Retirement Planning – Some Super Choices
When the Australian government first set eligibility to the “old age” pension to age 65, an Australian’s life expectancy was 55. That’s right, if you lived ten years past your life expectancy the government said OK, we will now help you out.
Wind the clock forward to 2013 and the average life expectancy for an Australian woman is 84. Now the government could have to make over 19 years of payments (on average). With an aging population, the Government will have a dwindling % of workers paying taxes to support a growing retirement force. This huge future liability is why our government is so keen to encourage people to save for their own retirement (self-funded retirees).
Let’s again wind the clocks back. Australian companies used to offer employees retirement payments for life. This was called “Defined Benefits”. There were some catches though. You could not change jobs (or you would lose your pension entitlement), your pension amount was determined by years of service (eg. 30 years +) and the average of your last three years pay.
The main point to note however with “Defined Benefits” is “no market risk”. That’s right; it does not matter if share markets go up or down. The company (or government for our politicians) is bound to pay you a set amount for life (indexed to inflation), and usually a reduced continuing amount to your surviving partner. It is no surprise then that companies no longer offer defined benefits, and those with employees still on the old “defined benefits” system continue to tempt employees away by offering a large lump sum roll-over to other super funds . The moment a person accepted such an offer, all market risk gets transferred to them!
So, the Government has encouraged Australian’s to take the market risk, including the risk of your super running out in your life-time. To help compensate to some extent, the government has encouraged building your super through a rising annual compulsory super contribution (was 9% but rising to 12% pa.), the ability to put extra salary sacrifice money into super (up to $35,000 for ages 60+) and tip in other after tax money (up to $450,000 every 3 years up till age 65).
Now, you may be thinking, ok if I have to bear the market risk, then I may as well keep my investments super safe (eg. term deposits). However, if we do a life-time projection based on an assumed interest rate for life (perhaps 4%), your desired annual living expenses (you nominate this amount), and inflation (say at 3%), then you can quickly see that it is likely your super savings will not last your life expectancy.
you can quickly see that it is likely your super savings will not last your life expectancy
a. My Super
MySuper is a new, simple, cost-effective super fund with a simple set of product features. If you do not tell your employer where you would like your super contributions to be paid, then from 1st January 2014 your employer will direct such payments to a MySuper product.
b. Industry Funds
If you work in the Building sector, Local Government, Medical Services, etc. there is a Super Fund consisting of employees from your industry. Administrative fees are kept to a minimum, and you usually ‘tick the box’ on a limited choice of investment options (eg. ranging from low risk to a higher % of share investments). A negative is you have limited choice to tailor investments to your needs.
c. Retail or Public Offer Funds
These are Super Funds open to anyone. They are usually established by a bank or fund manager, who acts as trustee, administrator and lodges the super fund tax return. They will usually offer a wider choice of investment options (including you choosing individual share investments).
d. Self Managed Super Funds (SMSF)
This is a special type of trust regulated by the Australian Tax Office (ATO). It allows members a lot more flexibility around their investment choices, but also comes with a lot more rules. Each member (maximum four) must also be personal Trustees, or if you set up a Corporate Trustee, each member must also be a Director. The ATO wants to increase the education of Trustees as there have been many cases of breaches of these rules. This can lead to large penalties, your SMSF being wound back from pension to accumulation phase, or worst case, your SMSF being de-registered and non-complying.
On a more positive note, a SMSF can invest in a wider range of investments, including direct property, artwork, etc. SMSF is growing rapidly and in the 2012 financial year represented approx. $439 billion of Australia’s approx. $1.4 trillion assets in super funds. Over 50% of SMSF assets are held in Australian shares, and approx. 23% in cash and short term deposits.
Set-up costs for a SMSF may be around $1,000 – $2,000 (Trust & Corporate Trustee) then ongoing fees of around $2,000 – $3,500 pa (accumulation or pension phase). For a $300,000 fund, this converts to around 0.70% – 1.20% pa. of fund size, but as your super grows your fee % drops (e.g. for a $1,000,000 SMSF this fee % drops to 0.20% – 0.35% pa.).
Another solution may be to buy a life-time annuity from a company. This may entail handing over your entire super savings for a guaranteed annual pension for life (indexed to inflation). However, the annual pension payments will likely be calculated on a low annual return assumption (eg. 5% pa.) as to be able to offer such a lifetime guarantee, the investments the company buys to support your payments must be very secure (this will usually entail a much higher allocation to interest bearing bonds and lower allocation to shares). And when you pass away, the balance of your annuity is kept by the company.
There has been major change in Australian super over the years. The main thrust of the government is to encourage (and educate) people to save for their own retirement, as the government will not be able to support the growing number of retirees in future at anything above a poverty level.
The good news is you do have many choices, all with varying degrees of investment choice and fees.
Your biggest risk is “Longevity Risk”, your super investments not lasting for your lifetime. History has shown that sitting on cash and term deposits will likely see your super investments exhausted before life expectancy. However, a well-diversified investment portfolio can deliver a better return while still protecting your nest egg.
However, before making any decisions on type of super fund and investments, I recommend having a discussion with a professional financial adviser. Super is a complex area, and the government has made it clear – it’s your future.
This article contains general information only and should not be relied upon as it has been prepared without taking account of your objectives, financial situation and needs. It is not intended to constitute financial, legal or taxation advice as it is of a general nature only. Accordingly, before acting on the information you should consider its appropriateness having regard to your objectives, financial situation and needs. Where the information relates to a particular financial product, you should obtain and consider the relevant product disclosure statement before making any decision to purchase that financial product.