I am retired and all my money is still in super. I haven’t yet transferred it across to an allocated pension or other form of income stream. The reason I leave it in super is that I am guaranteed 4% in the super fund, and that means that when the markets fall I still receive 4%. So when I need money out of my super I just cash it out, and when I run out, I cash out more money. I know that allocated pensions are the way to go, so I stress that my money should be in an allocated pension. But then, I like receiving the 4% guarantee. What should I do? Move my funds to an allocated pension and lose the 4% guarantee, or leave it as is?
Firstly, do I leave my retirement benefit as superannuation, or do I start an allocated pension?
Thankfully the recent changes to superannuation mean that both withdrawals from superannuation and allocated pension payments are tax-free for those over age 60. If you are less than age 60 there can be some tax on lump sum withdrawals and income streams. The catch for those choosing to leave their benefit within super is that there is 15% tax levied on all earnings within any super fund.
If your investments within super can earn 5% then you are left with 4.25% (or thereabouts depending on any franking or other tax credits). If your money was in pension mode and invested in the exact same investments then you would have the full 5% credited to your account and any franking or other tax credits would be extra earnings. On a $500,000 pension this could be as much as $3,750 per year in extra earnings.
The next issue is the underlying “Guaranteed’ fund you are investing into within your superannuation.
Many “Guaranteed” investment funds are either safe cash-type investment funds, or diversified-asset funds where the manager declares an earning rate of less than what is actually earned. They then credit excess earnings to a reserve to use to “smooth” earnings in future years when there might be poor returns delivered by the market. In essence the manager is taking the risk.
But are they really taking a risk? Investment into growth assets have shown superior returns compared to cash over the longer-term and patient investment managers know this. Most diversified funds have returned on average 8% or better over the long term whereas purely cash funds have averaged only 4 – 5% each year.
To offer 4% as a “Guaranteed” return would not be a serious challenge to most managers as most cash funds have returned in excess of this rate for most years, even after superannuation earnings tax. Sadly many retail guaranteed funds were closed to new investment after the previous market downturn when reserves were exhausted.
I guess the fund managers offering those types of funds felt that the risk they were taking wasn’t supported by the level of fees they were able to earn managing such funds, or the guaranteed returns weren’t attractive enough in the current investment climate to attract sufficient depositors who felt they could do better by taking the risk themselves. And my experience with “Guaranteed” funds is that if returns are downturned and reserves are exhausted then the future declared returns are trimmed downwards to compensate. So I seriously question the amount of risk the manager really takes.
My advice to an investor in a guaranteed superannuation fund who feels that the “guarantee” is very important to them and they would be better served starting an allocated pension is this. Why not ask if their superannuation provider also offers the equivalent “Guaranteed” product within their pension fund as well? And also ask if the actual investment can be transferred across from super to pension? There are a number of providers that can transfer assets like this between their super and their pensions.
And consider this. Is investing all your retirement capital into a “low-returning Guaranteed” investment the most prudent action for a long term investor. If you had $500,000 “Guaranteed” at 4% and you needed to live from the 4% earnings it generated, that $500,000 today would only have the purchasing power of $369,000 in 10 years time. And the $20,000 earnings would only purchase the equivalent of $14,760 of what it could buy today. How safe do feel that investment was after all?
If the answer is negative, then the investor really needs to examine how essential the “Guarantee” really is, in light of the low return on offer compared to safe cash rates offered by numerous other pension providers, and an investor’s need to protect against the eroding effects of inflation. Remember you always get what you pay for, you just need to know what you are actually getting.
Paul Jackson is a Brisbane-based Financial Planner with MacDonnells Financial Services, which is licensed under FYG Planners.
Disclaimer: This article is general in nature and is not intended as investment advice. Readers should always seek further advice before making any financial decisions.