There’s a certain euphoria that accompanies the act of reducing debt. Whether it stems from an unexpected windfall, like receiving an inheritance, or a deliberate decision to sell an asset, the idea of lightening the financial load is undeniably appealing. However, as we’ll unravel in this narrative, the seemingly straightforward path of reducing a loan may not always be the wisest choice. In fact, in the realm of ‘good debt,’ where loans were strategically used for investments, this decision could have unintended tax consequences and limit future financial flexibility.
The Joy of Debt Reduction
Imagine the joy of standing at a financial crossroads, armed with an inheritance or the proceeds from selling an asset. The natural inclination for many is to direct these newfound resources toward reducing existing debt. Lowering loan balances brings a sense of accomplishment and immediate financial relief.
The Quandary of ‘Good Debt’
However, the plot thickens when we delve into the specifics of the debt being reduced. Not all debts are created equal, and the concept of ‘good debt’ enters the stage. This term refers to loans strategically used for investments, such as property or shares. Herein lies the dilemma – reducing ‘good debt’ might inadvertently trigger unwelcome tax consequences.
The Tax Conundrum
In the world of ‘good debt,’ interest payments are often tax-deductible. This means that the interest you pay on loans for investments can be used to lower your taxable income. However, when you eagerly reduce the loan balance, you may unintentionally increase your taxable income, leading to unforeseen financial consequences.
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Accessing the funds in the future
This scenario may exacerbate if you ever decide to access these funds again and reborrow the money using, for instance, a redraw facility. While gaining access to the funds may seem advantageous, the act of effectively reborrowing or redrawing from the loan means that the interest loses its tax deductibility benefits. In essence, the loan has transitioned from being ‘good debt’ to ‘bad debt.’
Preserving Future Flexibility
This approach means that while you may be reducing immediate costs, you’re also sacrificing potential tax advantages in the future. This becomes particularly crucial if you ever plan to access these funds again for lifestyle purposes down the road.
Next Steps
As we conclude, the call to action is clear: if you find yourself at the crossroads of debt reduction and potential tax implications, seeking professional advice is paramount. Our financial advisors can guide you on how to leverage the funds from an inheritance or the sale of an asset to not only reduce costs but also preserve the tax deductibility of interest for future financial flexibility.
To discover how to navigate this intricate puzzle and make the most informed decisions for your financial future, we invite you to contact us. Let’s work together to ensure that your journey toward debt reduction is not just a momentary triumph but a sustainable and strategically sound financial path.
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Disclaimer
This information is general advice. We have not considered your objectives, personal or financial circumstances. You should consider the appropriateness of the advice for your circumstances before making any decision. You should obtain and consider the relevant Product Disclosure Statement and seek the assistance of an authorised financial adviser before making any decision regarding any products or strategies mentioned in this communication.
Past performance is not an indication of future performance.
This presentation has been prepared and presented by Roger Perrett, Freshwater Wealth Management Pty Ltd CAR no.1307016, Alliance Wealth Pty Ltd AFSL No.449221. This information cannot be used or copied in whole or part without our express written consent.
While every effort has been made to ensure the accuracy of the information, it is not guaranteed. It is based on our understanding of regulations and laws as at the publication date. As these are subject to change you should talk to a professional adviser for the most up-to-date information.
To the maximum extent permitted by law, no person including Alliance Wealth Pty Ltd nor its related entities, employees or representatives accepts responsibility for any loss suffered by any person arising from reliance on this information.
