The threefold attack on your retirement plans

Summary: The potential challenges that reduce the incentive for people to save for their retirement.

Key take-out: You can be better off having saved $300,000 for your investment compared to having saved $800,000 for your retirement.

With the Federal Budget behind us, the political focus now turns to the looming election.

Amongst the possible policy outcomes that a change of government might bring, the Labor Party's policy to significantly reduce the refundability of franking tax credits adds another challenge for people looking to navigate retirement. That's alongside the Coalition's change to the assets test for the Age Pension that happened in 2017, and the low interest rate environment that we find ourselves in.

These three challenges potentially reduce the incentive for people to save for their retirement.

Indeed, there is a simple example that highlights the challenge nicely. Let's consider a homeowning couple with $300,000 of investments, and another with $800,000 of investments, with both couples also owning $50,000 of ‘lifestyle' assets.

Given the current situation, let's assume that both investment portfolios are invested at 25 per cent cash and 75 per cent growth assets, with both also producing a gross income (total including franking credits) of 5 per cent annually, which both the couples use toward their retirement needs.

The homeowning couple with $300,000 of investments will receive investment income of $15,000. Add this to their full Age Pension of $35,568 and they will be able to have income of about $50,000 in retirement, keeping in mind you can have up to $380,500 of assets as a homeowning couple before it impacts your Age Pension.

The homeowning couple with $800,000 of investment assets and $50,000 of ‘lifestyle' assets will no longer be able to receive any Age Pension.

Prior to January 1 2017, the rate at which people lost access to the Age Pension was doubled.

For example, someone with $800,000 of investment assets and $50,000 of lifestyle assets would have received a part Age Pension, however under the current arrangements they receive nothing, as $837,000 is the level where a homeowning couple will no longer receive a part Age Pension.

So, using a 5 per cent withdrawal rate from their $800,000 portfolio they will have income of $40,000 per year and no Age Pension. This is $10,000 less than the couple with half a million dollars less in retirement assets.

The low interest rate environment compounds the challenges for both retirees, however it is the couple with the larger portfolio that faces the greater reduction in income because of the low returns from this part of their portfolio.

Labor's proposed policy around franking credits also seems to potentially negatively impact the family with $800,000 more.

If they are in a situation where they currently benefit from the refundability of franking credits, (which they would if they held an investment portfolio in joint names) under the current tax rules this would produce a level of income that would see them get a refund of franking credits. With the ALP policy, they would potentially lose this.

Labor has come out and said that under the pension guarantee, part and full Age pensioners and current recipients of an income stream from self-managed super funds, will be exempted from changes to the way franking credits can be refunded. This does not seem to protect this couple with assets held in their own name, who don't receive any part Age Pension. Reduced franking credits refunded means less income in retirement.

This is a challenging environment for people looking forward to retirement – how can it be that you can seemingly be better off having saved $300,000 for your investment compared to having saved $800,000 for your retirement?

The second question is, how should we react to this environment that seems to have the benefits of saving sucked out of it?

To save, or to spend?

The first reaction that I think is important is for people planning for retirement is to be ahead of the game. When weighing up the level of salary sacrifice that we are making to superannuation, one needs to find the balance between spending income and saving. It is also important to keep in the back of our mind that we have to be responsible for our retirement and if, for example, we want $75,000 a year of income then we are going to have to hit retirement with about $1.5 million of assets.  

If we want a level of income in retirement, it will be up to us to make the commitments to get there and the earlier we start to think about this the easier it will be.

The second reaction that people need to think about is being prepared to spend some of their assets in retirement. In this case study, the couple with $800,000 of assets might choose to spend $20,000 of their capital each year, giving them $60,000 of funds to spend to support their lifestyle when added to their $40,000 investment income.

Sure, this will reduce their investment capital, however they will get to a point where they are eligible for some part Age Pension to support their lifestyle.

Indeed, just as there seems to be little incentive to save more for retirement, there seems to be an incentive for people to spend in retirement. Every $1000 of assets that are reduced once you are between the upper and lower asset test thresholds you gain an extra $3 per fortnight of Age Pension ($78 per year). If you spend $20,000 on, say, a luxury cruise you potentially have a luxury cruise and, because you have reduced your level of assets by $20,000, extra Age Pension income of $1560 per year.

The third reaction is that people see the Age Pension as a safety net when planning around their asset allocation. If they have assets with a value that puts them around or just above the level at which they receive a part Age Pension, they might choose to be a little more aggressive with their asset allocation. Keeping in mind that a fall in the value of growth assets will see the individual receive increased Age Pension payments, while if the growth assets have a period of strong returns, they also benefit from that.

Take responsibility for your retirement

Record low interest rates, question marks over the future refundability of franking credits and the recent increase in the rate at which the Age Pension reduces as assets increase, highlight some key challenges for people planning for or navigating retirement.

For those with the time to react, I think the calculations show that we have to take responsibility for building the assets we need for our own retirement, and the sooner the better.

There is an increased reason to think about spending some investment capital throughout retirement, and the Age Pension might be well served as a safety net to encourage people to be slightly more aggressive with their retirement asset allocation.