What Next for Self-funded Retirees?  26th May 2009

Self-funded retirees who are invested in the sharemarket have arguably been the hardest hit by the global financial crisis.

Many may now be wondering if they should move their account-based pension into a more conservative investment portfolio, which contains less growth assets such as shares and property.

So we went back through history to see the impact that switching to a more conservative portfolio would have had, if done after a major market fall.

We also outline some strategies you could discuss with your financial adviser to help you weather the storm.

What is an account-based pension?
Before we reveal the lessons we can learn from history, we thought it was worthwhile going back to basics to explain how account-based pensions work.

An account-based pension enables you to invest your superannuation savings and receive a tax-effective income to help meet your living expenses.

By law, you must draw a minimum (1) income from the pension. This is calculated as a percentage of your account balance based on your age at 1 July each year.

Most people elect to receive the minimum payment, but it is possible to draw a larger income depending on your needs.

What impact would switching investments have had after a market fall?
To answer this question, we calculated the minimum income payments a 60 year old would have received in two different scenarios.

Firstly, we looked at what happened if:
they invested $300,000 in an account-based pension at the start of some of the worst one-year periods since 1900, and
selected a portfolio made up of 70% in growth assets.

Then, we calculated the minimum income payments they would have received if they switched their account-based pension at the end of the first year into a more conservative portfolio, made up of 30% in growth assets.

The graph below shows the difference that switching into the more conservative portfolio would have made to the minimum income payments.

In other words, it demonstrates the increase (or decrease) in pension payments that would have resulted from changing the investment strategy.

As you can see, in some instances, switching to the more conservative strategy resulted in a modest increase in income payments over the short term. This was particularly the case for the pensions commenced in 1930 and 1970.

However, over the longer term, switching generally resulted in lower pension incomes. This was because, in addition to locking in the investment losses, the more conservative portfolio didn’t benefit as much when sharemarkets recovered.

While history provides no guarantee for the future, this research suggests that staying the course is likely to be a better option for people who have a suitable time horizon and risk tolerance.


What other options do retirees have?
It’s understandable if you are concerned about the impact the global financial crisis is having on your retirement savings.

There are, however, some other strategies you could consider discussing with your financial planner that could help improve your long-term prospects.

For example, you may now be eligible for greater Centrelink benefits because of the reduction in the value of your assets.

As a result, you could consider reducing the income payments you receive from your account-based pension if you are currently drawing more than the minimum (1).

Alternatively if you are already receiving the minimum1 income, you could spend less and save the difference, in a unit trust for example.

Both these strategies can leave more of your money in the sharemarket to participate in the eventual recovery.

Another option is to return to either full or part-time work. This could enable you to use the strategies outlined above.

You may also be able to contribute more into super and build up your retirement savings.

We can help you work through your personal circumstances and determine which strategies may be right for you.

(1) On 18 February 2009, the Government announced it will reduce the minimum pension payment requirement by 50 per cent for the 2008/09 financial year. If you’ve already received half of your current minimum payment amount, you can choose to stop receiving or reduce your pension payments for the rest of the 2008/09 financial year. For more information, please speak to your financial planner.

Important information: We have assumed the current account-based pension rules applied throughout all periods. All incomes are in today’s dollars. The asset class returns used in this analysis have been calculated by MLC and incorporate data presented in DMS Data Module offered through the Ibbotson Associates’ software program EnCorr. Based on copyrighted books by Dimson, Marsh, and Staunton, Triumph of the Optimists, Princeton University Press, (c) 2002, and Global Investment Returns Yearbook 2004, ABN AMRO/London Business School (c) 2004. All rights reserved. Used with permission.

(Courtesy of MLC)