Pre-payment "catching up"

A friend of mine is a new property investor, and is attempting to understand a lot of IP concepts. Once concept that caused grief was prepayment. My friend says that by prepaying in June 2015 then in June 2016 there will be less payments for FY16, and hence the prepayment "catches up". That is, prepayment in June 2015 might save $100 tax in FY15 but the taxpayer will have to pay $100 more tax in FY16. This is true to some extent, but I'd rather have that $100 now.

Varying tax laws make it somewhat of an unknown 12 months away. For example, by 30 June 2016 the 2014 federal budget may be passed. Used carefully, I like prepayment, and I've done it on some years to bring assessable income into the next MTR.

Can anyone think of reasoning that would persuade my friend that prepayment can be good? TIA.

 

Prepaid insurance does come with a catch. It must be repeated annually or you end up with no deduction. What it does is bring two years of deductions into a year and if repeated next year there is just one etc etc... Its a dangerous game as many people forget or do it late and then find they have no deduction. No solution either. It can also leave a nasty PAYG instalment shortfall or debt too. (that can get complex)

It can be very effective at addressing a situation where income is substantial in one year (cap gain at highest marginal rate) and nil the next (ie a sabbatical break ??). Allows timing differences to be shifted. I would argue it something that should be confirmed with tax advice so the merits of it can be valued.

You friend should explore a PAYG variation as a first step to maxing cashflow.

 

Prepaying interest can be good if the person won't be working next year or will have a low income.

 

OK, interesting topic. In my situation working in the auto industry means that I may potentially be out of work at the beginning of 2017. What should I do in that hypothetical situation?

 

Start looking now!

Reassess the tax situation in May 2016 and try to estimate your income for 2015-16 and 2016-17

 

Thanks for the advice.

Follow Terry's advice with a view to possibly pre-paying in June 2016 if your income will be lower in FY17. It can be hard as you do not know for sure in May 2016 what your work situation will be a year later. You may need to go through several options and see what comes up, looking at best and worse case results for all options. It may come down to probability.

 

One of the mistakes I see many make with prepaying is thinking it must be 12 months or 100% of the loan. Some banks can split loans and can do shorter terms than 12 months so that the outcome can be engineered to avoid overkill.

 

I wonder how the recent APRA changes may affect prepayments ?? The servicing calcs may be nasty now. Any broker views on this ?

 

Servicing calculator changes will vary depending on the lender. Some lenders do want to reassess the loan when setting up pre-paid arrangements, for others it's simply a product switch with no new assessment necessary.