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The minimum drawdown for account-based, allocated and market linked pensions was reduced by 25% of the standard rates for the 2011/12 and 2012/13 financial years. From 1 July 2013, the minimum drawdown amount will revert back to the normal percentage and therefore increase for the 2013/14 financial year. The minimum drawdowns on account-based pensions for 2013/14 are:
Account-based pensions continue to have no maximum drawdown amount unless it is a Transition to Retirement account-based pension where the maximum is limited to 10% of the account balance.
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Looking at the summary of the AFR article in today's paper, only confirms my view that no non-government agency or organisation should be allowed to run a defined benefit scheme for employees. Even governments in my view shouldn't run them, but for entirely different reasons, but at least they can always dip into general revenue to pay the amount defined as the member's benefit.
UniSuper has been in trouble for a couple of years now after it initially came out that they had a funding short fall in their defined benefit scheme. Yes, returns do vary (in both an upward and downward direction) but the point of a defined benefit scheme is that these gyrations don't affect the employee's retirement benefit. They are a risk borne by the employer. When returns are high, they don't have to put as much cash into the system (because the investments are taking care of it) and when returns are low they may need to contribute more. My understanding of the trouble for UniSuper is that when they asked their employer members to stump up the required cash, they didn't want to. So the funding shortfall persists.
What's the answer if the same employers who were happy with the scheme during the good times, decide to ignore a key component of the employee's safety mechanism during the lean times (remember these aren't even bad times)? You redefine the metrics used to calculate the benefit of course! So the defined benefit pension is only as good as the definitions it uses to determine what you're entitled to. Perhaps one of these should be that the definitions can't be changed to suit the circumstances. Otherwise I'd rather have control of my own retirement savings. Markets may be volatile and at times unpredictable, but at least I'm not reliant on employers and scheme managers who forget their obligations when its inconvenient to do so.
Heaven help members of UniSuper if they cotton on to the fact that many of their members are also going to live longer. It may be death by a thousand definitions.
UniSuper pay-outs tipped to drop
6 August 2013 I Sally
Patten, The Australian Financial Review, page 19
Up to 80,000 employees in the higher education sector could have their retirement pay-outs cut after UniSuper, one of the country's biggest superannuation funds, changed the formula for calculating benefits. UniSuper chief executive Kevin O'Sullivan blamed the decision on low government bond yields, which are expected to lower annual returns to 7 per cent from 8 per cent in the coming years. "The advice the board received was the future returns will be lower," Mr O'Sullivan said. The decision to act was taken at a board meeting last week and was conveyed to members in a letter sent on Monday. The changes relate to UniSuper's $14 billion defined benefits scheme.
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I was reading in the Fin Review the other day an article from a prominent listed property investment and management company. In it, they said that they thought that if income can be maintained, commercial property values will rise and yield will fall.
In commercial property, value and yield have an inverse relationship if income remains constant. This is because value for commercial property is generally derived from the ‘capitalisation rate’ an investor is happy to accept. In simple terms, the ‘cap rate’ and ‘yield expressed as a %’ can be considered the same thing. For example, if you have a building yielding 6% and it was purchased for $500,000, if cap rates move to 8% and the rent remains unchanged at $30,000 the value will now only be $375,000. So cap rate changes are significant for the valuation of property and will generally rise and fall depending on the perception of risk and growth characteristics with respect to a particular property and/or class of property.
So the manager is suggesting that they expect cap rate compression, or that required yield will come down on commercial properties through the coming cycle. They are potentially even more bullish if the reserve bank cuts interest rates further. My question is why?
The reason given is that if cost of debt goes down and risk premium also follows, then asset prices go up. This is despite demand for office space going down. To me, this sounds like old mistakes being
Property is a long term asset class. It is expensive to buy and sell, and the market itself can be very inefficient. Deciding that you would pay more for an asset because it is cheaper to borrow money, or that you can get less on your term deposits, strikes me as a great way to lose money. In the short term, no – you could ride a wave of positive valuations, but they are not built on anything substantive. If you look across a business and/or property cycle and see that a particular property type will generally yield 7%, then a long term property investor should not purchase for a yield less than this. You may then even demand a higher cap rate if the building has poor tenancy or lease expiry to compensate for the added risk.
The time you may look to decrease expected cap rates is if you expect higher rents in the near future than are currently being achieved. These rises can be due to the individual characteristics of the building or systemic changes. Either way, if they are sustainable, these rental increases will reinstate your cap rate back to what it should be. But this isn’t the case discussed here.
If you follow the crowd and pay more for something just because cost of debt and cash yields have gone down, you are not accepting cap rate compression because risk has gone down. You may actually be paying more just as risk has actually increased. All I can say is hang on, there’s turbulence ahead.
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There are important questions to be answered before superannuation contributions are made for people between the age of 65 and 74. The most commonly referred to is the work test. This test asks whether the member has worked 40 hours in 30 consecutive days or less at some point during the financial year. In order to receive contributions into the fund, the trustees of the fund must be satisfied that the answer to this question is ‘yes’ before the contribution is accepted.
The exception to this is if the contribution is a ‘mandated employer contribution’. In this case the SIS Regulations do not require the work test to be met. Mandated employer contributions include contributions that satisfy the employer’s liability for the superannuation guarantee.
Superannuation guarantee is payable under most conditions, however there are a number of exemptions to the definition of employee for SG purposes. These include:
* Employees who earn less than $450 (gross) in a calendar month. This is assessed on a month by month basis, no averaging is permitted.
* Employees under age 18 working less than 30 hours per week
* Non-resident employees working outside of Australia
* Resident employees, working for a non-resident employer, for work done outside Australia
* Employee paid for work of a domestic or private nature of up to 30 hours per week (eg. nanny).
Keeping this example simple, these conditions suggest that if a person is resident in Australia, is aged between 65 and 74 years of age, and earns more than $450 per month, then the employer will be required to make SG payments. This will mean the payments are ‘mandated employer payments’ and the person will be eligible for that money to be placed into Super regardless of whether they meet the work test.
So you can see from this that the question of whether contributions can be made for a person aged between 65 and 74 years of age depends not just on the work test, but also the type of contribution. However, as we see people working later in life (and you may have already picked it up in the age ranges discussed) there is a catch. If a person is aged 65 years or older and they are trying to maximise the amount of money they have in super, only SG payments are considered mandated employer contributions. If there is a salary sacrifice arrangement in place, the non-SG payments would require the work test to be satisfied prior to the trustee accepting the contribution. Its not as easy as simply instructing your employer to pay all income into your fund, particularly if you work part time or on an ad hoc basis. So take care with this.
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Over the last few months we have seen some very strong gains in shares and along the way we have asked clients to take profits from companies we see as having raced ahead of themselves. This can be very hard to do, because the call to sell a share whose share price is in an upward trajectory makes you feel like you might be missing out on a party that hasn’t finished yet. For us as advisers it’s hard because invariably the share continues to rise and we look like the goose who made you miss the party.
However, we need to continually remind ourselves of what we are trying to do when placing our money in a particular company. We are trying to invest in a good business, at a good price. A good company at a ridiculously high price is still a good company. It’s just no longer a good investment. While money can be made trading on momentum (that is, price rises tend to lead to further price rises) it is a dangerous game to play because you never know what may come out of left field and spoil the party.
A recent example of this is Telstra. It has traded very strongly and we have been recommending for some time for clients to take profits and/or sell as the price went above our estimates of value. And yet the price just continued to rise. We would argue this is because investors are chasing yield and even at a price above $5 (compared to a value in the low $3 range) its yield was attractive compared to cash. It is clearly an example of compartmentalising the risk/return considerations of a business and focusing, if not solely, predominantly on only one part of this relationship.
Now we’ve all read of the problems Telstra is currently having with the recent asbestos scares and this has helped contribute to a 9.6% fall from its recent highs. From a business perspective we don’t think anyone was thinking of asbestos a couple of months ago. Buying the stock for yield has so far proven quite expensive and it shows that when a stock is trading well above value, anything that questions the company’s future results can have a dramatic effect on price because the utopia that’s priced into the stock market starts to look shaky. Where to from here? Who knows, but if the company was trading closer to its value, we would have more faith in its price not deteriorating further as people perhaps start looking more closely at the business, rather than just the yield.
Cochlear is another example. Great company. A world leader in its field. However people always seem willing to price it for beyond perfection. It recently announced slower than expected sales, apparently because of an anticipated upgrade to its product that would provide it with even more competitive advantage. This was greeted by a 30% decline in share price (and it remains well above value). It’s still a great company, but its price was/is silly.
May we live in interesting times? They’re always interesting. Even when perhaps we don’t expect/want them to be. Interesting times tend to draw us back toward value.
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Refund of excess concessional contributions
Tax penalties on excess concessional contributions are high (at 31.5%) and this may mean a person pays a higher rate of tax on these contributions than on salary. Legislation was recently passed to allow a one-off opportunity to have excess contributions refunded provided the excess does not exceed $10,000. However, this is now proposed to become even more flexible with the ability to refund all excess concessional contributions if the cap is exceeded after 1 July 2013. Excess concessional contributions will be taxed at marginal tax rates plus an interest penalty (due to the deferral of tax).
This is a much simpler and less punitive approach. Most people exceed their caps (if they do) by accident and we think that a system that ensures no-one gets a benefit from this error (but doesn't treat you like you're trying to cheat the system and therefore deserving of punishment) is fair. Why they didn't make it for the current financial year I'm not sure. Perhaps they're still hopeful of some revenue.
Higher concessional contribution caps
Clients will have an increased opportunity to build superannuation savings with proposed increases to concessional contribution caps. Exposure draft legislation has already been released for consultation. Under the proposals, the concessional contribution cap will be increased for clients age 60 or over from 1 July 2013. The concessional cap for 2013/14 is proposed to be:
1. Clients age 60 or over - $35,000 per year (non-indexed)
2. Clients under age 60 - $25,000 per year (indexed)
3. Clients who turn age 60 in a year will be able to access the higher cap for that financial year, even if they pass away before their 60th birthday.
4. The higher cap will become available to clients age 50 or over from 1 July 2014.
Finally a bit of common sense. Everyone in the real world knows that your greatest saving years to Super occur later when the kids have left home, perhaps the mortgage is paid off, and you are in prime income earning years. The higher limits were meant as a transitional measure and you can see under these proposals that the higher limit is not indexed. So eventually the standard contribution rates will meet the transitional ones (provided they stop delaying the indexation of the standard rates).
Minimum pension payments
For the past four financial years, the Government has reduced the minimum pension drawdown amount for account-based, allocated and market linked (term allocated) pensions. No further reduction announcements were made in the Budget, so for 2013/14 the minimum pension payment is expected to increase back to the standard minimum payment levels.
This makes sense unless the Government was going to make the reduced levels permanent (and therefore adjust the rates in the regulations). The lower minimums were a direct response to the GFC and were aimed at helping preserve people's superannuation savings during that time. Personally we liked the greater flexibility offered with the lower rates, but not if they need to be renewed each and every year.
So generally there has been some common sense shown in the last couple of weeks in relation to Super. Its only taken 5 years and caused quite a lot of havoc for some people (both financially and emotionally) along the way. Of course, the best way to avoid problems is to ask for advice before acting. However the changes outlined above make Super a better
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stay in their own homes and the difficulty with bringing new residential facilities to market.
The key areas of reform include:
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We have seen a big push with Regulators trying to ‘encourage’ people to address the big insurance gap that exists for many people. It seems that while we are all happy to insure our house and car, many of
us continue to assume that our current good health will continue, and thus personal insurance is expensive, and a waste of money.
As part of their push, regulators have now changed the legislation with respect to investment strategies for superannuation funds, stating that they must at least consider the insurance needs of members. While
many big industry/corporate/employer funds have default levels of cover, these are in no way tailored to individual members (we recently had a client who was terminally ill, and having a birthday a week before their death, their industry fund automatically reduced the death cover they would pay out – clearly no-one would individually choose that course of action). It’s also hard to see how big funds can be tailored in a meaningful
SMSFs have a distinct advantage here, even if that advantage isn’t access to low cost group pools of insurance. Like all aspects of the fund, the advantage is that they can be specifically set up to address member
However, all members regardless of the type of fund face a common problem when it comes to insurance. How do you pay for it? There is virtually no point in paying for insurance inside superannuation
using non-concessional contributions. Yes the fund may get a deduction for the premium, however the real benefit of this is relatively small given the tax rate in Super and you also expose the payout to taxation if received by
non-dependants. You will have effectively paid for the insurance with after tax money and so may as well hold it personally.
So the sensible option would be to pay the premiums using concessional contributions. However we are all subject to significantly lower contribution limits than in the past, and there is no segment of the Superannuation community feeling this more than those over the age of 50. Since 2007 you have seen your limits fall from $100,000 to just $25,000 (and the indexation of this amount has been postponed twice). This hurts members significantly in relation to insurance. As you get to 50 it is likely than insurance needs remain quite high, however the cost of premiums also starts increasing steadily from this age. So more and more of your contribution
limit is ‘eaten up’ by insurance premiums and in some cases the limits may not be sufficient to cover the premiums. While this may be acceptable from an insurance perspective, aren’t we also meant to be saving for a self-funded retirement?
So under the current arrangement it seems that we can have our insurance and put our long term adequacy of savings at risk, or we can maintain our savings and put our adequacy at risk of the unforeseen. Needless to say,
neither is an ideal circumstance.
What can be done? Firstly, push for higher contribution caps. Secondly, choose carefully the types of insurance held within your Super and don’t be afraid to alter ‘default’ positions within bigger funds. There is a clear tax advantage to holding life cover and ‘any occupation’ TPD cover within Super when payments will be made to a tax dependant. If you only have non-tax dependants these benefits are less clear. Income protection (IP) is tax deductible to you personally and there are no tax benefits to IP payments coming from a super fund. So these are best held outside of super unless you simply cannot afford them from a personal cash flow perspective. For small business owners, there is no FBT if your business pays for IP on your behalf. Trauma cover is also generally better held outside of super for a number of reasons.
So insurance within super has become a juggling act between protecting your financial objectives and safeguarding your contribution limits. Both aspects need attention to get a good result.
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The ATO has outlined its attitude to claiming the tax free 'exempt current pension income' (ECPI) in circumstances where for one reason or another, the member fails to take the minimum required. The basic starting point is that the tax free status of the assets backing the pension is removed for that year. If the standards are subsequently met in a future year, the fund is held to have commenced a new pension.
There is the ability for a fund to continue to claim the ECPI where the minimum has not been met in the following circumstances:
1. The under payment was due to a genuine mistake on the part of the trustee or was outside of their control
2. The under payment was for a small amount not exceeding 1/12th of the required annual minimum
3. The trustees have not claimed this relief previously.
4. The error is remedied within 28 days of the trustees becoming aware of the problem.
Provided these conditions are met, then the trustees can self assess their continuing to claim the ECPI. Otherwise, they would need to ask the Commissioner to exercise his discretion.
This seems pretty straight forward, although it once again (similar to the relief from the excess contributions tax) assumes that if you ever make more than one error you deserve to be punished. Oh if only the ATO was held to such lofty standards. The punishment can be severe, and not just the obvious loss of the tax exemption for the year. It could also undo years of planning using pensions to segregate superannuation components. Because of course an SMSF cannot have multiple member interests while in accumulation phase. So as soon as the pension/s is deemed to have ceased, all affected accounts would roll back to a single interest.
There is also an interesting extra point thrown in by the ATO and it reads as:
“Furthermore, the payments made from the SMSF for that year are not super income stream benefits and instead should be treated as super lump sums received by the member for income tax purposes for that year.”
So what happens in the event that someone is taking a transitional pension, however they fail to take the minimum required. They had not satisfied a condition of release (thus the transitional pension) and any lump sum makes them guilty of early access. One can only hope that this ‘furthermore’, thrown in toward the end of the page, was simply ill considered and the Commissioner would exercise his discretion. Otherwise, transitional pensions become a far more onerous compliance obligation (in terms of the potential ramifications).