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NEWS - PLANNING
How to be rich in retirement
9/13/2004
Nobody wants to retire poor, but saving as much superannuation as possible does not guarantee a comfortable lifestyle when you eventually trade in your briefcase for a deckchair.
It's equally important to decide how to invest your retirement savings. Should you take super as a lump sum and spend it with gay abandon before your dotage? A yacht or Grange Hermitage collection, after all, are worthwhile rewards for a long working life. Or is it better to be responsible and buy a special product with tax concessions to maximise your income, helping create a nation of self-funded retirees?
The question is a no-brainer for most financial advisers. Tax-effective products or retirement income streams help stretch retirement capital as long as possible and don't have to compromise your way of life.
But this is the only simple choice in retirement planning. Once it's done, you must choose an income stream and decide on any number of strategies to maximise its benefits.
Kate Anderson, technical services manager at Mariner Financial, says dozens of retirement strategies need to be considered before quitting work.
"I've accumulated all my superannuation, I'm 65, and I have to live off that money for the rest of my life. How do I structure it so I can maintain the lifestyle I had when I was still working?" asks Anderson.
From September 20, there will be a new product to add to your list of options. It's called a term-allocated pension (TAP), or growth pension, and will be sold by major financial institutions.
Retirees who want an income stream will get to choose between:
- Term-allocated pensions
- Allocated pensions
- Term-certain annuities (that is, annuities that pay out over a set period of time)
- Lifetime annuities (which continue to pay out no matter how long you live)
It's difficult to estimate the income each of these might bring because it's determined by complex government rules and actuarial calculations.
But figures compiled by AMP for the Weekend AFR give an inkling of what to expect.
AMP estimates that a 65-year-old single male home owner with $250,000 in super and no other assets will get income of $29,542 in the first year of a 17-year term allocated pension (see accompanying table for details of how income varies year by year, increasing with time).
The same amount invested in a traditional allocated pension would give him $20,578 to $33,673.
Why is there a range for the traditional pension? This is where it starts to get a bit tricky.
Term-allocated pensions, as the name suggests, run for a set term. A 17-year TAP runs for exactly 17 years. At the end of the 17 years there is no capital left - these products are designed to leave no assets at the end of the set term.
Retirees cannot choose how to run down the capital, they instead receive an annual payment based on their life expectancy and other factors.
Allocated pensions are more flexible than TAPs. You can vary your annual income, as long as it falls between minimum and maximum rates set by the government.
You can also withdraw lump sums for something like a new car. And the capital in an allocated pension lasts until it runs out - a real bonus for the spendthrift.
If, for example, AMP's hypothetical investor drew the maximum income from his allocated pension every year, it would run out after 16 years, or one year shy of a TAP.
But if he only drew the minimum income, he would have $193,608 left after 17 years.
This begs the question why a sensible cost-conscious adult would choose a TAP over an allocated pension.
There are two very important reasons: you might want to claim the pension reasonable benefit limit (RBL) or social security benefits like the age pension.
RBLs place a cap on the tax benefits that a superannuation investor can receive in his or her lifetime.
If neither are important to you, an allocated pension is likely to prove more attractive.
You might qualify for at least a part-age pension if you buy a TAPs because only 50 per cent of its original value is counted in the aged pension assets test.
If you instead buy an allocated pension, 100 per cent of the amount you invest will be counted in the assets test.
The TAP exemption is enticing but don't forget you also have to pass the age pension income test before you get any money from the government.
AMP's John Perri says the way TAPs work might also mean that you fail the income test in the latter years of the investment.
"People can use these new products to manage asset test issues and get that extra income in those early years. But because you have to return all the capital, the income payments start to get much higher in the back end," Perri says.
But the lower age pension in itself doesn't mean that your overall income is any less. It might be offset by the higher TAP payments.
Perri also gives an interesting example of a how a TAP can help someone who has an RBL problem. The RBL cap is doubled if you take your superannuation as an income stream (other than an allocated pension), rather than a lump sum.
The pension RBL for the 2004/2005 financial year is $1,238,440, versus a lump sum RBL of $619,223.
"If you had $1million, you might currently choose to start two allocated pensions. One up to the lump sum RBL $619,000 and one for the excess," Perri says.
"The one up to the lower RBL has some favourable taxation rules attached to it - you get a 15 per cent rebate.
"The other doesn't get the 15per cent rebate and if it is paid as a lump sum to non-dependent adult children when you die, it is taxed at excess benefit rates."
But, he says, if you split the $1million between an allocated pension and a TAP, both get a 15per cent rebate. And when you die there is no extra tax on either income stream.
You could also invest some in a term-allocated pension to get at least a part-aged pension or social security benefits like the health card, and then invest the rest in an allocated pension to retain greater control over your assets.
It's an old strategy modified for TAPs. Retirees in the past used annuities to get around similar problems and will still have that option when TAPs are launched on September 20. But those with enough capital to risk on the sharemarket might find TAPs more attractive than an annuity.
This is because TAPs can invest in assets such as shares. Annuities, on the other hand, rely on fixed-interest assets which tend to produce lower returns than stocks.
The lifestyle of AMP's 65-year old hypothetical investor, for example, would not be as good if he bought a 17-year fixed-term annuity instead of a TAP.
In the final few years of the investment, the difference in his annual income could be as much as $5000.
But income isn't everything. Some retirees, particularly those with limited assets, might still opt for the security of an annuity, according to ipac head of technical services Colin Lewis.
"I still see annuities being attractive for some people. Given that a lot of elderly people are conservative by nature, I think capital-guaranteed products still have a place," Lewis says.
Both lifetime annuities and term-certain annuities are capital guaranteed. But the returns from a TAP will vary with the vagaries of financial markets.
Reproduced from the Australian Financial Review - 13 Sep 2004
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