Legislative changes will mean that advisers need to re-assess the way they structure a client’s retirement portfolio. Advisers need the back up of more dynamic strategy support to stay ahead of the changes. Investors are expected to look beyond super to fund their retirement and this will affect the strategies that advisers utilise for their clients to deliver a customised solution based on the more complex and specific situation of their clients. There are a few reasons for this.
There is general support within the financial services industry and government parties for superannuation to be limited to providing clients with adequate income in retirement, rather than being used as a tax minimisation or estate planning vehicle. Both major political parties favour significantly limiting an investor’s ability to accumulate wealth inside superannuation and/or capping access to the tax benefits in the pension phase.
Furthermore, investors are growing cautious of the frequency of changes made to superannuation rules and prefer to diversify their exposure to potentially adverse legislative changes by holding some assets outside of super.
These developments will require that clients consider other investment structures and strategies to complement their super in their retirement planning.
Diversifying exposure to investment structures
There are likely to be a range of alternatives to super considered by clients depending on their motivators and drivers. If tax minimisation is a key driver, alternative structures like insurance bonds that pay a maximum tax rate of 30 per cent on earnings may be considered once the client has maximised their contributions to super. If the client invests in Australian shares via the insurance bond, any franking credits will reduce the effective tax rate paid on earnings. This may encourage a reasonable exposure to Australian shares and other growth assets in the insurance bond.
Other tax induced strategies may include:
- Negative gearing (into property and shares)
- Use of discretionary trusts to manage the tax payable on distributions, which are likely to hold a significant proportion in growth assets
- Increasing exposure to the family home via renovations and/ or buying more expensive homes to take advantage of the capital gains tax free status of the residential home
It may also encourage some clients to consider limited recourse borrowing arrangements (LRBAs) inside a self-managed superannuation fund as a way of boosting the earnings inside superannuation.
The asset allocation conundrum
A key thing to note about these alternative structures and strategies is their bias to growth assets, which may conflict with the client’s risk profile. Structuring a retiree’s asset allocation to match their generally more conservative risk profile, while providing secure levels of income in retirement, is becoming increasingly complex and difficult.
Where the client has a higher growth allocation in their non-super assets, the client may need to hold more conservative investments in super to ensure an overall asset allocation in line with their risk profile.
An alternative thought is that if there is a limit placed on the amount that can be invested in the superannuation pension phase (as outlined in the 2016 budget), clients may favour growth-oriented investments to maximise the growth of their superannuation to ensure it lasts as long as they do. Or, clients may be cautious to protect the balance of their super savings from market downturns given the contribution limits and may instead opt for a more conservative asset allocation.
The outcome of these asset allocation possibilities is that advisers need to ask the right questions of clients, to understand their preferences, in order to provide quality advice tailored to their specific needs. Advisers are likely to be judged by their clients based on whether they listened to their needs and provided strategy solutions that suited them.
Structuring the client’s income portfolio in retirement
The trend towards diversifying investment structures for retirement savings means that the traditional models used, such as the “bucket approach,” to meet the client’s income needs in retirement need to be modified. Strategy advice will become an even more important service provided by advisers to pre-retiree and retiree clients.
An advantage of the ‘bucket’ strategy is its relative simplicity in meeting the client’s essential and discretionary income needs in retirement, partly due to the fact that the bulk of the client’s retirement savings have been in superannuation. This strategy segments a client’s pension super fund into income and growth buckets. A conservative income bucket is used to fund one to three years of essential or total income needed by the client, although the low returns from cash and fixed interest is making this strategy difficult to implement.
If a greater portion of the client’s retirement assets are held outside of super, there needs be a rethink of which assets will be used to fund the client’s essential and discretionary income needs.
Conservative assets are generally used to fund the client’s essential income needs. This may be sourced from the age pension if the client is eligible, annuities, cash and fixed interest assets in the super pension fund.
Non-super growth assets may serve to provide the discretionary component of the client’s income needs.
Careful planning and cash management analysis should become more important for clients adapting to the changing retirement landscape. Increasingly, tailored strategy outcomes will continue to be the key to delivering quality advice.
