The market downturn has hit many retirees hard. Retirement savings may be dwindling and interest rates are low.
In a falling market, it may be appropriate to continue to hold quality assets so the client remains fully invested and can maximise the value from a market recovery. Retirees who draw income from their investment portfolios may not be able to use this option as effectively as a person who is still accumulating savings. Retirees may need to sell assets at a loss to receive their pension (or income) payments.
An investment portfolio that has experienced a 30 per cent fall in value needs to experience around a 42 per cent rebound to restore the original balance. For retirees who draw income from their investments, an even greater market recovery is required.
Reduced minimum payments
On February 18, 2009 the Government announced that it would suspend the requirement for minimum payments in an account-based pension for the second half of this financial year. This will be achieved by halving the minimum annual payment required.
The benefit of a reduced minimum is to minimise the need to sell assets at a loss in order to meet the minimum income payment. Not all clients will benefit from this concession. It will only benefit clients who:
Ã¢â‚¬Â¢ Can afford to live on the lower income from reduced income payments, and/or
Ã¢â‚¬Â¢ Have other resources to provide income (but note, if these resources are in market-linked investments, reducing the minimum payment may not provide any real relief), and have not already received the minimum payment in this financial year.
Pension payments already paid cannot be reversed. Therefore, if a client has already received more than the reduced minimum this year they can elect to stop future payments but cannot ask for the overpayments to be reversed back into the account-based pension. If they are eligible to make contributions to superannuation, they could choose to contribute the payments back into an accumulation account.
The reduction in minimum payments for this year also applies to account-based pensions started under the transition to retirement (TTR) rules. But before reducing the pension payments in a TTR pension, the client’s situation should be assessed to determine the most appropriate balance between pension and salary income to maximise the taxation benefits.
In-specie pension payments
Superannuation Circular No I.C.2 (paragraph 10) issued by APRA states that pension payments must be made in cash, and cannot be made in-specie. Administration issues Providers of account-based pensions may have difficulty in suspending income payments due to the short notice for making system changes. In these cases, a temporary solution may be to change the income payment instructions to annual payments. This may give the provider more time to adjust. You may wish to discuss the logistics with the pension provider.
Self-managed super funds (SMSFs) should have no problems in ceasing to make payments once the new minimum has been reached. However, it is important to ensure that the correct paperwork is in place. The client should write to the trustee and request the pension payments for the year be reduced to the new minimum payment. Acceptance should be minuted in a trustee meeting.
Social security implications
Account-based pensions provide a significant income test advantage and often result in very little assessable income where a client takes only the minimum income payments.
Assessable income is based on the income schedule provided to Centrelink at the start of the financial year. If the client reduces their income payment during the year, they may wish to advise Centrelink of the change if they are impacted by the income test. Where there is no impact, they may decide not to notify Centrelink.
For many clients, an account-based pension is likely to have a greater impact on the assets test assessment rather than the income test. As the account balance falls, clients may wish to update their Centrelink records to reduce the level of assessable assets recorded.
Some other tips
Other tips that may help clients to manage the market impact on account-based pensions:
Ã¢â‚¬Â¢ Pension instructions – review the instructions for which asset classes (or investment options) to draw pension payments from. Clients may wish to amend instructions so that they draw payments from cash or fixed interest holdings first.
Ã¢â‚¬Â¢ Auto-rebalancing – review instructions for auto-balancing to determine if this strategy is still appropriate for the client’s needs.
Ã¢â‚¬Â¢ Franking credits – consider investment options that are expected to generate high levels of franked dividends as the franking credits are refunded to a pension fund and this boosts the effective return.
Ã¢â‚¬Â¢ Dividend reinvestment schemes – in SMSFs, consider whether it is appropriate to cancel dividend reinvestment schemes to allow the cash account to build up to make income payments.