How financial planners can tailor retirement solutions to clients

The appropriate mix of retirement products combined with the age pension should provide certainty, growth and access to capital at a level suitable to each client. Rachel Leong looks at some of the appropriate mixes.

Most retirees have invested into superannuation and will usually commence an account-based pension.

There are many benefits provided by an account-based pension including tax-free earnings, access to capital and an account balance payable to beneficiaries (within super law) upon death.

There is also scope to vary income payments, as long as income is above the minimum pension amount for that year. 

An account-based pension can also be rolled back and forth from pension to accumulation stage at any time.

This may be useful for clients who have fluctuating income from other sources.

However, it is well known that the downside of an account-based pension is that income may run out before the client dies.

Retirees will often only consider an annuity if they have funds to invest and are unable to contribute to super (because of their age or the contribution limits).

However, annuities should be considered for other reasons such as certainty, ie how long the income stream will last and exactly how much the client will receive as income.

There is generally no lump sum payable unless a residual capital value is payable or the client has died within the guarantee period.

In addition, the client does not receive any benefit from growth on the underlying investment; the annuity provider benefits from this.

Retirement goals

The goals of the client will determine the appropriate retirement product mix.

For example, if someone is risk adverse or requires a minimum standard of living, they may prefer the certainty of a lifetime annuity. Individuals who would like to “live the high life” in early retirement (while they are physically more able) may wish to invest in an account-based pension during this time.

However, some clients may see the later stage of retirement as more expensive because of aged care or increased medical costs and will therefore require more income as they age.

Therefore, for any type of investor, it is worthwhile considering a mixture of retirement products to provide the benefits of each type of income stream.

Of course, the proportion of investment will differ across each client, depending on their personal circumstances.

Centrelink treatment of retirement products

Centrelink does not differentiate between super and non-super income streams. It simply differentiates between long-term and short-term income streams and the types of products, eg lifetime and term income streams. Short-term income streams are classed as financial investments.

Lifetime income streams

The assessable portion of income stream payments will be reduced by the following Centrelink deductible amount:

Purchase price less commutations less residual capital value / life expectancy.

If the income stream has been set up with a reversionary beneficiary, the longer life expectancy will be used in the above formula.

Term income streams

The assessable portion of income stream payments will be reduced by the following Centrelink deductible amount:

Purchase price less commutations less residual capital value / term of the income stream.

Short-term income streams

Generally, a short-term income stream is one that has a term of five years or less. This type of income stream is treated as a financial investment and therefore deemed for the Centrelink income test.

Case study

Ian, aged 70, has both an account-based pension with a balance of $150,000 (purchased with $175,000) and an ordinary 15-year annuity, which was purchased with $300,000.

Both income streams were purchased when Ian retired at age 69.

Ian’s annuity payments and age pension entitlement provides enough income to maintain a minimum standard of living.

The account-based pension is in place to provide growth and therefore additional income.

Ian is happy to accept the risk associated with investment in a balanced portfolio in return for the prospect of a higher standard of living.

Other than a few personal assets, some cash and a term deposit, Ian only has his account-based pension and annuity.

Let’s look at how each income stream impacts Ian’s age pension entitlement.

15-year annuity

With an investment of $300,000, the annuity provides gross income of $25,000 per annum (no residual capital value and indexation of 3 per cent per annum).

Ian has not commuted from the annuity. Gross annuity income is reduced by the Centrelink deductible amount.

Centrelink deductible amount = $300,000 / 15 = $20,000 per annum.

Therefore, assessable income from the annuity is $5,000.

Account-based pension

The pension was purchased with $175,000. The current account balance is $150,000 and Ian has chosen a pension payment of $12,190 this year.

Ian commuted $10,000 from the pension last year. The gross pension amount is reduced by the Centrelink deductible amount.

Centrelink deductible amount = ($175,000 - $10,000) / 15.49 = $10,652 per annum.

Therefore, assessable income from the pension is $1,538. The following table summarises Ian’s assessable assets and income.

Age pension entitlement

Ian is a single homeowner and therefore his age pension entitlement is calculated as follows:

Income test

Reduction to maximum age pension =
[($8,119 / 26) - $150] x 0.5 = $81.13 per fortnight.

Assets test

Reduction to maximum age pension =
($505,633 – $186,750)/1,000 x 1.5 = $478.32 per fortnight.

Entitlement

As the assets test provides the higher reduction to the maximum age pension, this will determine Ian’s entitlement.

Ian’s age pension entitlement =
$729.30 - $478.32 = $250.98 per fortnight = $6,525.48 per annum.

Ian’s income situation is summarised below.

In the following year, Ian decides he would like to take a photography course for nine months. He decides to increase his account-based pension payments to $15,000 to pay for course costs. Ian can rely on the fact that his annuity payments will remain at the same level (indexed) to cover most of his living expenses.

As the determining test for Ian’s age pension is still the assets test, his entitlement remains the same (in today’s dollars).

Conclusion

While many retirees choose an account-based pension as their retirement solution of choice, it may not be the only answer. An account-based pension does offer flexibility, however an annuity can provide certainty for the client.

Thought should also be given to the implications for age pension entitlements. The optimal retirement solution for a given client may be a mix of both an account-based pension and annuity.

Rachel Leong is technical services manager at Suncorp Life.