A new home downsize incentive could reduce your age pension
A NEW incentive to tempt senior Australians to downsize their home could cost them their entire age pension. The dressed-up superannuation tax break, promoted by the Federal Government as helping housing affordability, risks leaving many retirees worse off financially and will mostly benefit wealthy people.
From July this year, people aged over 65 can pump up to $300,000 of the proceeds of selling their home into super without affecting other super contribution limits. However, the proceeds get counted in their pension assets test — while the family home is exempt — and could dramatically reduce their pension.
Single Pensioner Example
For example, a single pensioner homeowner currently receives the full $906.70 a fortnight if their assets are below $253,750. Assets above that reduce pension payments until it is cancelled when assets reach $552,000.
Financial strategist Theo Marinis said the super downsizing rules were “like a lot of changes they make — they sound good in principle but when you look at the devil in the detail in practice, it’s not as good”.
“Quite often they’re foolish changes, and this is one. It’s like everything they’ve done in the last 10 years — half-cocked,” he said.
80% retirees receive part or full pension
Australian Bureau of Statistics data shows almost 80 percent of retirees receive a full or part age pension. National Seniors chief advocate Ian Henschke said pensioners looking to downsize should seek professional advice or at least speak with a Centrelink Financial Information Service officer.
He said the changes would mostly benefit those with enough wealth to make them ineligible for a pension.
“A full pensioner or part pensioner, depending on their Super-tax break could cost retirees circumstance, could have their age pension reduced or cut completely.”
National Seniors is calling for up to $250,000 of downsizing proceeds to be exempt from Centrelink means testing.
Others have made similar calls, but seniors group COTA Australia’s chief executive officer, Ian Yates, said this could distort the market. He said the downsizing rules would “add another option” for retirees. “It’s going to suit some people but will be irrelevant to other people’s decisions, and
some people will downsize anyway,” he said.
Planning for Prosperity senior adviser Bob Budreika said transaction costs such as stamp duties and real estate agent fees could often make switching homes not worth the money or effort. “And I don’t know anyone moving home who says ‘I can’t believe it — all the furniture fits perfectly’,” he said.
This article in the News’ Financial selection suggests people are maybe living in ‘Pixie Land’ when it comes to planning their superannuation. The article reports new research by Apia Insurance has found that three-quarters of people aged over 55 say they have been financially preparing for retirement. However, Planning for Prosperity senior financial adviser Bob Budreika said statistics showed that only 17 per cent of Australians were retirement-ready and “the rest are living in pixie land”.
“Until something serious happens like they run out of money or their investments are lost in a market downturn, there’s utter complacency,” he said.
Mr Budreika said many people believed they could get by on the age pension, but for an average couple, the pension could be paying just half or one-third of their pre-retirement income.
“Be realistic about what your living expenses will be — don’t just assume,” he said. “Make sure in your calculations that you have a buffer for unexpected things.”
Mr Budreika said there was a good chance that at least one member of a retiree couple would live beyond 90, so pre-retirees should be thinking about diversification, risk and longevity.
Bringing understanding to your investments
It surprises me how much faith people have with their superannuation investments, especially those with Industry Funds. Much of this is predicated on fairly decent average returns over the last 10, 15 and 20 years and reflects the growth in prosperity of much of the developed world. Generally, comparable retail investment funds have achieved similar returns though it’s almost impossible to do a fair comparison because of the diverse range of underlying investments that can be used by an adviser to create a portfolio. No two funds are exactly the same.
Investment Results Complacency
Because of excellent long-term average returns, there’s now a great deal of complacency that investment results will continue as they have in the past especially since many superannuation portfolios have 65% or more allocated to Australian and International share markets. While it’s true that investment risk actually reduces over longer periods such as ten years or more this doesn’t mean that we can rest easy. A good example of this is when preparing to retire and there’s a distinct change in the investment philosophy from accumulating savings through working life to using savings to fund lifestyle costs. This is commonly referred to as the draw down phase. So, if share markets fell 20% (which is not considered to be a large fall) and you’re relying on your capital to meet living expenses, this can have a dire impact on the longevity of your retirement savings. This is a tricky situation and it’s for this reason that those near retirement, as well as those who are retired, should take a greater interest in their investment accounts so they are informed and in the position to make appropriate decisions.
Please remember this – just because an investment has done well in the past is no indicator of future returns. Please read this again.
If this is the case how do you know what to do?
First, know what your attitude to risk is. This means identifying your tolerance to negative returns, especially if you are retired and relying on your investments. An effective way to do this is by completing a risk profile questionnaire.
The results of the risk profile questionnaire will assist in developing your investment asset allocation, which in simple terms, is the proportion of your savings invested between growth and defensive type investments. We can not stress enough that this step and the first step are the most important. Defining your allocation to the asset classes will provide around 80% of the predictable return of your portfolio. If you’re relying on your investments to provide retirement income then this is a separate and very important consideration in creating a well-diversified investment portfolio.
The most effective way to diversify your investment pool is to use all of the major asset classes. No one asset class performs the best all the time. For example, over the last year it was Australian shares, over the last 2 years it was listed property, International shares for the last 5 years and surprising to many, fixed interest securities have out performed all asset classes over the last 10 years.
Be disciplined by reviewing and rebalancing your investment portfolio annually so that the asset allocation (step 2) matches your initial risk profile. The key point here is discipline. I’m sure we all know plenty of life examples where those who are disciplined in what they do achieve remarkable results. Investing is no different.
With 30 June fast approaching, time is running out to make any last super contributions before a raft of important rule changes from 1 July 2017.
From 1 July 2017, the concessional (deductible) contributions cap is reducing to $25,000 for everyone. Previously, it was $35,000 for people 49 years and older at the end of the previous financial year and $30,000 for everyone else. These caps include Super Guarantee employer contributions and salary sacrifice. If you are self-employed and looking to maximise your contributions for this financial year, so it’s important to check what concessional contributions have been made to all your super funds from 1 July 2016 to ensure you are not in excess.
Maximising the non-concessional bring forward rules
Non-concessional contributions are made after-tax where no deduction is made. Under the current rules, these contributions can be made at $180,000 per year or 3 years at once brought forward to $540,000.
From 1 July 2017, the annual non-concessional contribution cap will be reduced from $180,000 to $100,000 per year. This will remain available to individuals aged between 65 and 74 years old if they meet the work test.
If you have triggered the bring-forward period in 2015–16 or 2016–17 but you have not fully used your bring-forward amount before 1 July 2017, transitional arrangements will apply. This means that the maximum amount of bring-forward available will reflect the reduced annual contribution caps. Note that your maximum bring-forward amount in 2016–17 has not changed. It is still $540,000 if you have not triggered the bring-forward rules in 2014–15 or 2015–16. Besides any large lumps sum non-concessional contributions, it is important to take into account any smaller contributions that may have been made over the past 3 years (eg. To qualify the Government co-contribution), which will form part of the cap.
From 1 July 2017, your non-concessional cap will be nil for a financial year if you have a total superannuation balance greater than or equal to $1.6 million. In this case, if you make non-concessional contributions in that year, they will be excess non-concessional contributions.
Those looking to qualify for the Government Co-contribution should look to make a non-concessional contribution before 30 June 3017.
To receive the maximum co-contribution of $500 you must contribute $1,000 of after-tax money and earn less than $36,021 during the 2016/17 financial year. If your income is greater than $36,021, the maximum entitlement will gradually reduce to zero at $51,021 per year. Age and work tests apply to those between age 65 and 71.
Minimum account based pension payments
For those people with Self Managed Super funds who are drawing an account based pension, remember to make the minimum age-based pension payment before 30 June. Failure to do so may mean losing the tax-free earning status within the fund.
We strongly recommend seeking advice before making any ad-hoc contributions to super to ensure it is appropriate to your situation.
Bob Budrieka has again been quoted as a subject matter expert in a recent Daily Telegraph article highlighting how improper use of your super fund can result in a big fine or even a prison sentence.
Large penalties for misuse of SMSF
Anthony Kean reports that “SELF-managed super funds are being illegally used to pay household bills, lend money to family members and even buy groceries.” Those who break strict super rules are risking hefty tax penalties: $10,000-plus fines and potentially jail.
Planning for Prosperity senior adviser Bob Budreika said it was common for people with several online banking accounts to accidentally use their SMSF account for personal spending, or deliberately withdraw money without realising the potential penalties.
“They see it like a business and think ‘I will pull the money out and just pay it back later’,” he said.
“Many people treat the legislation with disrespect.”
WHAT YOU CAN’T DO WITH A SMSF
Pay personal expenses
Lend money to yourself or a relative
Buy a holiday home
Use an SMSF as bank account for business or household transactions
Buy real estate from yourself or a relative
Rent a property to a relative
Buy art or other collectibles to display in your home
Withdraw money before retirement
The ATO and SMSF
The ATO are very clear on your responsibilities as an SMSF operator. Read more here
Here is an informational video from the Australian Tax Office on this subject:
Is $1 Million enough Super ?
In a recent review meeting, our client raised the topic of how much money might be needed for a comfortable retirement. He bandied the figure of $1m as perhaps being the ideal amount of capital required. This seems to be a common belief and it’s easy to understand why because $1m earning 5%, would generate $50,000 of income per year. Of course, this is a generalisation and doesn’t take into consideration:
The earning rate may not average 5%
The 5% rate doesn’t allow for an increase in the income payments in future years.
Are you prepared to use your capital and if so, how long will it last?
The bad news is that the majority of baby boomers won’t have enough saved to enjoy a financially secure and independent retirement. While there are effective strategies to bridge the gap, ultimately there needs be a commitment and discipline to saving and investing.
Other retirement financial objectives
Money is one way to measure your financial objectives in retirement but not the only way.
Really, the most important question is defining the type of lifestyle you wish to lead. Exploring this question will give you a better understanding of how much capital you’ll need. If there’s a shortfall. then set about identifying your choices and options. For example, you could:
Work longer or part time
Have an open mind of how you could earn extra income (eg. from a hobby or personal interest)
This exercise will build confidence about your future because you’re in control and realise that you do have choices.
Planning your retirement
It makes perfect sense to do your homework first so you have clarity around your objectives and the outcomes you wish to achieve. From there, develop a plan of how you intend to work towards those things that are most important to you.
The project might seem daunting and is much easier when you have someone who can guide, help facilitate and monitor your progress. This is exactly what our role, as financial advisers entails. The probability of success is far greater when someone is keeping you honest and focused.
If you would like to know more, we specialise in personal rural financial advice and visit the Eyre Peninsula regularly.
Daniel Budreika has provided input to a News Corp article reported today on how the ‘2.1 Million small business owners’ may not be able to retire they way they want. This is based on research from MYOB indicating that 50% of small business owners under 50 have done no superannuation planning.
MYOB CEO says: “Our research shows that SMEs believe they will need around $1 million to retire comfortably yet 54 percent of them will not have saved enough when the time comes,” says MYOB CEO Tim Reed. “They will always sacrifice themselves to make sure they pay their employees and their employees’ super first,” he said.
Daniel’s input was that many business owners treated their business as their superannuation, but this was a very risky approach. “It’s risky for people to not put money aside, because their business may not be worth a lot for them to sell when they want to exit.”
The article goes on to interview Joel Trethowan, managing director of marketing agency Alchemy One. He did not contribute to super when he started the business in 2012 because there were “so many other priorities and financial matters.”
Joel went on to explain that: “Cash flow is a constant struggle in the earlier years of business and while super is incredibly beneficial long term, for many small businesses, it’s about year-to-year survival and growth.”
A common question we often get asked is “How much do I need to retire?”
Obviously this depends on many factors such as; the age you and your spouse stop working, how long you live for, how much you will need to live on each year and how the money is invested.
A US Study on safe superannuation withdrawal rate
In 1994, a study was undertaken in the US to help answer this question. The purpose was to determine a safe percentage rate that could be withdrawal annually from a pool of funds that needed to last 30 years. The funds were invested 50% in US stocks and 50% in US bonds. Income payments increased each year to account for inflation. Using historical average rates of return, the study concluded that 4% of the account balance could be safely drawn each year to make the money last. Given this is based on US data, it posed a good question.
Safe Superannuation Withdrawal Rate in Australia
Can we use this same rule of thumb here in Australia? Morningstar decided to answer this question by applying it to our own historical investment and inflation data as well as management fees that are typically charged here. The results concluded that a safer withdrawal rate would be closer to 2.5% per year. This implies that a retiree needs approximately 40 times their desired annual income saved to achieve this. In other words, if you wanted to achieve $50,000 per year to safely last 30 years, you would need a starting balance of $2m. While most people will likely fall short of saving $2m in retirement assets, it may not necessarily need to be made up of solely superannuation savings. Retirement investments may include the value of the family home or a business, which can eventually be sold. Those who will be able to qualify for the Age Pension need not worry about saving for this regular income to be generated from as a lump sum of money.
The study also produced some interesting tables that showed the probable safe drawdown rates for different lengths of time using different allocations to growth assets. For a balanced portfolio to last 40 years with 99% certainty, the safe withdrawal rate is 2.2%.
An important part of the study concluded that historical returns used have been higher than expected and we should all lower our expectations going forward.
Australian Government Superannuation Drawdown Requirements
If we compare the safe drawdown rate to the rules of the superannuation system in Australia, it is interesting to note that drawing 2.5% of capital each year is much lower than the minimum drawdown rates that the Government requires retirees to draw as an annual income stream. For example, someone with an account based pension that is aged between 55 and 64 must draw a minimum of 4% of their account balance each year. This percentage continues to increase as the account holder gets older. If 2.5% appears to be the right number, then why does the Government make you take more? This is to ensure that the money you have accumulated in a tax-effective environment is being spent and not merely saved as a wealth transfer tool. In some cases, for those over age 65, we have found the complexities and minimum drawdowns of super to be too great to justify, particularly if the additional income is not needed.
It should be noted that this study is general in nature and should not be relied upon as personal advice.
Daniel Budrieka was quoted in this article in the Daily Telegraph by Anthony Keane on how the increasingly active aging population has an impact on our retirement and superannuation planning.
AUSTRALIANS are being urged to reinvent retirement, and it starts with seeing age 50 as only the halfway point of our lives. As life expectancy increases, so we are seizing opportunities to pursue new careers activities and hobbies, but advisers not that this means financial factors must be considered at a younger age than this has been in the past.
Financial giant Perpetual, which has launched a new guide to living a rich life from 50 to 100, says more years were added to life expectancy in the 20th century than all the years of prior human evolution combined. One in five Australians now aged 65 will live to 97, it says.
Perpetual says planning for “your second wind” starts in 40s with adequate insurance and an investment plan, retirement planning gets serious in your 50s, and beyond 60 factors such as charitable giving, business succession, investment management and lifestyle assistance come into play.
Planning for Prosperity financial adviser Daniel Budreika says most people start to think about later-life finances from about age 40.
“If you leave it late, it’s harder to make changes,” Daniel Budreika says he is concerned that many of today’s Baby Boomers will have to scale back their lifestyle expectations amid forecasts they will live much longer than they previously expected. They will have to be more realistic about the retirement income they generate and what that’s going to mean. Know what your cost of living is and then factor in money for holidays. It’s about feeling comfortable with what you are doing, having a plan and knowing why you are doing it.”
There’s a lot said, written and discussed about superannuation. I know it’s generally not a popular topic amongst business people and farmers in particular. The main objection is that they can’t use their superannuation savings in their business. While it might be a wonderful off-farm asset to have, running a business like farming needs lots of capital so superannuation actually diverts capital away from where it’s needed. The other common concern is that you can’t access your retirement savings until you are 60 and retired (there are transition rules around this age). These are valid objections if you only understand superannuation from what we hear in the media. I think this is why it hasn’t been accepted by the rural community as an ideal way to invest.
Superannuation is not an investment
The greatest misconception about superannuation is that people believe it’s an investment. It isn’t. It is a tax special tax structure with a raft of taxation and compliance laws. How you invest your superannuation is largely the decision of the super fund member. That means there’s more freedom and control of how your savings are invested than you might think. Generally, the vast majority of super fund investors leave this important decision to industry and retail fund managers. This is a bit like buying a new home and leaving to the builder to decide what’s best for you.
Superannuation and your farm business
I want to discuss the principle of investment choice a little further and relate that back to operating a business. One of the most cost and tax effective ways to employ your superannuation savings is in purchasing assets such as farm land or commercial property. This is where huge amounts of capital can be soaked up especially if borrowing is involved. When you include the interest costs and additional tax involved, it becomes a very significant amount of money. One of the great benefits of this strategy is that you are the manager of your superannuation and you make the investment selection. Even better, you’ll be farming the land owned by your superannuation fund. I can’t think of a better tenant than yourself. The objection of not being able to use your retirement savings until retirement now goes out the window.
You can buy farm land with Superannuation
I feel the story even gets better. When you operate your own super fund (known as a self managed super fund) you have the unique ability to borrow to purchase farm land or commercial property. As a rule of thumb, a lender will lend dollar for dollar.
One of the most powerful benefits of the borrowing strategy is the tax effective way of repaying the loan. While interest costs are tax deductible, principle payments are fully taxable. We find this is often over looked and can be a problem when large capital re-payments are made. Even worse, it will affect your 5 year averaging. Superannuation is far more cost effective because of the flat 15% tax rate as opposed to personal or company tax rates which are generally twice as much or more than super. In a transaction involving significant amount of borrowing, the savings can be many hundreds of thousands of dollars.
I know this might sound too good to be true. And yes, there’s much more you should know and understand before going down this path. It is paramount that you get sound financial and tax advice around this strategy so you can make an informed decision if this is right for you. I do know that for those farmers we’ve assisted, they are grateful for the advice, support and savings.
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This information is of a general nature only and neither represents nor is intended to be specific advice on any particular matter. We strongly suggest that no person should act specifically on the basis of the information contained herein but should seek appropriate professional advice based upon their own personal circumstances. You should read the PDS and consider whether the product/s is right for you. Past performance is not a reliable indicator of future performance.
Strategic Advice Solutions Pty Ltd (ABN 86 619 221 662) t/as Planning for Prosperity is a Corporate Authorised Representative of Infocus Securities Australia Pty Ltd (ABN 47 097 797 049) AFSL and Australian Credit Licence No. 236523