Death and taxes: the two certainties in life. When considering investing for retirement, and then receiving income from that nest egg, it has to be factored in that people are living longer and that taxes are highly unlikely to fall. Building a sizeable nest egg is a large piece of the conundrum of living a full and financially secure retirement. Just as important is protecting it and any income produced from the tax man.
Important questions for retirement planning
When deciding upon a financial plan to create wealth for retirement, it is necessary to answer several key questions, such as:
- What type of lifestyle is desired/ expected?
- When is the best time to retire?
- What level of withdrawal from a nest egg is sustainable?
- How is it best to withdraw funds from a nest egg?
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Creating an Income Strategy
The first element in deciding upon income withdrawal is to calculate a sustainable withdrawal rate. This will depend upon a number of factors, including age and asset mix at the time of withdrawal. If too much is withdrawn then the retirement nest egg simply won’t last long enough, and if too little is taken then living standards will be sacrificed.
Key to maximising future income is the understanding of the theory of life stages, maintaining broad diversification, and managing remaining assets. Consideration needs to be given to transition and post-transition income needs, the options for nest egg investment, and any shortfall between income and expenditure at any given age. This allows proper planning to cover the shortfall.
There are a number of strategies that can be employed to perform these calculations. Most commonly, by factoring in a standardised growth factor and then combining with investments made through to retirement, a final nest egg amount can be estimated. To keep investments on track, the performance of investments should be assessed regularly (at least annually).
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Account based pensions have developed a long way since they were first introduced in the 1990s. Funds have to pay out a minimum income each year, so investors may find themselves forced to cash in some units irrespective of need. A risk is that the value of investments falls due to market volatility, with less income delivered as a result. Also, there is no guarantee that the investment will last through to death. However, there are a number of significant benefits associated with account based pensions:
- No tax to pay on income from age 60
- The entire nest egg can be accessed at any time
- Because it remains invested, any positive performance increases capital
- Payments can be varied
- Excess funds after death can be bequeathed to the estate and beneficiaries
As a general rule of thumb, income from super money will be tax free from age 60.
Other retirement options
An interesting development over recent years is the transition to retirement (TTR). It is now possible to reduce working hours once past the age of 50, and take some benefits from super investments. This also enables investors to take advantage of the fund to save tax while boosting the super. This is a complex operation, and should only be considered after taking advice from a financial advisor.
The annuity used to be an attractive and popular method of creating retirement income. That was in the days when average annuity returns were as high as 13%. However, even though this level of income is long gone, annuities do offer a range of benefits to the retiree:
- The term is highly customisable
- Income is flexible
- Income can be protected from inflation
- Super money can be used to purchase (post-60 years old)
- They are guaranteed (by a life company)
A retiree using a super fund to buy a market–linked allocation pension with a value of $500,000 is likely to run out of money by the time they reach age 84: that’s a little way short of the average life expectancy for an Australian male.
Market shocks and crashes can have a devastating effect on super funds, especially if the crash happens immediately before planned retirement age. Such a fall will either force the expected retirement to be delayed, or severely and negatively affect income and living standards through retirement. This possibility should be fully examined and revisited at every review meeting with an investment advisor.
The bottom line
In summary, account based pensions and annuities provide income solutions but an individual and informed solution will help the retiree to decide the best option available both while investing for retirement and withdrawing income through retirement. Salary sacrifice and active asset management strategies are more relevant today than they have ever been.
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