While conducting a client review last week, I came across a strategy that might have some application for others. The story also has some good lessons about investing for the long term.
The background story
Let me tell you about Paul. At age 62, Paul received a $550,000 inheritance from his mother and came to us for advice in 2007. By October 2007, the advice was complete and he made a $450,000 non-concessional contribution to a superannuation account in a wrap service and immediately invested in a portfolio of direct Australian shares (the All Ords was about 6,650 at the time) with some allocated to cash.
By March 2009, with markets hit by the GFC, at age 64, the super fund balance was $292,056 (All Ords about 3,100). He had not made any further contributions. Paul needed income, so he started an account-based pension, staying invested for the transition. The share portfolio did not need to be sold down and re-bought. You can do that with a wrap service, one of the many reasons they can be an interesting alternative to an SMSF.
Through the subsequent years, Paul’s share portfolio, although prima facie down in value, continued to pay dividends. The account’s share portfolio generated enough dividends supported by the cash allocation to meet all fees and the pension payments. He wasn’t forced to sell down the shares, nor did he sell down out of panic.
Fast forward to today. Paul’s account balance is back up to $360,000 (All Ords about 5,200), and he has received $117,000 in pension payments along the way. If he had panicked and sold down all his shares to cash, it would be a very different story for him.
Paul remained focussed on the dividends and being an investor in the businesses he owned a share of. He was invested in good companies in important industry sectors, with strong balance sheets making strong profits and paying reliable dividends. If a company no longer met those criteria, he listened to advice and then and only then would he sell to reinvest into companies that did.
The Income Test kicker
Paul is married and claims a part age pension assessed under the Income Test. Account-based pensions are not deemed for the Income Test. (In the May 2013 Federal Budget, the Labor Government proposed to ‘deem’ new account-based pensions that commenced on or after 1 July 2015. At the time of writing, no legislation has been drafted, and the Coalition Government’s stance on this issue is unclear). The pension income drawn is assessable by Centrelink; however, it is reduced by a ‘deductible amount’. This deductible amount is calculated as the purchase price divided by the member’s life expectancy at the time of purchase. For Paul, this formula worked out to be: $292,056 / 22.85 = $12,781
With Paul drawing an annual income of $36,000, Centrelink assessed him as receiving $23,218 assessable income from the account-based pension, and that was really hitting his and his wife’s age pension benefits.
Now that Paul’s account balance has come up again, and his life expectancy is lower because he’s aged a few years (it is now 15.49 years), we have decided to re-set the account-based pension so that the deductible amount formula is now: $360,000 / 15.49 = $23,241.
Of the $36,000 a year he is drawing, Centrelink will now only count $12,759 and as a result his age pension income will go up by as much as $172 a fortnight.
How does he re-set his account-based pension? He just rolls from his current account to a new account-based pension in the same wrap service. Again, in his case, there is no selling down of investments to then re-buy them (and in the process incurring brokerage charges). With his wrap account, the shares he already owns are transferred to his new pension account: it’s just a matter of paperwork. You can do that with a wrap service, and in fact you can also do it within your SMSF – it just requires paperwork.
With the markets recovering, if you are a part pensioner assessed under the Income Test and have an allocated or account-based pension, check with your adviser to see if it’s worth re-setting the deductible amount to improve your Income Test. It’s a quick and easy calculation with great ongoing potential benefits.
Alex Denham was Head of Technical Services at Challenger Financial Services and is now Senior Adviser at Dartnall Advisers.