Retirement in 2007: Time for a rethink! Tim Wedd Managing Director, Financial Essentials 24 November 2006
Retirement in 2007: Time for a rethink!
Tim Wedd
Managing Director, Financial Essentials
24 November 2006
A focus on ‘total wealth’
AgendaIssue 1: Lifestyle Transition
(how & why)Issue 2: Retirement
(before or after age 60)
Issue 3: Lump sum v Income (a new challenge)
Federal Budget 2006
• Fundamental shift• Lower effective MTRs
• Plus super reforms
How will you optimise the benefits?
What’s the impact on retirement?
Taxpayer Type Tax-free $
Individual taxpayer (< pension age)
$10,000
Age Pensioner (single) $24,867
Age Pensioner (couple) $20,680 each
Super pension (< age 60) $32,900 each
Super pension (age 60+) $ unlimited
Realigning perceptionsPreviously… From 1 July 2007…
Surcharge impost Max 15% contribution tax
Tax-advantaged savings ? 0% exit tax (over 60)
RBL & LST problems Fund tax (< 15% or 0%)
Lack of super access Super contribution splitting
Constantly changing rules Greater access from age 55
Complexity Individual ‘choice’ required
The Core Tax Package
A fundamental baseline…
+ $uper
…what else?
Alternative options
Gearing stock takeRelies on tax savings to offset project costs
• both assessable income & capital growth required
Generally long-term propositionOften property centricTest assumptions & perceptions
Savings analysis Target similar annual net cash flow cost each year Salary sacrifice $ increases with higher MTR Assume 7% pa net super fund returns*
Savings Plans (gross incomes)
Gross Salary Cost (inc. ML)
Net Super Cont (pa)
After-tax Equiv. cost
< $75,000 (30%) $14,599 $12,409 $10,000
< $150,000 (40%) $17,094 $14,530 $10,000
> $150,000 (45%) $18,692 $15,888 $10,000
* cash distribution = 3.3% pa. (50% franked) plus 4% pa. growth
Testing the theoryIllustrates the gap between super and non-super savings at higher MTR for a total cost of $100,000.
Considers:All CGT, super taxes; no indexation of savings; geared loan of $325,000 at 8.6% pa.
$0
$20,000
$40,000
$60,000
$80,000
$100,000
$120,000
$140,000
$160,000
$180,000
$200,000
$220,000
$240,000
$75,000 (30%) $150,000 (40%) $150,000+ (45%)
Gross Income ($)
Projected 10 Year After Tax Results(assumes $10,000 pa net savings, 7% pa net super earnings)
Deductible Super (0% tax after 60) Deductible Super (16.5% tax < 60)
Geared savings (equivalent MTR) Non-super savings (equivalent MTR)
$208K
Key observations• No longer just an annual ‘tax savings’ story
0% lump sum tax changes the relativities Self-employed & employed finally equal
• Tax-advantaged strategies need tax benefits Dramatic shift in incomes to reach 45% MTR
• Franking credits & CGT discounts Protect 30% MTR clients (income < $75,000) Narrow the savings gap (under age 60)
• Maximise Gov’t Co-contribution (income < $58,000)
Lifestyle Transition
• Why the fuss? Helps extract the value at the end Over age 55 (currently) Tax favoured income (< age 60) Pension premium (0% tax in fund) Tax-exempt income (from age 60) No RBLs & no reporting
Lifestyle transition
• Points to remember… No work tests Available for new flexible pensions Non-commutable until ‘unpreserved benefits’
• can cash and roll back to super at any stage
Complying pensions & annuities• Relevant for purchases prior to 20/9/07
• Remain non-commutable (post purchase!)
• Can cash and roll back during 1st 6 months
Lifestyle transition
• If purchasing under 60 Assessable income in pensioner’s hands New! Annual deductible amount based on the
calculated exempt component
• ETP components still matter
• Draw down components in proportion 15% tax offset on taxable part of annual
pension payments
Boosting savings levels
• TTR in practice… John currently aged 55, earns $125,000 pa. Proposes to ‘salary sacrifice’ $50,000 p.a. Current super balance = $450,000 Assume gross fund earnings of 8% pa. (i.e.
7% pa. net of 12.5% average fund tax)
What actually happens over the next 10 years?
TTR illustration
John @ $125,000 pa. Salary as cash Sal Sacrifice + Pension
Gross Salary 125,000 75,000
Salary Sacrifice (40%) 0 (50,000)
FAP Income (Gross) 0 40,000
Taxable Salary/Income 125,000 115,000
Income Tax (excl. ML) (37,850) (27,850)
Target Net Income (pa) $87,150 $87,150
TTR illustration• The bottom line…
Change in Super Benefits Total $
New Salary Sacrifice +50,000
• Less Contributions Tax -7,500
• Less Pension Gross Payments -40,000
Plus earnings tax saving (at 12.5%) +4,500
= Net savings in super $7,000 pa.
Pension income can reduce to $30,000 pa from age 60= Net savings in super $17,000 pa.
TTR results
• Now project forward 10 years...
Strategy position (at age 65) Totals $
Remaining TTR pension balance 450,249
Plus – new super contributions ($50,000 pa) 609,234
Total accumulated super assets 1,059,483
Less: existing accumulated $450,000 super (885,218)
Additional (TTR) strategy benefits $174,265
Retiring: Before/After 60
• Does it matter? Consider short-term funding issues
• $1M contributions prior to 30/6/07
• Ongoing access to $450k limits (3 yrs)
Pensions favoured under age 60 Debt management strategies Using tax-deductible contributions Contribution splitting (reverse order) New! Small business CGT concessions
What about debt management?
Potential Options• Continue with existing mortgage/loans for current terms
and capital/interest repaymentsOr• Pay interest only now and ‘salary sacrifice’ balance (extra
cash) as additional super contributions
Target 10 year repayment plan in both cases (equal cash flow)
Case study: Mary currently age 50Potential combinations considered:
Earning $175,000 with $200,000 loan balance Earning $125,000 with $150,000 loan balance Earning $75,000 with $100,000 loan balance
Originally, 25 year P&I mortgages set at 7.5% pa.Assume:Interest only loan rate = 8.0% pa.
Net super fund return = 7.0% pa.
Debt Illustrations
Debt v Super Outcomes
Remaining Loan $
Gross SalarySuper
Gain/Loss
$200,000 $175,000 + $78,400
$150,000 $125,000 + $41,400
$100,000 $75,000 + $9,400
Assumes all lump sum withdrawals occur tax-free after age 60.
Management Issues
• Using debt Key is pre-tax dollars and 0% tax Similar principles for extra debt repayments Consider contribution caps
• Generally only $50,000 pa. available
• What else will contributions be used for?
Assess risks (interest rates, legislative) Note super preservation issues
Lump Sum v Income
Some of the challenges… Cash out and/or re-contribution? Model portfolios, guarantees? Super v Pension tax rates Super v Non-super income (MTR?) How much to leave outside super? Estate planning for non-tax dependants?
Age Pension can help
• Major adjustmentRemoval of 50% Assets Test exemption from
20/9/07 for new complying incomesKeep existing product status (100% or 50%)
Plus 50% improvement in Assets Test Single homeowner cut-out (circa $515,000)Couple homeowner cut-out (circa $820,000)
• Consider Mike (age 65) and Jan (age 63) Mike has $480,000 in super $70K personal contents, car and a caravan Currently they seek income ~ $40,000 p.a.
• Option 1 is to simply use allocated pensions
• Option 2 is to consider impact of AT changes
Short-term TAP revival
TAPs and the Assets Test
Income AssessmentOption 1 Now
Option 1 20/9/07
Option 2 20/9/07
Allocated Pension – Male age 65 40,000 33,000 16,800
TAP - Min income, 35 Year Term - - 11,250
Age Pension ($) – Eligible couple - 10,603 15,139
GROSS INCOME ($) 40,000 43,603 43,189
* Assumes: current pension rates & thresholds index at 2% pa; 7% pa for all pension fund earnings. Figures reflect Assets Test impact in Year 2.
Option 1 = 100% AP; Option 2 = 50% AP/50% TAP solution.
Capital issues
• What happens over time?
Improved total income returns to age 100 Improved longevity with age pension support
Remaining Capital $ Age 70 Age 80 Age 90
Option 1. 100% AP 474,023 435,822 259,332
Option 2. 50% AP/TAP 502,650 529,058 416,722
Now to simplification…
What about it? • New! transitional contribution rules• New! annual contribution limits & penalties• New! tax components (maximise exempt)• New! death benefit issues & pensions• Pre-30/6/07 & Pre-20/9/07 planning options
watch, assess & prepare to implement quickly!
Conclusion
What will 2007 bring?• An emphasis on ‘Total Wealth’
• Need for annual reviews & plans
• Increase in debt products
• Focus on effective capital management
• Further investment options/models
• Removal of product boundaries
Put simply, it will be all about lifestyle!