Winning in the retirement risk zone
September 28, 2009
PORTFOLIO POINT: Minor changes to retirement plans can have a big impact on your situation.
There is no disguising the fact that the global economic crisis has, from an investment perspective, tended to hit hardest those people approaching or in retirement. This is not a surprise, with the phrase "retirement risk zone" used to describe the period five to 10 years either side of retirement, a zone in which people's situations are most vulnerable to a fall in investment values.
People in this zone are most likely to be impacted by the 30%-plus fall in sharemarket values we are still enduring despite the recent recovery.
People might pursue various strategies to try and recover from this situation, including working longer than planned or returning to work. The good news is that at least financially the decision to keep working might pay a significant financial dividend.
Indeed, there are four financial factors that will reward those who stay or go back to work:
- The chance to invest while investment markets are depressed.
- The chance to put in place a (very) tax-effective transition to retirement income strategy.
- The chance to deliberately use your superannuation contributions to position your retirement portfolio.
- The fact that the longer you work, the shorter the period that you rely solely on your investment assets to fund your retirement, and the more likely they are to meet your needs
It is worth looking at these in turn.
Investing in depressed markets
Sharemarkets fell by more than 50% at their lowest point, and remain more than 30% below their valuations from the end of 2007. Share prices have since risen more than 50% from those lows (plus earned investors some dividends), generously rewarding investors who have been regularly investing into growth assets over the past 12 months.
If Alan Kohler is correct in his recent forecasts about the new bull market and we are facing a period of strong market returns ahead, then superannuation contributions made in part into growth assets will look attractive in the future.
Those people who have continued to work, or returned to work, and made contributions over the past 12 months might find those contributions to be among the most effective they have ever made - and with a 50% "kicker" to start with things should be looking up in the average superannuation fund.
A tax-effective transition to retirement strategy
When it comes to personal finance, be wary of engaging with anything that sounds too good to be true: The Storm Financial concept of "maximising your personal balance sheet" was a typical too-good-to-be-true promise.
Promises also went unfulfilled at Basis Capital and Macquarie Fortress during the subprime crisis, and MFS and the MFS Premium Income fund never lived up to the promise of the plush hospitality offered to starry-eyed retail investors. Even the most promising super funds like MTAA with high levels of unlisted assets have, in the recent term, failed to live up to the promise of an asset class delivering higher returns with less downside (see Why MTAA's wheels fell off).
But by working longer you create a strategy that seems too good to be true and does actually work. Once you get to the age of 60, and for many people from the age of 55, a transition to retirement strategy is very powerful.
The strategy involves two key happenings:
1. People fund their living by drawing a tax-free income stream from their retirement savings.
2. People salary sacrifice all of their income (eg, their salary) over $6000 to superannuation.
This mean that there are three tax effects people need to understand:
1. They pay no tax on the income they draw from superannuation to fund their cost of living.
2. They pay no tax on earnings in their superannuation fund as it is paying a pension to them - this is worth about 1% to 1.5% a year, or at least $4000 a year for a fund with a $400,000 balance.
3. The maximum tax they pay on their salary that is salary sacrificed to superannuation is 15% (provided this is within their contributions limits). So, a person who salary sacrifices $45,000 to superannuation that is taxed at 15%, rather than 30% as income, saves a further $6750.
Add the $6750 income tax saved to the $4000 superannuation fund tax saved and your benefit is $10,750 a year. This is more than $200 a week, or the equivalent of a pay rise of $4 an hour. This is not a huge amount of money for a hard working former Qantas chief executive (Geoff Dixon went home with more than $10 million), however for those of us used to surviving on a more mundane brand of office coffee it might get us a little closer to whistling on our way to work.
Using super contributions to position your retirement portfolio
I imagine that there are two reasonably large groups of investors, including many people in the retirement risk zone, who fall into one of the two following categories;
Those who had too many assets in shares/listed property assets at the time of the market downturn, and are forced to wait things out in the hope that the prices of these assets recover.
Those who now have a very high weighting of cash and fixed interest, and are not sure about building the allocation to growth assets that will be needed to counter the impact of inflation during retirement.
In either of these cases, if you can work longer and have more ongoing superannuation contributions, especially if you can make your overall situation more effective with a transition to retirement strategy, then you can strategically employ these contributions to move your portfolio to the retirement asset allocation that you favour, building up either the cash or growth assets of your portfolio.
Working longer means a briefer retirement
Working a year or two beyond your planned retirement point also means an equivalent cut in the time you are relying on your investment assets to fund your cost of living. This should provide you with greater confidence to draw down on your assets - they now don't need to last quite as long.
The reality of having to return to work, or work longer than expected, is no doubt a little unpleasant. On the bright side, using a transition to retirement strategy might see your income be more tax effective than it ever has been in your life.