Most of us have debt in one form or another. For some of us, debt is limited to the monthly credit card bill, whilst for others it’s a tool we use to help us buy assets. Used effectively it can be a powerful lever for accumulating wealth.
Whilst the management of debt may seem relatively straightforward – we typically make our interest payments each month and hope we have some money left over to pay down some principal on the loan along the way – there are a number of strategies that can be employed to accelerate the reduction of debt and generate some tax advantages at the same time. The first of these is known as ‘debt recycling’…
Debt Recycling
In some cases, it may be appropriate to consider replacing inefficient debt with more efficient debt that can be used to create wealth tax effectively.
Debt recycling can be an effective strategy to accumulate wealth over the long term. It is a process of using available surplus capital or cash flow to reduce inefficient debt (otherwise known as non-deductible debt) and creating an investment loan for an equivalent amount. The investment loan proceeds are then invested to form part of your investment portfolio. The income from the investment portfolio is then channelled back into the non-deductible loan, thereby accelerating the repayment of this facility. The inefficient debt is eventually extinguished and an investment loan with fully tax deductible interest remains.
There is no tax benefit available on debt used for personal purposes, but a tax deduction is available on the interest expense on investment loans, where the loan is used to purchase income producing assets. Debt recycling therefore results in a more tax efficient outcome and wealth accumulation benefits through the accumulation of an investment portfolio. You should note that the investment loan would need to be repaid at some point in time.
To implement this strategy, your tolerance for risk should allow you to feel comfortable with borrowing to invest. There are two elements in play in the overview of this strategy outlined above:
Lump Sum Debt Recycling
If you have available capital such as bank account savings, this can be used to repay any inefficient debt, such as a home mortgage or personal loan. An investment loan can then be taken for the same amount and be used to invest in an investment portfolio.
Regular Debt Recycling
If you have regular surplus income, this can be used to increase the regular repayments on your inefficient debt, such as your home mortgage or personal loan. An investment loan can then be increased by a corresponding amount and the proceeds used to invest in an investment portfolio.
Written by: Matt Smith - Director - 0410 526 499
