Allocated pensions first became popular in the early nineties and many of these will be a decade old soon. Unfortunately this can mean trouble for those who hold them. AM Corp’sPhil Le Grecaexamines the dip in pension balances and how to deal with it as these products reach this milestone.
Allocated pensions are now highly popular investment vehicles in retirement as the product meets the desire of retirees to have both an income stream and access to capital. A key feature is the ability of the pensioner to control the cashflow, to some extent, by having minimum and maximum drawdown levels that change each year.
In the early years of most allocated pensions, the account balance actually grows as most retirees take the minimum drawdown and this level is below the amount of earnings on the account balance each year.
If we express the drawdown levels as percentages of the account balance we can see that for the balance to be maintained the earning rate on the investments for the allocated pension must equal the rate of drawing. (Table 1)
What becomes obvious from this is that by age 75 the investment return on an allocated pension must be over nine per cent per annum to not decrease the balance and over 11 per cent per annum by age 80. The question is how achievable are these returns over a long time frame.
Table 2 shows an allocated pensioner with an $144,000 opening balance earning eight per cent per annum who takes the minimum pension ($9,180 per annum).
Even though the pension level increases each year they will still see a steady increase in their account balance until age 74 with a level of $151,305.
However, from age 72 the minimum pension is drawing more income from the pension than is being added through earnings. Adviser’s clients will start to see their pension fund going backwards.
This is not just an academic discussion. Many of the first allocated pensions commenced around 1992 and are now, on average, in the eight to 10 year period which represents the peak of the account growth. What these pensioners can look forward to is receiving more pension payments than they want and an ever continuing slide in account balances.
What strategies can advisers look at to help clients understand the slide in account balances? And what can the pensioner do with the surplus income being paid out of the tax-free superannuation environment?
Gently remind clients that this is exactly what the allocated pension was established to achieve. As shown in the chart, it takes 20 years to consume one third of the allocated pension and earnings – at this stage your client is aged 85 and still has over $100,000 to provide their pension.
Be aware of clients making lump sum withdrawals as the minimum pension is not recalculated and a higher pension could be paid out of the fund for many months.
If possible make lump sum withdrawals in the latter part of the financial year so when the minimum is next calculated the withdrawal is taken into account.
If you have had a long battle to get clients to embrace growth investments, then this might be the best time to point out the earnings potential of growth over income assets.
They will now have surplus income and what they need to be aware of is that it is surplus money and encourage them not to spend but re-invest it.
This is best done by blending income streams and savings plans by running two accounts
Table 2 has the client earning surplus income in the first eight years. From age 65 to 80, an extra $47,102 is paid in pension payments which is available for investment. Unfortunately there is no way to place this money back into the superannuation system.
Normally the pension is paid into the client’s bank account and then spent.
Instead we suggest establishing a regular savings plan funded from the regular surplus amount in each pension payment. This excess could be reinvested into an equities or a high growth style fund.
Of course if your client is comfortable with the concept, this regular surplus can even be used to cover a geared investment strategy.
It is worth taking a positive outlook on this issue and start reminding your clients that have been in payment prior to 1994. While it would have been clearly explained initially to your clients that the account balance would decline and eventually run out, maybe they need to hear that the money has not disappeared, its just been paid to them!!
Philip La Greca is the strategic services national manager with AM Corporation.
Table 1 – Rate of drawing down allocated pensions:
Age 65 70 75 80 85
Min % 6.4 7.4 8.8 11.0 14.1
Max % 12.3 15.2 23.3 100.0 100.0
Table 2 – What happens to $144,000:
Age Opening Balance Selected Pension Account Earnings
65 $144,000 $9,180 $11,127
66 $145,947 $9,540 $11,267
67 $147,674 $9,920 $11,389
68 $149,143 $10,360 $11,488
69 $150,271 $10,740 $11,562
70 $151,093 $11,200 $11,608
71 $151,501 $11,570 $11,625
72 $151,556 $12,030 $11,609
73 $151,135 $12,390 $11,560
74 $150,305 $12,850 $11,474
75 $148,929 $13,180 $11,350
80 $134,148 $14,742 $10,101
85 $105,855 $14,909 $ 7,830
Table 3
Age Pension Payment (Min.) Surplus
70 $11,200 $2,020
75 $13,180 $4,000
80 $14,742 $5,562
