Distressed investment markets coupled with a growing ageing populationpresent advisers with unprecedented challenges in both the pre-retirement and retirement markets.
Compounding these issues are the latest figures for the September quarter from the Westpac ASFA (Association of Superannuation Funds of Australia) Retirement Standard, which depicts living expenses for a couple living comfortably in retirement are currently about $50,000 per annum, and rising.
This environment is the most critical time many investors have ever faced and provides advisers with an opportunity to lead them through these difficult times by sticking to key investment principles and remaining focused on their clients’ ultimate financial goals and objectives.
Here are five practical tips for advisers to help guide their clients, particularly those either in retirement or nearing retirement.
Salary sacrifice: more than just saving tax
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Salary sacrificing into superannuation is not only one of the most tax-effective methods to save for retirement, it is also a very effective method of investing.
Salary sacrificing by default is dollar cost averaging, which is a prudent investment strategy in markets of extreme uncertainty and volatility. Dollar cost averaging ensures investors maximise the amount of units they are buying at a lower price while minimising the amount of units at a higher price.
This method ultimately averages out the entry point over a period of time and ensures investors are taking advantage of the opportunities that lie in the current market environment and doing so with a measured approach.
The strategy will further ensure that when markets eventually turn, investors will be holding more units, which may allow an accelerated turnaround.
Rebalancing: not just about managing risk
Regularly rebalancing an investor’s asset allocation back to their original risk profile is much more than just managing risk. With growth assets falling disproportionately to defensive assets, portfolios are automatically overweight asset classes such as fixed interest and cash.
By reducing the exposure to fixed interest and cash and increasing exposure to growth assets to realign within the investor’s risk profile, you are effectively buying more growth units at a lower price without needing to inject further capital.
Not only will this ensure that portfolios are more aligned to the appropriate risk profile, but having more exposure to growth assets at a lower purchase price may allow investors a greater opportunity to accelerate their capital growth as the markets rebound.
Transition to retirement while working full-time
The Government introduced the transition to retirement (TTR) condition of release from July 2005, enabling individuals who are over the age of 55 to take an income stream prior to ceasing work. This provision allows individuals to reduce their working hours by allowing them to commence non commutable income streams, effectively topping up their reduced cash flow.
However, if an investor wishes to continue working full-time this strategy may be used to assist in accelerating retirement savings tax effectively.
The strategy works by converting existing superannuation assets to the pension phase where earnings are subject to a zero per cent tax rate. The investor receives regular income payments that are tax free if they are age 60 or over.
If the investor is over 55 but less than 60 then the taxable component of the pension payment is subject to tax at the individual’s marginal tax rate. However, a 15 per cent tax offset is available on the taxable component.
At the same time as drawing the pension, the investor then salary sacrifices back into superannuation.
An important consideration is to ensure the investor has adequate components of cash and fixed interest to ensure pension payments are not being derived by the redemption of growth assets while the salary sacrifice contributions are building up in an appropriate weighted diversified portfolio.
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<td $550,500
<td $675,000
<td $873,500
<td $998,000
Use super to pay off debt: stop paying the mortgage
The fact that you no longer need to pay tax on super withdrawals once you turn 60 means that by doing things a little backwards, investors’ accumulated savings are going forwards. If investors are currently paying principal and interest on their mortgage, the idea is to switch to interest only payments for some or the entire loan. That way, the loan repayments will drop leaving more money that can be directed to superannuation.
The distinct difference in this approach is that salary sacrificing into superannuation is made with before tax dollars as opposed to making home loan repayments from after tax dollars. So the mortgage repayments drop $1,000 per month and the marginal tax rate is 41.5 per cent (including Medicare levy); the investor can salary sacrifice $1,709 each month and the take-home salary will still roughly be the same.
The money that usually goes towards the mortgage is only taxed at 15 per cent when it goes into super.
So, in the example above, instead of paying $709 to the Government in tax, they are only paying $256. That extra $453 is going straight into super. When the investor retires at 60 or over, they then pay off the mortgage from the super fund. With the new rules, investors can do this without paying any tax on the lump sum.
Age pension
Take advantage of decreased investment values and the increased allowable asset test to qualify for a part age pension. The amount of age pension retirees receive depends on their income and assets, which are assessed according to certain limits.
From September 20, 2007, the Government increased the allowable asset limit. This could now work in the investor’s favour.
Investors were potentially ineligible for the age pension under Centrelink’s income and assets test prior to the market downturn and if they fit into one of the categories below, and their assessable assets are lower than the recently increased allowable asset limits, they could become eligible for a part age pension.
Investors would also receive a pensioner concession card entitling them to cheaper medicines under the Pharmaceutical Benefits Scheme (PBS) and entitlement to a range of other concessions, such as for travel and utilities.
David Simon is an executive financial planner with Westpac Financial Planning.
