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Hewison Insights

Capital preservation in retirement

Chris Morcom
Partner/Private Client Adviser
24 May 2016

Last week, former Treasurer Mr Peter Costello warned that the Federal Government’s proposed changes to superannuation transfers – which would put a cap of $1.6 million on tax-free superannuation pension transfers – will not be as beneficial for retirees as promised.

The government has claimed that a proposed pension balance of $1.6 million can support an income stream in retirement around four times the level of the single Age Pension. A statement that caused Mr Costello to express doubt, claiming it would require retirees to draw down on their capital.

Why is capital preservation in retirement important?

Preservation of capital is especially important in the retirement phase because it ensures retirees will have enough funding to last them in their old age (especially if they live into their late 80’s and 90’s). It also acts a buffer should the markets experience a downturn, because retirees have limited time to recoup losses.

So, let’s crunch the numbers

The full single age pension is currently $22,783 per annum, so four times that amount would be $91,132 per annum. A retiree with $1.6 million in a superannuation pension, withdrawing $91,000 per annum, would need to generate a return in excess of 5.7 per cent per annum, to ensure they are not drawing down on their capital when taking their pension.

Theoretically, this rate of return could be achievable over the longer term via a diverse portfolio of investments. However, many retirees have their retirement funds sitting in less risky asset classes like term deposits. Given the historically low interest rates we’re currently seeing – that many experts believe will hang around for a long time to come – it would not be possible to achieve a return of 5.7 per cent per annum, while maintaining a large investment in term deposits or cash.

A point the former Treasurer conveniently ignored is the minimum annual pension requirements. To ensure their super fund withdrawals meet with legislative requirements, retirees over 65 years of age must withdraw at least 5% of their superannuation balance annually. This amount increases to 6% at 75, 7% at 80 years of age and 9% at 85 years of age.

The increasing rate of required drawdown forces retirees to begin removing their capital from superannuation as they age. A wise decision is to ensure withdrawals in excess of annual income needs are reinvested outside of superannuation so as to protect capital over the longer term.

The upshot?

The message is fairly simple – retirees need to seek advice to ensure their asset allocation will provide the income needed, otherwise they will start to spend capital and potentially run out of funds prematurely.

There are a range of choices retirees could adopt, including:

  • Review your investment strategy and consider diversifying your portfolio by investing in more volatile asset classes than term deposits (but again this comes with higher risk).
  • When interest rates are low, lower your income standards. Interest rate cycles come and go, and we will eventually see rates rise again in the future. As with all investment markets, it is important to be conservative with long term expectations, and not unrealistic.
  • Seek advice from a qualified professional adviser who can help lighten the burden and navigate a sensible solution.

Any financial product advice provided is general in nature. It does not consider your needs, financial situation or objectives. You should consider the appropriateness of this advice to your circumstances before you act on it.

Hewison Private Wealth is a Melbourne based independent financial planning firm. Our financial advisers are highly qualified wealth managers and specialise in self managed super funds (SMSF), financial planning, retirement planning advice and investment portfolio management. If you would like to speak to a financial adviser on how you can secure your financial future please contact us 03 8548 4800, email info@hewison.com.au or visit www.hewison.com.auPlease note: The advice provided above is general information only and individuals should seek specialised advice from a qualified financial advisor. The views in this blog are those of the individual and may not represent the general opinion of the firm. Please contact Hewison Private Wealth for more information.