Advisers have spent hours working out long-term retirement plans for clients. But those plans may have been disrupted by changes to Centrelink asset thresholds which come into force at the start of 2017.
Under the changes, some clients will lose pension payments entirely, while others will have them reduced under the changes.
Advisers are not only having to re-evaluate long-term projections, but also the strategies their clients will need to fund retirement. Capital, for many clients, has suddenly become much more important.
Advisers need to become more mindful of how a client’s capital can be managed to replace lost pension income, and they may need to consider bolstering their strategy and product toolkit to help clients have more certainty around retirement cash flow.
The three elements of changes
It has been estimated the changes mean more than 50,000 additional Australians will receive the full Age Pension. However, around 300,000 retirees on a part pension will have entitlements cut; and around 100,000 will lose entitlements altogether.
There are three elements to the changes: the lower threshold, upper threshold and the taper rate.
The changes increase the assets test lower threshold below which clients are eligible for the full pension. For example, the asset threshold for a single homeowner rises from $210,000 to $250,000; for a home-owning couple the threshold rises from $298,500 to $375,000.
The Age Pension assets test taper is also increasing. Pension payments will fall by $3 a fortnight for every $1,000 of assets above the lower assets test threshold. Currently, the taper is $1.50 (75 cents each for couples) per fortnight, which means from 1 January 2017 pensions will reduce at a faster rate.
This means that the upper threshold, above which a client is ineligible for a part pension, will be reduced. For a single homeowner, the upper threshold falls from $804,500 to $542,500; for the home-owning couple, it falls from $1,194,000 to $823,000.
Many advisers will therefore have clients, both close to retirement and in retirement, who will be losing retirement income.
A tale of lost pension income
As an example, a homeowning couple, Graham and Helen, are over 67. They have $770,000 combined in an account-based pension (ABP) and $30,000 in lifestyle assets.
The couple need $50,000 per annum (indexed) to meet their desired lifestyle. Using the pre-1 January 2017 pension rules, they could achieve that without drawing down on capital.
Centrelink Age Pensions would be around $15,365 per annum, and the sustainable after-inflation investment return (of around 4.5 per cent) on the $770,000 would be around $34,650, giving a total income stream of $50,015.
But after the changes, the age pension would slump to just $1,773 per annum, a significant fall of $13,592. The shortfall between their total income (the pension and investment return) of $36,423 and the $50,000 needed to fund their lifestyle is $13,577.
Other clients, of course, will have pension payments eliminated altogether.
Capital drawdown: suddenly an elevated issue for many clients
Many advisers will no doubt look at improving their client’s Centrelink asset position, or adjusting their client’s retirement goals and expectations.
But that shortfall will also need to come from capital drawdowns: withdrawing capital to fund retirement needs.
So, from the start of next year management of capital drawdowns is likely to be elevated as an issue for advisers and their clients.
Advisers are going to have to access processes, strategies and funds that adequately manage capital drawdowns, and particularly the risks that it creates.
New risks to be managed
A major risk when drawing down capital is sequencing risk. Clients have their largest exposure to investment risk when they retire; a sharp market down turn early in their retirement can lead to your client’s money running out unexpectedly early.
Before the assets test changes, a sharp market down turn early in Graham and Helen’s retirement would be manageable since they were only living off their income – their capital would be preserved long enough for the market to recover.
However, under the new rules, now that Graham and Helen are drawing down on their capital to supplement the government pension, they may be selling assets during a temporary market downturn at supressed prices. That could dramatically impact the value of their assets and the period they can expect to live off the drawdown in those assets.
For Graham and Helen, a drawdown management strategy or process will provide greater transparency. Clients will benefit from visibility around how much has been drawn down, but also, importantly, greater detail around how long their capital is going to last.
To optimally manage capital drawdowns, advisers will also need to address the issue of providing clients with access to tailored investment strategies that manages downside risk, as well as managing inflation and cash flow risk.
What’s more, a targeted level of liquidity would also needed to be maintained for retirees to be able to access greater parts of their capital for emergency situations.
Additions to an adviser’s toolkit
Advisers will play an important role in the management of capital drawdowns. Advisers will need to work out a client’s drawdown rate, perhaps using a bucket approach to address sequencing risk, where they would keep a few years of a client’s assets in a low-risk strategy to draw up in the event of a market downturn.
But to enhance their ability to manage the capital drawdown process and deliver their clients a well-funded retirement, advisers may also need to turn to a growing suite of new products, including funds that provide cash flow streams from both income and capital.
AMP Capital has launched a series of funds, The Future Cash Flow Range, designed to allow advisers to manage the specific challenges their clients face when drawing down capital to fund retirement. In the next edition we’ll explore how these products help advisers manage the specific challenges their clients face when drawing down capital to fund retirement.
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