family trust, in a margin loan, in a PAF – so many different structures which you can choose from but all depending on what are your goals, ambitions and values.

It is always an interesting journey to see how clients are emotionally affected by their financial position and how their financial position is affected by their emotions. What I enjoy a lot is to sit with you and decide what is your most important goal, what are your obstacles and what are you most worried about – from then, we will look at how your finances are impacting everything else and come up with a strategy to help you gain financial freedom.