Brad is 65 years old and has accumulated superannuation benefits totalling $1 million, which is all post-June 1983 component.
Brad retires and needs an income of $50,000 a year to live on. If he took his benefits as an allocated pension, the pension would only have a rebatable proportion of 0.5622. His minimum pension in year one would be $60,241 after rebates, while he would pay tax of $11,517, leaving him with net income of $48,724. That means he would need to draw a pension slightly higher than the minimum.
If, on the other hand, he used $500,000 to start a complying life expectancy pension and the remaining $500,000 to start an allocated pension from his do-it-yourself (DIY) fund, he would be assessed against the pension reasonable benefit limit (RBL) and therefore these pensions would both be fully rebatable.
So if Brad had the same pension income of $60,241, he would only pay tax of $7,561 (a saving of nearly $4,000 a year), leaving him a net income of $52,680, which more than meets his requirements.
While this is a significant benefit, it pales in comparison to what would happen if Brad were to die.
Brad is married to Janet and they have no children. We’ll assume that 12 months after establishing his retirement income streams, he dies and the value of his benefits have not changed.
If Brad had used the allocated pension option, Janet would now be facing a tax bill on the non-rebatable proportion of Brad’s savings of $212,335. In the case of the death benefit from the combination of complying and allocated pensions, there would be no excess benefits tax payable. So Janet would be more than $200,000 better off.
Now you are probably saying that all of this could have been easily achieved using a combination of a life office complying annuity and an allocated pension, and that is true. However, what happens in 15 years time when Brad’s complying pension stops?
In a DIY fund, if the underlying investments have outperformed the actuarial assumptions, there will be money left over. This money would form a reserve of the fund and could be allocated to Brad’s allocated pension account to supplement his allocated pension payments.
Depending on the amount in the reserve, the transfer may need to take place over a number of years to avoid incurring a surcharge liability. However, this potential for upside is very important to the Australian investor’s psyche.
It is also a very big decision to commit $500,000 to one, or even two separate life insurance companies for a period of 15 years or more. Particularly given the current adverse publicity and share price concerns being experienced by a number of insurance companies.
The benefit of a properly structured DIY fund is that you are not tied to one service provider or investment manager. You would generally be diversified across a range of investment managers and direct investments.
You are also able to change providers with relative ease, you can replace administrators, auditors, actuaries, fund managers, even trustees without having to commute and roll over benefits, which can have huge adverse RBL and tax consequences.
A correctly structured fund also allows you to pay a range of benefits, including lump sums, allocated pensions, and defined benefit pensions (both lifetime and fixed term). It is this level of flexibility that helps to ensure that your fund can be adapted to your changing life circumstances, as well as the changing regulatory environment.
The example above considers a single member in a fund. But one of the other significant benefits of your own DIY fund is the ability to bring in other family members, helping to reduce the costs per member. It also adds a great deal of estate planning flexibility, particularly if your fund is able to pay lifetime pensions.
However, a word of caution. It is absolutely essential that the fund be run properly. Failing to do so can result in a fund losing up to 47 per cent of its income and assets. In addition to this there are also substantial fines that can be levied against trustees.
When you consider that in a recent compliance review of self-managed super funds (SMSFs), the tax office discovered that 90 per cent of pension funds they reviewed had deeds which only provided for lump sum payments, there is obviously substantial room for improvement in the compliance processes of SMSFs.
Steve Davis isPerpetual PrivateClients national manager forfinancial planning.
