PORTFOLIO POINT: Looking to adjust your pension mid-year because of market volatility? Here’s a strategy to keep in mind.
Super pensions can be a relatively simple affair. Take the value at June 30 of the previous year and decide what percentage – within your limits – you want to take for the year.
If you’re on a transition to retirement (TTR) pension, then you’ll generally take between 4% and 10%. If you’re not, then you just have to worry about minimums.
It should really be as simple as that. But, of course, it usually isn’t.
Market volatility can play havoc with a super pension. Plummeting fund balances – caused by the likes of recent fluctuations – can mean that taking the percentage balance that was set by the value of your pension fund on June 30 might cause some heartache. And worse, it can mean having to sell positions when they’re at low points.
The best example of this was following the plunge between November 2007 and March 2009, when the value of Australian shares fell 55% from top to bottom. In response to this, the Federal Government halved the minimum pensions that were required to be taken by super members. Those rules applied for FY2008-09 and FY2009-10.
For FY2011-12, the 50% reduction in the minimum pension has been reduced to a 25% reduction.
But what happens if your $1 million pension fund fell by 20% between 1 July and September 30 (and is still kicking around those lows)? Are you stuck taking your nominated percentage of a fund that’s falling in value and thereby crystallising assets that have fallen in value?
The answer is no. There are many things that you can do about it. Today, we’ll discuss one – rolling back a portion of your super pension to accumulation – and we’ll look at other pension strategies in the coming weeks.
Let’s start with a table that shows the current pension minimums:
Table 1: Pension minimums
|Age||Legislated minimums (%)||FY2011-12 minimums (%)|
Roll back super to accumulation
If you find yourself in the position of having to take a pension that now seems too big, one thing to consider is whether or not you should send some of your pension back to accumulation.
That is, if your pension fund was worth $1 million on June 30, but has since fallen to $800,000, you might no longer want to take 5% or even 3.75% of your June 30 pension (if you’re between 65 and 74), which would be $50,000 or $37,500. Or 4%/3% if you’re 64 or younger.
In this case, you could potentially roll back a portion of your pension to accumulation.
For the purpose of this example, let’s assume the date is January 1, 2012 (so, in about five weeks’ time). And we’ll assume our pensioner is aged 70.
If you were to roll back, for example, half of your pension to accumulation, you would have had $1 million in pension for the first half of the year. If your pension fund had dropped from $1 million to $800,000 to December 31, then if you rolled back half of your pension to accumulation, then you would be rolling back $400,000.
You would have to take the proportion of each size of pension for each period.
That would mean that for half of the year, you would need to take a minimum pension of 3.75% of $1 million for the year, pro-rated for half of the year. That would be $18,750 ($1 million x 3.75% x 0.5 years).
For the second half of the year, after half of the $800,000 has been rolled back to accumulation, you would need to take $7500 ($400,000 x 3.75% x 0.5 years).
That would leave a total pension of $26,250 needing to be taken for the year. And, if you’re trying to preserve capital, that figure is $11,250 less than you would have to take if you were taking a full 3.75% pension on your original $1 million.
Operating within your pension limits
This applies most to people who want to operate at the lower end of their pensions. And there are many people who want to do that, potentially because they are still working, or drawing incomes from elsewhere or are simply taking a pension to have their fund remain tax free. For recent columns on that strategy, click here (22/6/11) and here (15/6/11).
When you have turned 60 and have retired, then there is no upper limit on accessing your super tax free. If you are still working, then you need to wait until you are 65 to be able to have limitless access to your super tax free.
But be aware …
By rolling back some of your pension to accumulation, a few things happen. Primarily, the funds, or assets, become subject to taxation within super again, which comprises of 15% for income (and short-term capital gains, which are treated as income) and 10% for long-term capital gains.
When funds or assets are in pension phase, they are tax-free from income and capital gains. So, in the above example, rolling back $400,000 to accumulation would make any income from those assets taxable (at 15% for income and 10% for capital gains).
Therefore, it could make sense when this is being considered, to roll back those assets that pay low or no dividends (such as BHP Billiton or Rio Tinto shares) to accumulation, while maintaining those assets that do pay higher dividends, such as the banks, within your pension.
Then, when asset values appreciate again, they could be the assets that are transferred back into your pension (or a new pension).
The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are advised to consult your financial adviser.