Is your lifetime pension financially sound?

SMSF technical expert and columnist for The Australian newspaper
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Today I’m going to explain lifetime pensions, a type of income stream that provides defined income payments for the duration of the pensioner’s life as well as the life of their reversionary beneficiary (if one was nominated when the pension commenced).

Lifetime pension payments are a benefit promise – that is, they’re guaranteed to be paid.

These pensions are purchased and they typically commence when the purchase price is converted into an initial annual income amount and, if required, an agreed level of periodic indexation (typically, payments are adjusted for consumer inflation but occasionally some people have managed to negotiate a better arrangement such as wage increases).

These products are similar to annuities, the major difference being that lifetime pensions are purchased from a super fund, while annuities are purchased from a life insurance company.

Lifetime pensions are the oldest form of pension available from super and have been around since retirement benefits began in the nineteenth century. Before December 1992, only lifetime pensions could be paid from an Australian super fund.

There are two major disadvantages with these products. Firstly, when you and your spouse die, any remaining lump sum stays in the super fund, which means nothing is available for your estate. Secondly, if you had to start this type of pension when market interest rates were low, then your pension income would often be quite low too. The reverse of this could also occur, and this has benefitted some people who started a lifetime pension in the early 1990s when interest rates were more than 15% plus indexation.

Typically, these pensions could only be paid from larger retail and corporate super funds. The financial management of these products has always been left to actuaries.

You might recall that between 1988 until 2007, the Reasonable Benefit Limit (RBL) boondoggle reined over the Australian super system. For reasons that are unimportant now, these lifetime pensions were treated very favourably under this RBL assessment system. This delivered significant tax advantages to investors who used this type of product.

In addition, the assets used to purchase these pensions were exempt from Centrelink’s Assets Test.

In the early part of this century some wiser heads asked actuaries if a lifetime pension could be payable from a self-managed super fund. Investors were after three extremely valuable and attractive benefits:

  1. the RBL tax advantages;
  2. the distributable assets left in the SMSF when the pensioner and their spouse died; and,
  3. Centrelink’s Assets Test exemption.

For a while, SMSF lifetime pensions enjoyed a moment in the sun with many reasonable wealthy retirees using these products.

But in the 2003 Federal Budget, the Government announced that SMSFs would no longer be allowed to provide new lifetime pensions. This restriction finally came into effect in late December 2004.

Any SMSF still paying a lifetime pension must get it reviewed by an actuary each year. The purpose of this review is to make sure the pension is financially sound and the super fund trustees will be able to meet their future pension payment obligations.

A lifetime pension will only be financially sound in an SMSF if an actuary is very confident about its future prospects.

The GFC – and its lingering financial market impacts – have caused many SMSF lifetime pensions to become financially unsound.

As a result, many of these lifetime pensions in SMSFs have had to be restructured. Typically, the investors have had to move to another type of pension called a Market Linked Income Stream or they have had to agree to reduced pension payments.

Under normal Centrelink rules, if you restructure or get out of a lifetime pension, you lose any concessions that were attached to those pensions. However, Centrelink has put in place rules to be lenient in some circumstances.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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