Tag Archives: Retirement
7 age pension traps to avoid
By Robert Wright /June 03,2022/
After a lifetime of hard work, it’s important you maximise your entitlements in retirement. So you need to structure your finances carefully to make sure you don’t lose your age pension. After all, you’ve earned it. Here are some common traps to be aware of.
Helping loved ones out
It’s only natural to want to help younger family members get a leg up financially. But if you’re nearing or already in retirement, you need to be careful how you go about this, as you could inadvertently affect your age pension entitlements.
If you’re thinking of giving money, the rules are you can gift $10,000 per financial year, and no more than $30,000 over a five-year period.
Any excess amount is counted as an asset, and deemed to earn income, for a full five-year period from the date of the gift.
Buying property
With house prices so high and home ownership getting out of reach for younger Australians, it’s no surprise that many parents want to help their kids get a foot on the property ladder. But with property you need to be extra careful in how you set things up.
Let’s look at an example. A couple aged 55 want to help their daughter buy her first home. Without taking advice they buy a 50% share of a house worth $500,000 so she can obtain a loan.
Fast forward 12 years and the house is now worth $1,000,000, of which their half share is $500,000. Their other financial assets are worth $700,000 so they believed they would be eligible for a part age pension. To their dismay they discover their equity in their daughter’s home has taken them over the assets test cut-off point, meaning they won’t be getting any age pension from the Government.
So what can they do? If they transfer their ownership share to their daughter the capital gains would be as high as $125,000 after the 50 per cent tax discount, on which capital gains tax could be as much as $50,000. And they would have to wait five years to qualify for the pension because Centrelink would treat the $500,000 as a deprived asset. The total value of the capital gains tax and the lost pension could be as much as $150,000!
If they’d been aware of the trap, or taken advice, they could have gone guarantor for their daughter, possibly putting up their own home as part security, and this would have had no effect on their future pension eligibility. Alternately, they could have transferred their ownership to their daughter at least 5 years before they became eligible for the age pension. They still would have had a capital gains tax liability, but at least the 5-year period for counting the gift would have elapsed by the time they applied for the age pension.
Borrowing against the family home to invest
If you’re already, or about to be, on the age pension, purchasing an investment property with the loan secured against your family home (primary residence) can be a trap.
Normally, the debt against an investment asset—for example, an investment property—is deducted from the asset value when working out whether you’re eligible for an age pension. But if the mortgage is secured against another asset like the family home, then the gross amount is counted. So this may affect your age pension as the full value of the investment is counted as an asset.
A way to avoid this could be to secure the asset against the investment instead.
Downsizing the family home
If you’re thinking of selling your family home and buying a smaller place, there’s an added incentive as the Government is allowing downsizer contributions into super for eligible Australians of up to $300,000.
But there could be a Centrelink sting in the tail, as you’re converting an exempt asset (the family home) into a counted asset (money left over) that could affect your eligibility for the age pension.
Let’s look at an example. Ray (70) and Gina (67) receive close to the full age pension, based on their assets and income.
They want to downsize their family home, which they could sell for $2.5 million. They’d prefer to buy an apartment closer to their kids for around $1.5 million.
If they go ahead, they’d have surplus assets of up to $1 million, which will either considerably reduce their age pension, or cut it off altogether.
By consulting their financial adviser, Ray and Gina could decide either to proceed as planned, or perhaps buy a more expensive replacement property and have less surplus capital, with less of an impact on their age pension.
And their adviser could help to invest the surplus capital to generate an income—for example, by making downsizer contributions into super and starting an account-based pension.
There’s plenty to think about if you’re looking at downsizing, so you might want to get some advice.
Leaving a bequest in your will
Many retired couples leave all their assets to each other in their wills if they pass away.
While this is perfectly understandable, it could cause grief to the surviving partner if their age pension is reduced or lost altogether. The asset cut-off points for singles and couples are quite different—$595,750 for a single person and $901,500 for a couple.
Let’s look at an example. Jack and Jenny have assessable assets of $740,000 and are getting around $11,800 a year in age pension payments. Jack dies suddenly and leaves all his assets to Jenny, taking her over the assets test limit for a single person and she loses the pension entirely.
Unfortunately, Jenny can’t get around this by passing the assets on to their children. If you’re a named as a beneficiary in someone’s will, and you gift it away to, say, your children, it’s still counted as part of your assets and subject to the income test for the next five years.
If Jack and Jenny had consulted a financial adviser, one solution could have been to leave specific assets to their children and bypass the surviving spouse altogether.
Starting a super income stream early
If you start a super income stream once you reach preservation age and before you reach age pension age—for example, as part of a transition to retirement strategy—it could affect your entitlements to Centrelink allowances like Jobseeker. So it’s important to get financial advice.
Advice can make all the difference in how you set up your super and pension arrangements in general. If you have a younger partner, one option could be moving assets into super as a non-concessional contribution for the spouse who is underage pension age.
The amount placed in super for the younger spouse is preserved until they meet a condition of release. This may work well if their condition of release is only a few years away but could be a concern if there’s more of an age gap.
Changing account-based pensions
If you’ve been receiving an account-based pension (ABP) for a while, you should be aware of a change made on 1 January 2015 which impacted how much income from the ABP is counted towards the age pension income test.
If you were in an existing ABP you were exempt from the new rules—but only for as long as you continued with the same provider.
So if you change providers you could inadvertently reduce your age pension entitlements.
A financial adviser can help work out the best option for your particular circumstances—the benefits of a new ABP or the higher age pension.
Setting up a family trust
If there’s a family trust or private company involved in your affairs, the rules are even more complex, so you’ll need expert advice before applying for the age pension.
Source: AMP
Roughly 500,000 Australians plan to retire in the next 5 years.
By Robert Wright /June 03,2022/
According to the ABS, some half a million people intend to retire within 5 years.
While many Australians will remain working until they can access their superannuation savings and/or the Age Pension, some 32% of people choose to retire beforehand due to health reasons, retrenchment, or a lack of suitable employment opportunities.
No one can predict the future. Unforeseen circumstances can strike at any time, so it’s best start your retirement plans early while you are young, healthy and earning an income.
A well-structured retirement plan can guide you towards your dream retirement while giving you a sense of security and confidence about the years ahead.
An effective retirement plan will outline how you can make the most of your money and investments today, so that you can afford the retirement lifestyle you imagine in the future.
As retirement planning specialists, we can show you how to make your retirement goals a reality. Even if you feel you have left it a little too late, it’s never too late to get started.
For further information about how we can tailor an effective retirement plan for you, don’t hesitate to contact us today.
Volatility Bites: How Retirees can manage Jumpy Markets
By Robert Wright /May 25,2022/
The 2020 COVID-19 share sell off and recent equity market volatility shows just how quickly share prices can move.
Volatility can have different meanings for different investors, those with a long-term horizon can be less concerned, knowing they have time on their side. But what about retirees? How can they manage the mental challenge of watching their hard-earned capital shrink before their eyes? And do it without becoming so conservative they have to downgrade their lifestyle?
It’s a pertinent question right now because higher inflation, rising interest rates and the Russian invasion of Ukraine are making markets nervous.
Perpetual Private’s Associate Partner, Daniel Elias says volatility is more tangible for retirees. “The numbers on your portfolio spreadsheet aren’t theoretical – they pay your bills. Because that capital is so important, the challenge for retirees is reining in the fear and anxiety that can lead them to irrational decisions.”
In the years around retirement, the risk that a market downturn occurs right before you retire, or soon after, is called sequencing risk. To manage sequencing risk, having a diversified portfolio of assets can help dampen the effect on your portfolio when markets fall.
That’s when things go V-shaped
When COVID-19 lockdowns first hit in March 2020, markets fell, quickly and sharply. As people stayed at home and started upgrading their Netflix accounts, economists and analysts were arguing about the shape of a potential recovery.
Would markets fall even further, then bump along the bottom before gradually rising again (U-shaped)? Or stay down for years (the dreaded L-shape)?
Ultimately, we surfed a dramatic V-shaped recovery. Writing in January 2022, Mano Mohankumar from superannuation researcher Chant West said, “Since the market low-point at March 2020, growth funds have surged an astonishing 31%, which now sees them sitting 16% higher than the pre-COVID-19 crisis peak.”
Investors who looked through the dramatic market falls associated with COVID-19 were rewarded for sticking to their strategy. But many who reacted emotionally paid a price.
In May 2021, the McKell Institute estimate that those who redeemed via the Early Release of Super scheme at the nadir of the COVID-19 crisis gave up nearly five billion dollars in lost returns during the markets’ rebound.
Remaining rational in times of crisis is a difficult challenge for all investors, but ensuring you listen to the financial advice and don’t react with emotions is the key to not making the wrong decision during times of market stress.
Ask yourself – how much risk is right for you?
The key to investment selection and portfolio management is optimising ‘risk efficiency’ by choosing the right mix of assets to give you the maximum return for the level of risk you’re able to absorb.
Before making any changes to your investment strategy, ask yourself, “Am I still comfortable with the level of risk I originally implemented in my portfolio.”
Understanding your risk tolerance will help you find the right mix of assets that will have enough risk to grow your portfolio, but not so much that you can’t sleep at night or you are led to sell at the wrong time.
As you approach retirement, you have fewer years of earnings to save and invest and may need to draw down on your savings. This shorter time horizon limits the ability to overcome a market downturn. As a result, the amount of investment risk in your portfolio matters.
Diversification – your best defence
The other great weapon retirees can wield against market volatility is diversification. Whilst the volatility in January and February 2022 was felt in the majority of retiree portfolios, losses would have been lower than the broader equity market because many retiree portfolios are diversified across other asset classes including bonds, credit assets, property and increasingly, alternative assets.
Diversification helps to smooth returns across different economic conditions. This is because of the low or negative correlation between certain asset classes, so if one asset class falls in value in response to an economic or geopolitical event, another might rise.
Bonds can also play an excellent role in protection against equity market risk in times of market volatility and help to minimise sequencing risk.
There are alternatives
In times of ultra-low interest rates and share market volatility, alternative assets can add another source of income and an additional layer of diversification to an investor’s portfolio.
Alternatives include things like private equity, venture capital, opportunistic property and private debt. They can add returns to clients’ portfolios but must be considered in context of each retiree’s overall investment goals, portfolio size, time horizon and their appetite and tolerance for risk.
Investors must clearly understand the risks associated with investing in alternative assets as they can have long lock up periods, and are less liquid than more traditional assets, meaning they can’t be sold as quickly and converted into cash.
Building a resilient portfolio
Volatility will persist while the world adjusts to a changing economic and geopolitical order. That could mean a wider range of returns – but not necessarily a poorer real-life outcome if you stick to a robust, diversified strategy that’s attuned to your needs.
Remaining diversified across asset classes can help ensure you have the optimal blend of assets in your portfolio to weather a variety of market conditions. When it comes to ensuring you don’t let your emotions influence your investment decisions, your financial adviser can really help.
Source: Perpetual
Constructing a retirement portfolio in a low return world
By Robert Wright /February 18,2022/
Portfolio construction is a much-used term that can be misunderstood. Fundamentally, the term portfolio construction refers to the process of selecting investments to create the optimal balance of risk and return.
By mixing different types of investments and different asset classes, portfolios can be built in a way that maximises the return for any given level of risk.
This concept of risk is fundamental to portfolio construction. The key to effective portfolio construction is understanding that each individual experiences risk differently and investment needs change dramatically as people’s priorities change over the course of a lifetime.
Risk tolerance
Depending on what stage of life they are at, individual investors can have quite different goals.
An investor early in their career can afford to seek higher returns from their investment portfolio by taking a higher level of risk because they have more time to make back any downturns in markets.
They also have less need for income from their investments than someone approaching or in retirement and can weight their portfolio towards growth assets.
A younger investor can be less concerned about inflation than a retiree because they can rely on wages growth that can maintain their purchasing power. They can also afford to lock up investments for a longer period without worrying about liquidity because they have time before they need to draw down on their assets.
In contrast, retirees tend to be more concerned about capital preservation because they need to draw on their asset pool throughout their retirement.
As they are no longer earning income from work, they need to draw income from their portfolio. This means they should consider weighting their portfolios towards income-generating assets.
Any increase in inflation erodes a retiree’s purchasing power as it costs more to maintain standard of living which means their capital can be eroded faster than planned.
And liquidity is critical for a retiree as assets may need to be sold quickly – for example if there is a medical emergency – without punitive valuations.
The concept of sequencing risk is also a critical difference between early and late-stage investors.
Sequencing risk
Sequencing risk refers to the risk of being forced to sell investments after a fall in valuations. A younger investor can typically ride out market volatility and even buy more assets when valuations are low.
However, late career investors and retirees who are forced to sell assets at low prices to fund their lifestyles have no way of regaining the lost value. A sensible portfolio construction process can protect against this.
Hedging risk
A question that often comes up is the role of downside protection in portfolio construction. The answer is different depending on where an investor is at in their investing journey.
Take the example of a pre-retiree and a younger investor with portfolios split equally between equities and bonds going into the global financial crisis (GFC) – with and without downside protection using options strategies.
Without downside protection, the retiree would have seen a pullback in the value of their assets of about 25 per cent and, because they were drawing down on their assets to live their life, they would not have been able to fully participate in the subsequent recovery.
Had they used downside protection on their portfolio, they would have been back on track by 10 years later.
The same is not true of the same strategy deployed by a younger investor. Without downside protection, young investors just keep buying into the market through a downturn and continue to accumulate assets.
But with downside protection – which comes at a cost – they see a drag on their returns, lowering their ultimate savings. It’s a reminder of the difference between younger and older investors.
Human beings also have the potential to make mistakes in their investing lives. If a retiree investor facing the same kind of GFC drawdowns suddenly became risk-averse and shifted their portfolio to 30:70 equities and bonds, this would be an understandable and apparently rational decision to preserve assets.
But markets recover. If that retiree waits until the storm passes and takes three to five years to switch back their allocation to 50:50, they would be 30 per cent worse off than if they did nothing at all.
Asset allocation
So, what assets should retirees look for?
In our view, the key is to seek out desirable risk attributes and not simply take the approach of investing by asset class.
In Australian equities for example, franking credits offer a good income stream for retirees by refunding the tax paid by the underlying companies. It should also be noted, however, that in seeking a higher exposure to Australian equities in pursuit of franking credits, a portfolio will acquire other concentrations of risk, for example: exposure to China. Good portfolio construction should consider and diversify away these concentrations.
In direct assets, infrastructure offers good opportunities for retirees. Many infrastructure assets earn a return on an availability basis regardless of actual usage or economic conditions, providing a stable income. The key consideration for direct assets is liquidity, as holding large allocations of illiquid assets could mean having to disproportionately sell down liquid assets, like equities, at an inopportune time if larger sums of cash are needed for, say, a medical emergency.
For bonds, the traditional defensive characteristics may not be available in a world of near zero interest rates and the potential of rising inflation.
In the last 30-40 years we have seen a terrific run in markets, particularly with bond rates coming down from as high as 16.5 per cent in the case of 10 year Australian government bond yields almost 40 years ago to near zero now. The performance was further buoyed by lower tax rates, falling tariffs and the rise of globalisation.
The corollary of this is that throughout those 40 years, forward return expectations have been declining.
In fact, a fund with a traditional asset allocation split 60:40 between equities and bonds is near its highest ever valuation level.
We believe this means return expectations from investment portfolios should be expected to be lower going forward until interest rates normalise.
Inflation is also a looming threat to portfolios. US annual consumer price inflation pushed up beyond 6 per cent in October of 2021 and there is a risk that price pressures associated with deglobalisation and decarbonisation defy the widely held ‘transitory’ thesis and stick around.
Goals-based investing
Given lower expected returns and higher inflation, what’s the right portfolio response?
Doing nothing is one approach – simply accept that returns are going to be lower.
Another approach is to increase risk – adding riskier, more leveraged asset classes will improve the probability of getting a return but also increase the probability of losing money.
A third approach is to lower your expectations. This means not changing how portfolios are constructed but accepting the likelihood of lower returns and perhaps adjusting things elsewhere in your life accordingly. In our view, this isn’t of much use or comfort however to today’s pre-retirees and retirees.
And the final – and more important – approach is to adjust strategy to those areas most likely to achieve objectives. This could include taking a goals-based approach to investing.
For example, a retiree could decide that rather than taking a traditional asset allocation approach to portfolio construction, they instead want to take on the goal of protecting and maintaining their standard of living in retirement. That goal might be measured by providing returns equal to the consumer price index plus 3.5 per cent as an example.
By focusing on the desired outcomes rather than simply considering traditional asset class allocations, investors can consider including alternative investments and strategies that may not be available under a traditional approach.
Source: AMP Capital