Retirement in 2007: Time for a rethink!

Tim Wedd

Managing Director, Financial Essentials

24 November 2006

A focus on ‘total wealth’

AgendaIssue 1: Lifestyle Transition

(how & why)Issue 2: Retirement

(before or after age 60)

Issue 3: Lump sum v Income (a new challenge)

Federal Budget 2006

• Fundamental shift• Lower effective MTRs

• Plus super reforms

How will you optimise the benefits?

What’s the impact on retirement?

Taxpayer Type Tax-free $

Individual taxpayer (< pension age)

$10,000

Age Pensioner (single) $24,867

Age Pensioner (couple) $20,680 each

Super pension (< age 60) $32,900 each

Super pension (age 60+) $ unlimited

Realigning perceptionsPreviously… From 1 July 2007…

Surcharge impost Max 15% contribution tax

Tax-advantaged savings ? 0% exit tax (over 60)

RBL & LST problems Fund tax (< 15% or 0%)

Lack of super access Super contribution splitting

Constantly changing rules Greater access from age 55

Complexity Individual ‘choice’ required

The Core Tax Package

A fundamental baseline…

+ $uper

…what else?

Alternative options

Gearing stock takeRelies on tax savings to offset project costs

• both assessable income & capital growth required

Generally long-term propositionOften property centricTest assumptions & perceptions

Savings analysis Target similar annual net cash flow cost each year Salary sacrifice $ increases with higher MTR Assume 7% pa net super fund returns*

Savings Plans (gross incomes)

Gross Salary Cost (inc. ML)

Net Super Cont (pa)

After-tax Equiv. cost

< $75,000 (30%) $14,599 $12,409 $10,000

< $150,000 (40%) $17,094 $14,530 $10,000

> $150,000 (45%) $18,692 $15,888 $10,000

* cash distribution = 3.3% pa. (50% franked) plus 4% pa. growth

Testing the theoryIllustrates the gap between super and non-super savings at higher MTR for a total cost of $100,000.

Considers:All CGT, super taxes; no indexation of savings; geared loan of $325,000 at 8.6% pa.

$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

$140,000

$160,000

$180,000

$200,000

$220,000

$240,000

$75,000 (30%) $150,000 (40%) $150,000+ (45%)

Gross Income ($)

Projected 10 Year After Tax Results(assumes $10,000 pa net savings, 7% pa net super earnings)

Deductible Super (0% tax after 60) Deductible Super (16.5% tax < 60)

Geared savings (equivalent MTR) Non-super savings (equivalent MTR)

$208K

Key observations• No longer just an annual ‘tax savings’ story

0% lump sum tax changes the relativities Self-employed & employed finally equal

• Tax-advantaged strategies need tax benefits Dramatic shift in incomes to reach 45% MTR

• Franking credits & CGT discounts Protect 30% MTR clients (income < $75,000) Narrow the savings gap (under age 60)

• Maximise Gov’t Co-contribution (income < $58,000)

Lifestyle Transition

• Why the fuss? Helps extract the value at the end Over age 55 (currently) Tax favoured income (< age 60) Pension premium (0% tax in fund) Tax-exempt income (from age 60) No RBLs & no reporting

Lifestyle transition

• Points to remember… No work tests Available for new flexible pensions Non-commutable until ‘unpreserved benefits’

• can cash and roll back to super at any stage

Complying pensions & annuities• Relevant for purchases prior to 20/9/07

• Remain non-commutable (post purchase!)

• Can cash and roll back during 1st 6 months

Lifestyle transition

• If purchasing under 60 Assessable income in pensioner’s hands New! Annual deductible amount based on the

calculated exempt component

• ETP components still matter

• Draw down components in proportion 15% tax offset on taxable part of annual

pension payments

Boosting savings levels

• TTR in practice… John currently aged 55, earns $125,000 pa. Proposes to ‘salary sacrifice’ $50,000 p.a. Current super balance = $450,000 Assume gross fund earnings of 8% pa. (i.e.

7% pa. net of 12.5% average fund tax)

What actually happens over the next 10 years?

TTR illustration

John @ $125,000 pa. Salary as cash Sal Sacrifice + Pension

Gross Salary 125,000 75,000

Salary Sacrifice (40%) 0 (50,000)

FAP Income (Gross) 0 40,000

Taxable Salary/Income 125,000 115,000

Income Tax (excl. ML) (37,850) (27,850)

Target Net Income (pa) $87,150 $87,150

TTR illustration• The bottom line…

Change in Super Benefits Total $

New Salary Sacrifice +50,000

• Less Contributions Tax -7,500

• Less Pension Gross Payments -40,000

Plus earnings tax saving (at 12.5%) +4,500

= Net savings in super $7,000 pa.

Pension income can reduce to $30,000 pa from age 60= Net savings in super $17,000 pa.

TTR results

• Now project forward 10 years...

Strategy position (at age 65) Totals $

Remaining TTR pension balance 450,249

Plus – new super contributions ($50,000 pa) 609,234

Total accumulated super assets 1,059,483

Less: existing accumulated $450,000 super (885,218)

Additional (TTR) strategy benefits $174,265

Retiring: Before/After 60

• Does it matter? Consider short-term funding issues

• $1M contributions prior to 30/6/07

• Ongoing access to $450k limits (3 yrs)

Pensions favoured under age 60 Debt management strategies Using tax-deductible contributions Contribution splitting (reverse order) New! Small business CGT concessions

What about debt management?

Potential Options• Continue with existing mortgage/loans for current terms

and capital/interest repaymentsOr• Pay interest only now and ‘salary sacrifice’ balance (extra

cash) as additional super contributions

Target 10 year repayment plan in both cases (equal cash flow)

Case study: Mary currently age 50Potential combinations considered:

Earning $175,000 with $200,000 loan balance Earning $125,000 with $150,000 loan balance Earning $75,000 with $100,000 loan balance

Originally, 25 year P&I mortgages set at 7.5% pa.Assume:Interest only loan rate = 8.0% pa.

Net super fund return = 7.0% pa.

Debt Illustrations

Debt v Super Outcomes

Remaining Loan $

Gross SalarySuper

Gain/Loss

$200,000 $175,000 + $78,400

$150,000 $125,000 + $41,400

$100,000 $75,000 + $9,400

Assumes all lump sum withdrawals occur tax-free after age 60.

Management Issues

• Using debt Key is pre-tax dollars and 0% tax Similar principles for extra debt repayments Consider contribution caps

• Generally only $50,000 pa. available

• What else will contributions be used for?

Assess risks (interest rates, legislative) Note super preservation issues

Lump Sum v Income

Some of the challenges… Cash out and/or re-contribution? Model portfolios, guarantees? Super v Pension tax rates Super v Non-super income (MTR?) How much to leave outside super? Estate planning for non-tax dependants?

Age Pension can help

• Major adjustmentRemoval of 50% Assets Test exemption from

20/9/07 for new complying incomesKeep existing product status (100% or 50%)

Plus 50% improvement in Assets Test Single homeowner cut-out (circa $515,000)Couple homeowner cut-out (circa $820,000)

• Consider Mike (age 65) and Jan (age 63) Mike has $480,000 in super $70K personal contents, car and a caravan Currently they seek income ~ $40,000 p.a.

• Option 1 is to simply use allocated pensions

• Option 2 is to consider impact of AT changes

Short-term TAP revival

TAPs and the Assets Test

Income AssessmentOption 1 Now

Option 1 20/9/07

Option 2 20/9/07

Allocated Pension – Male age 65 40,000 33,000 16,800

TAP - Min income, 35 Year Term - - 11,250

Age Pension ($) – Eligible couple - 10,603 15,139

GROSS INCOME ($) 40,000 43,603 43,189

* Assumes: current pension rates & thresholds index at 2% pa; 7% pa for all pension fund earnings. Figures reflect Assets Test impact in Year 2.

Option 1 = 100% AP; Option 2 = 50% AP/50% TAP solution.

Capital issues

• What happens over time?

Improved total income returns to age 100 Improved longevity with age pension support

Remaining Capital $ Age 70 Age 80 Age 90

Option 1. 100% AP 474,023 435,822 259,332

Option 2. 50% AP/TAP 502,650 529,058 416,722

Now to simplification…

What about it? • New! transitional contribution rules• New! annual contribution limits & penalties• New! tax components (maximise exempt)• New! death benefit issues & pensions• Pre-30/6/07 & Pre-20/9/07 planning options

watch, assess & prepare to implement quickly!

Conclusion

What will 2007 bring?• An emphasis on ‘Total Wealth’

• Need for annual reviews & plans

• Increase in debt products

• Focus on effective capital management

• Further investment options/models

• Removal of product boundaries

Put simply, it will be all about lifestyle!