Powering up the pension

PORTFOLIO POINT: Many pensioners are facing massive increases in the minimum super pensions they draw this year. Here’s how you can deal with it.

Hands up if you want more income?

It sounds like a rhetorical question, with the logical answer being everyone.

Not so.

Many readers will be forced to take dramatic rises in their incomes this financial year. And those increases might neither be particularly wanted, nor easily controllable.

Why? As of 1 July, minimum pension payments were returned to their “normal” rates, ending five years of government-allowed reductions that allowed pensions to retain capital during the worst of the Global Financial Crisis.

Add stellar performances for some/most portfolios in the FY13 year and some pensions will potentially be forced to take an income from their super fund of double what they took last year.

Some of you might wish to do this. Others won’t. (If that’s the case, I’ve got some tips below that might be useful for some of you.)

The history

In 2008, as market chaos was at its height and the dark curtain of the Global Financial Crisis was descending, the government kindly put a short-term measure in place to reduce the need for sell assets (to meet pension payments) at the bottom of the market.

Initially, they reduced the minimum pension required to be drawn by 50%. It was only supposed to be for a year, but got extended.

With some improvement in markets, though continued volatility, the 50% discount was reduced to a 25% discount for the past couple of years.

It was always intended that the minimum pension drawdown figures would go back to normal, as they now have.

The problem

As of this year, there are two forces that will have huge upwards impacts on the minimum pension you must take from your super funds.

The first one is the removal of the pension minimum discount, as outlined above. Even if there has been no increase in the value of your pension fund, you will have to draw an extra 33.3%, from the removal of the minimum pension payment discount.

Table1: Back to “normal” minimum withdrawals

Secondly, the investment gods have smiled on us this year. The Australian share market did around 22%, including dividends. Anyone with listed property and international shares got a kicker on top of that.

Typical balanced funds will score a rating of around 15-17% for the financial year just completed. (It was not a great year for cash and fixed interest.)

Let’s assume that sort of a return and a 62-year-old pensioner. If a $1 million pension fund grew to $1,150,000, then the pension the pension that person must taken has increased from $30,000 to $46,000 – an increase of 53.3%.

And there’s a kicker for some

But if you have had a birthday that has put you into a new band, your pension will have increased significantly more.

If someone has turned 65 during last financial year, their pension on the $1 million fund that has increased to $1,150,000 will have increased by 91.7% from $30,000 (3% of $1,000,000) to $57,500 (5% of $1,150,000).

The biggest increase is actually for those who have turned 85 during the 2013 financial year. They will have seen an increase from $52,500 to $103,500 – a 97% rise.

You wouldn’t need much outperformance above 15% to have seen the minimum pension requirement double.

What can you do?

There are two main ways you can deal with this issue. But both options aren’t available to everyone. And they come with conditions.

The first is to recontribute the extra payments back into your super fund’s accumulation account. Obviously, in order to do this, you need to be able to make contributions to your super.

This requires meeting the “work test” of working 40 hours in a given 30-day period during the financial year. Meeting the work test allows you to make both concessional ($25,000) and non-concessional contributions ($150,000) to your fund.

This will not be too difficult for younger pensioners who are still working, but might be on a transition to retirement pension. But it might pose problems for older pensioners who simply don’t work and have no intention of doing so.

The second option is to “roll back” your pension, or a part of it, to accumulation phase.

You can roll back a pension to accumulation at any stage. This means moving the assets from being in a pension fund to being in an accumulation fund. As they are no longer assets of the pension fund, they are no longer included for the purposes of being an asset on which to pay a pension.

The downside of this is that accumulation funds pay tax (which is why the government allows this to occur). Any assets moved back into accumulation will incur 15% tax on income earnings and 10% tax on long-term capital gains.

It’s not something to be done lightly. The tax benefits of a pension fund are considerable (no tax on income or gains), which needs to be weighed up prior to considering this.

Another thing to consider is the capital gains that have been achieved, particularly during FY13. If you were to switch these assets back to accumulation and then to sell them, they would incur CGT.

In some cases, it might be worthwhile to sell the assets in pension phase, move the cash to accumulation and then repurchase new assets (but be very careful of the “wash sale” rules).

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The information contained in this article 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 strongly advised to consult your adviser/s, as some of the strategies used in these articles are extremely complex and require high-level technical compliance.

Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking. E: bruce@castellanfinancial.com.au