A retirement conundrum

Endless tinkering with superannuation rules has sent people scurrying back to the drawing board to review their retirement plans following last month's budget changes.

Governments have a long tradition of moving the goalposts and the latest changes are a reminder that you should not put all your eggs in one basket.

The key changes are a lift in the age for eligibility for the age pension and caps on concessional contributions.

As a result, retirement plans are being unsettled, particularly for those aged in their early 50s and younger who will be most affected by the changes.

Those who want to retire earlier are going to have to set aside a retirement lump sum outside of super, which can be accessed at any time.

"Super has started to be scaled back from its position as the all-dominating investment structure and now looks a little risky from an investor-access point of view," says Andrew Baker, the managing partner of Tria Investment Partners, which advises the funds management industry.

Concessional contribution caps are also to be halved. From July 1 the $100,000 cap for over-50s will be halved to $50,000 and for those under 50, the cap will be halved from $50,000 to $25,000. In three years' time, the $50,000 cap for over-50s will be reduced to $25,000 to match under-50s.

The halving of concessional limits the maximum amount that can be salary sacrificed into super in any one financial year will hit higher-income earners. The $25,000 is actually less than it seems because it includes the 9 per cent superannuation guarantee charge.

But a reassessment of retirement plans is not just for the wealthy. The age at which the age pension and pensioner concessions can be accessed will be increased from 65 to 67. That is important, because about two-thirds of retirees get at least a part-age pension.

The Government has also floated the idea of raising the access age to retirement savings, perhaps to 67 to align it with the pension age.

The access age (or preservation age, as it is also called) is being raised to 60 anyway. Under current arrangements, those born before July 1, 1960, can access their super at age 55 while those born after June 30, 1964, have to wait until 60.

Concerned at a barrage of stories in the media of blue-collar workers in physically demanding jobs who are unlikely to be able to work to 67, Prime Minister Kevin Rudd ruled out the possibility of raising the access age.

The Government will wait for the final report at year-end of the Henry tax review, which is looking at income adequacy in retirement, before making any decisions.

Currently, those over age 60 can draw a lump sum or pension payments tax free. However, there are fears the Government will increase the access age for lump sum drawdowns or will limit the amount that can be taken as a lump sum, to encourage people to take an income stream instead.

The qualifying age for the age pension will be increased by six months every two years, commencing from July 1, 2017, and reaching 67 on July 1, 2023. That means anyone aged 57 or younger will have their pension age increased from 2017. Those born after January 1, 1957, will not be able to claim the age pension until they turn 67.

Any increase in the super access age would have to protect those older people for whom it is too late to change the rules. Those that will be affected by the new rules are those aged in their early 50s and younger.

"I have always advised clients to have money in super and outside super, just to manage the legislative risk," says a financial planner with Griffin Financial Services, Ray Griffin.

He says accumulating an alternative lump sum outside of super is "very sound financial planing".

However, few are expecting an exodus from super, as it is the most tax-effective vehicle for retirement savings outside the home. So what can you do to manage the legislative risk?

TAX EFFECTIVE

"Particularly for those over 50, super is still the best investment that you could be putting your money into," says the technical counsel for the National Institute of Accountants, Reece Agland. With super, there is a 15 per cent tax on concessional contributions, such as employer and salary sacrifice contributions, and investment earnings are taxed at 15 per cent. Withdrawals, including lump sums and pension payments, are tax-free after age 60.

During the biggest global financial crisis in 75 years, super funds have held up relatively well. Super funds are down about 20 per cent from their highs of late 2007. Fund members will be unhappy with that but they are unlikely to lose their shirts. Most super funds are run conservatively and the negative returns reflect the broader market.

This contrasts sharply with the 200,000 or so investors, mostly retirees, who have lost much more, sometimes all of their savings and their homes, investing in property-backed debentures, or taking the advice of financial advisers or accountants to gear into the sharemarket, property development projects and tax-effective agribusiness investments.

While there are tax-effective investments that are reasonably secure for those who want to build up some savings outside of super, tax effectiveness should never be the sole reason for choosing an investment.

The chief executive of the National Institute of Accountants, Andrew Conway, says the recent collapses of Timbercorp and Great Southern, which ran tax-effective managed investment schemes, reinforce the need to ensure that any tax-effective strategies are still viable investments.

GEARING

Borrowing to invest can still be a good idea but the borrowing levels should be conservative, says a financial planner and director of WLM Financial Services, Laura Menschik. She says it is only worthwhile gearing into assets expected to give reasonable capital gains over the long term, such as shares and property. It requires a long-term commitment to ride out the inevitable falls of investment markets and the investor has to be comfortable with those risks.

Just as gearing magnifies the gains of the underlying investment, it also magnifies the losses. Menschik says the numbers have to stack up for the individual. Anyone gearing to invest would want to be in secure employment to meet ongoing repayments, Menschik says. She also recommends keeping some cash on the side, just in case.

A drop in business investment last month sparked speculation there would be a further rise in unemployment, with analysts expecting the jobless rate to jump to 9 per cent by the end of 2010 from about 5.5 per cent now.

But for those with the stomach for risk, shares are probably a better prospect than property, says Agland.

"It comes down to time-frame," he says. "If the time-frame is to retire in the next four or five years, you are not going to see a lot of capital growth in property."

Over 20 years, however, Agland says quality property will continue to prove a good investment. He says many investors are worried about the stockmarket after the big falls of the past 18 months but says it is "at a low level and has been growing this year, although a bit chaotically". He says that over the next five years, investors with a well-diversified portfolio of shares in quality companies should do well.

WAYS TO GEAR

"Margin lending can still work but it is a long-term strategy and the investment time-frame has to be at least seven years," says the principal of Paramount Wealth Management, Wayne Leggett.

Only clients who understand and accept the risk should gear. For the right clients, Leggett prefers borrowing using equity in the home rather than a margin loan. Variable rate home loans are about 5.5 per cent and margin loan variable rates are about 8 per cent.

"Some people say the home is sacrosanct," Leggett says. "With a margin loan the security is the shares but the investor pays a high price for that through the interest rate charged. If they cannot meet a margin call their home is in jeopardy anyway, so why not borrow at the best possible rate."

A margin call is where the value of the portfolio drops and the lender requires the investor to pay up to restore the loan-to-valuation ratio. Margin calls occur when shares drop dramatically. If investors who receive a margin call do not have the cash to restore the loan-to-valuation ratio, they may have to sell some of their shares right at the time the shares have lost a lot of their value. Using conservative loan-to-value ratios reduces the risk of a margin call.

INVESTMENT BONDS

The founder of financial planners The Money Managers, Kevin Bailey, is cautious on borrowing in these uncertain economic times. He says super is still king and that any increase in the access age to super would occur gradually. Nevertheless, he says some people may well want to have some "belts and braces" and invest outside of super in case they need to draw on the money before they retire, or simply to add to their retirement savings pot.

He says investment bonds are one of the best tax-effective investments going. These are like managed funds in that the investor gets to select whether to invest in a balanced fund, which spreads the money between asset classes, or shares. They are a tax-paid investment with tax paid at 30 per cent, or a bit less because of the franking credits on the shares.

If the investor is on a marginal income tax rate of less than 30 per cent, he or she gets a refund for the difference between the marginal tax rate and 30 per cent.

If the bond is held for 10 years, the proceeds can be cashed in whole or part with no more tax to pay. Another advantage of investment bonds, or insurance bonds as they are still called, is that nothing has to be included in the investor's tax return as no income is received from the investment bond. With shares and managed funds, tax is paid each year on the income from the investments and then there is capital gains tax when the investments are cashed in.

RENTAL PROPERTY

Ray Griffin, of Griffin Financial Services, says property is always an investment for the long-term.

He says investors should be cautious about taking on excess debt, especially now that unemployment is rising.

He says it is not only the risk to the investor's job that is of concern but also the employment of the tenant, because the rental property may be unoccupied if the tenant loses his or her job.

With the prospects of capital gains in the short and medium term not that great, property investors need to focus on the yield they will be getting and look closely at the numbers, he says.

Vacancy rates in Sydney and Melbourne are tight but that could change if the unemployment rate goes to 9 per cent.

BEAUTY OF HOME OWNERSHIP

One of the best ways to help secure a comfortable retirement is to have the house paid off. It is also capital gains tax free. Any investment will involve fees and costs that eat away at the effectiveness of the investment.

An increase in mortgage repayments by just a small amount can reduce the outstanding loan term by a significant amount and reduce the interest costs substantially.

"Paying off your mortgage and owning your home is one of the best investments you will ever make, no question," says Neil Gearside, a certified financial planner with NW Advice.

"It depends on my clients' individual circumstances but generally I recommend that they get rid of non-tax-deductible debt, which includes their mortgage, as quickly as possible because the return, on top of the capital growth of the house, can be phenomenal," Gearside says.

"It is unlikely that you will get any investment that will match the return."

Joanna McCreery, a financial planner with Majella Wealth Advisers, agrees. She advises younger clients to get stuck into their mortgage. "If you have a home loan you really should be ploughing your money into that and do not want to tie too much of your money up in super."