Super shortfall: filling the gaps in your clients’ retirement funds

From a planning perspective to answer the question of whether clients can retire as planned in the next five years, we first need codetermine the ‘gap’ between clients’current positions and their pre-retirement lump-sum requirements.

Pre-retirement lump-sum requirements are generally driven by a few linked variables:

• retirement expenses;
• investment risk profile; and
• length of retirement, say,life expectancy plus five years.

Table 1 illustrates the pre-retirement lump-sum equivalent for a client planning to retire at age 60, five years from now.

If the calculated pre-retirement lump-sum is below the client’s estimated retirement benefits, then depending on thesize of the gap, one or a combination of the following could offer asolution:

• deferral of retirement;
• reducing retirement livingexpectations;
• increasing the level ofinvestment risk; and
• investing more.

Another option, which is not discussed further in this article, iswhether Centrelink assistance (ie, age pension) can be used tosupplement their investment income in order to meet their expectedliving expenses in retirement.

For most clients, deferringretirement, reducing their retirementliving expectations, or taking on more investment risk will probably bethe least favourable solution. This leaves the ‘investmore’ option as the one that will most likely be discussedfurther with the client.

While the traditional methodsof contributing to superannuation mayhave meant a client needed to forgo some income, investigating some ofthe cash-flow neutral strategies may be fruitful.

Transition To Retirement (TTR)Strategy

Since July 1, 2005, thetransition to retirement (TTR) strategy hasbeen gaining more support.

Broadly, TTR involves thesubstitution of employment income withconcessionally taxed income from a non-commutable income stream.

The benefit a client canachieve will depend on:

• their current accountbalance — as pension payments must be between 4 per cent and10 per cent of the balance each year;
• the tax-free percentage; and
• their age.

Generally, most benefit is achieved where the client has reached age60, as their employment income can be replaced with tax-free pensionincome.

However, when the client isover their preservation age, the benefit islinked to the client’s current marginal tax rate and thetax-free percentage.

Take, for example, a client whoearns $80,000 and has a superannuationbalance of $280,000. Their current take- home pay is $60,800 with a taxliability of $19,200.

Using a TTR strategy, the client’s current cash flow can be maintained with the benefit being used to contribute to super.

Combine the TTR strategy with Government Co-Contribution

To further enhance the amount being contributed to superannuation,under the current tax rules, where an eligible client’s total income is under $60,342, they may also be entitled to the Government Co-Contribution (see table 3, which follows on from the TTR example above).

The current draft Budget reforms propose that from July 1, 2009, salary sacrificed amounts will be included as part of the total income calculation for the Government Co-Contribution test, among others.

Contribution splitting

Since the introduction of‘better super’, little has been said about super splitting, however, splitting up to 85 percent of the concessional contributions received by one spouse to another is still a viable strategy.

Generally, a spouse can split a concessional contribution where the receiving spouse is under preservation age or is under age 65 and not retired from the workforce.

While this will not directly increase the net amount invested, it can help to boost the older spouse’s account in order to help maximise the amount that can be used to commence a TTR strategy.

Investment draw down combined with salary sacrifice

Another approach to contributing lump sums of money into superannuation is to use salary sacrifice to enhance the amount contributed.

For instance, where a client has $30,000 to contribute to superannuation, this could be made as a lump sum or alternatively as a regular contribution.

In this case, a possible strategy is to use the $30,000 on non-super money to help meet living expenses and salary sacrifice the grossed up equivalent amount of employment income into superannuation (see table4).

Strategy Considerations

Since July 1, 2007,contribution tax penalties are now a client issue.Within this regime excess concessional contributions incur 31.5 percent tax, which is in addition to the standard 15 per cent contributions tax already paid. Excess contributions that breach tenon-concessional cap are taxed at 46.5 per cent.

Therefore, understanding the amount being contributed is important. For most clients in accumulation funds this should be relatively simple.

For those in defined benefit division funds the issue is somewhat less clear. Where the contribution is made to the funded component then a formula based on the notional amount is counted towards the member’s concessional contribution cap. Where it is made to the unfunded component, the concessional contributions attributable to the member are generally nil.

In some funds, including the CSS and PISS there is a funded and an unfunded component and as such the client will generally have some level of concessional contributions counted to their concessional contribution cap.

So, whether it is still achievable for a client to retire as planned in the next five years will ultimately depend on their situation and the strategies considered.

Andrew Biviano is the technical manager at Fiducian Portfolio Services.