The current market volatility presents an opportunity to rethink your advice proposal to clients, placing greater focus on strategy advice.
In particular, you should determine whether strategies you are using still work in these volatile times and what you might need to do differently.
To evaluate a strategy, you need to understand where the benefits are derived from so you can decide if the strategy works effectively in different market circumstances and for different types of clients.
One of the most interesting strategies is the Transition to Retirement (TTR) strategy.
This allows clients who are age 55 or over and still working to roll superannuation accumulation balances into an account-based pension.
Salary is sacrificed into superannuation and income is replaced by drawing from the pension account.
The aim of the TTR strategy is to boost retirement savings in the run-up to retirement. Savings are boosted if:
– the client puts more into superannuation than they take out (arbitrage on taxes), and/or
– fund tax is reduced (due to the tax-free nature of the pension phase).
Market performance is irrelevant to the first point, but is critical for the second point.
Consider the case for Emily who earns $70,000 per annum salary (net $53,950 after PAYG tax) and has a superannuation balance of $350,000 which is to be rolled to a TTR pension.
Assume the fund is experiencing minus 15 per cent per an- num growth but is receiving 3 per cent per annum (gross) income from interest and dividends. Is the TTR strategy still worthwhile during periods of negative growth?
ASSUME EMILY IS AGED BETWEEN 55 AND 60
If Emily salary sacrifices $40,000 into superannuation and draws a pension of $32,810, after tax she maintains a net income of $53,950. Emily’s net contribution to superannuation is $34,000 and she takes out $32,810. Her balance increases by the difference of $1190.
If her fund was still in accumulation, tax of $1575 would be payable, but no tax is payable on a pension so this saving also boosts her account balance. The total benefit to Emily in the first year is $2765.
ASSUME EMILY IS AGE 60 PLUS
Emily salary sacrifices $40,000 into superannuation, but because no tax is payable on the pension (and she has access to tax offsets due to her lower taxable income) she only needs to draw a pension of $26,300 to bring her net income back up to $53,950.
Emily’s net contribution to superannuation is $34,000 and she takes out $26,300. Her balance increases by the difference of $7700. Her balance is also boosted by the tax saving of $1575 on fund earnings.
The total benefit to Emily in the first year is $9275. Emily can increase this benefit to $10,775 if she withdraws another $1000 tax-free from her pension and recontributes it as a non-concessional contribution, making her eligible for the $1500 co-contribution.
This only applies for the current year, as salary sacrifice amounts will count in the assessable income for co-contribution eligibility from July 1, 2009.
Tip: Review the balance between salary sacrifice and pension payments each year to ensure you do not breach the contribution caps or the 10 per cent pension limit. Also check whether any employment benefits will be reduced due to the decrease in cash salary as this may offset the strategy benefit.
Regardless of the superannuation fund earnings, the TTR strategy can still provide substantial benefits for a person who is age 60 plus. The value to a person in the age 55 to 60 bracket is more dependent on the level of earnings, but it is the income component of earnings and realised capital gains that is important.
The benefit of the strategy will be reduced by the cost of any advice to set up and administer the strategy so don’t forget to take this into account in your evaluation.
Louise Biti is Director of Strategy Steps www.strategysteps.com.au