Bryan Ashenden considers transition to retirement strategies in a new contribution cap environment.
The fallout from the crisis in financial markets will cause many clients to revisit their pre-retirement strategies to ensure they have sufficient savings for their retirement years.
The closer clients are to retirement — and therefore the shorter the timeframe until retirement looms — the bigger the potential issue for them.
Let’s take a look into the effect of the new contribution cap arrangements on transition to retirement (TTR) strategies to see how much of a difference it makes.
TTR strategies
Since the introduction of the TTR opportunity from July 2005, it has become an increasingly popular strategy to be employed for clients from age 55.
There are numerous examples that have been published that show how a TTR strategy can add additional savings to a client’s retirement portfolio over a number of years without the need to change the underlying investments.
Clients who have employed TTR strategies in recent years are likely to be better off than people who haven’t used such a strategy — even in falling markets.
This is because of the tax benefits offered by superannuation (particularly in pension phase) combined with the tax benefits of salary sacrificing.
This is illustrated by the example on page 23, which uses the higher concessional contribution caps that were in place before July 1, 2009. The case study illustrates a number of important concepts, some of which are relevant in the new concessional cap environment:
- Neil only looked to salary sacrifice $38,000 per annum. This is well under the old concessional caps that he would have had available (being up to $100,000 per annum until June 30, 2012, and $50,000 per annum thereafter, at the relevant indexed amount).
- In a falling market, you still lose money in a TTR strategy — but the impact is not as great as it would have been if you hadn’t implemented the strategy at all.
- In the falling market example, one important difference is that the ongoing review of the TTR account balance showed that at ages 58, 61 and 65, the 10 per cent maximum pension payments from the TTR pension would not be sufficient to provide the level of pension Neil required to achieve his objectives. As a result, at the beginning of each of those years, any accumulated super that Neil had (from his salary sacrificing and superannuation guarantee contributions) was converted into a new TTR pension (or combined with his existing TTR pension). This could have also been done in the positive market scenario to further improve the result.
- The example also shows the benefits of the right structure — with his pension payments becoming tax free from age 60, the tax differential between personal income tax rates and those applying to salary sacrificed contribution and the tax-free status of pension accounts, Neil’s wealth is growing in an environment of falling markets.
Impact of the new caps
As a result of the changes in concessional caps from July 1, 2009, how effective can a TTR strategy now be?
The biggest benefit from TTR strategies is where a client can maximise the level of salary sacrifice and offset it with the appropriate level of pension income from the TTR income stream. Under the old caps, this was potentially sacrificing up to $100,000 per annum.
Now only half this amount can be sacrificed, and from July 1, 2012, it will only be $25,000 per annum (or the relevant indexed cap at that time).
So how much of a difference does this make? Continuing the example above, if Neil’s annual salary sacrifice was reduced from $38,000 per annum to $25,000 per annum, his results over the next 10 years would be as shown in graph 1 (assuming the 7 per cent pre-tax return on investments):
The strategy adds just over $100,000 to his retirement savings over the next 10 years.
For clients considering using a TTR strategy, they still have benefits to add despite changes to contribution caps.
And the impact of a strategy that can make this level of difference without changing underlying investment options should not be overlooked when clients have suffered falls in their retirement savings.
Finally, it is always important to remember that planning to use a TTR strategy should not start when a client reaches their preservation age.
It should be considered as early as 10 years before preservation age, so as to employ strategies to help maximise the amount in super by the time the client can utilise the benefits of a TTR income stream.
Action items
The changes to the concessional contribution caps (and flow-on impacts to non-concessional contributions) have resulted in a number of opportunities for you to speak with your clients — not only about the impact the changes have, but also to further demonstrate the value of the advice that you provide them on an ongoing basis.
These include the examples contained in Table 1.
Bryan Ashenden is senior manager, technical and advocacy at BT Financial Group.
