Trustees of self managed super funds face greater pressure on their investment strategy with the Reserve Bank of Australia’s signal of even lower interest rates.
The reason: ATO distribution rules will require funds to increase the pension payments as a percentage of assets in the coming year.
Just when SMSFs face short-term interest rates below 4%, the rules will now force them to meet minimum payments one-third higher than in the 2012-13 year just ending. SMSFs will need to overlay a target return on any safety-first asset mix to meet the required higher payout.
The minimum pension distribution requirement for members in the 55-65 age bracket will rise from 3 to 4% return on assets for the coming 2013-14 year, while those in the 65-74 bracket will see the minimum rise from 3.75 to 5%. SMSFs can, of course, use cash reserves to meet the minimum but, with up to two decades of retirement ahead, most will prefer to cover their payouts from earnings to remain sustainable.
This pressure to achieve higher returns will clash with many SMSFs’ desire to protect their capital and avoid losing money, if the booming stock market starts to waver. The problem is that Australian super funds don’t have all the tools to manage this.
Our system has to fight this battle of retirement incomes without the ability to use annuities because some decades ago there was a tacit agreement to adopt a second best approach of paying pensions from an invested lump sum, rather than developing an annuity market. Few Australians understand or like annuities, except actuaries who love them, and despite much talk it seems that annuities are not on the immediate radar.
For fund members nearing retirement, this means both institutional and self-managed superannuation funds are forced to run their own risk insurance in the absence of a big pool of funds provided by traditional, life insurer-run annuities (or even a government-run system).
And the Reserve Bank’s lower interest rate signal simply confirms it would be a lousy time to consider annuities. Potential providers won’t want to guarantee future incomes by investing in low-yielding bonds and few investors want to commit to very low incomes they can buy with their lump sums.
This adds a new degree of difficulty to the accepted so-called lifestyle approach to investing funds near retirement. Earlier, it all sounded so easy: reduce equities and increase fixed interest holdings as you got older to protect against volatile equities.
But with already low bond yields likely to fall further, the bond market not only offers lower income but also the increased chance of an inevitable market bust. In a belated and ill-timed move, a helpful government has announced plans to make it easier for investors to buy tradeable bonds (see Paul Rickard’s article last week).
Don’t run scared
ASIC head, Greg Medcraft, has issued a warning to investors about the risks of high yield investments; hopefully SMSFs won’t react by rushing into government bonds at what may prove to be the low point in their market prices.
Big super funds can lessen their reliance on potentially tricky share and bond markets with infrastructure projects, property and alternative investments like hedge funds. But these can’t entirely replace shares and bonds – and the big funds can’t pile into alternatives because the investment choice system limits them to locking up too many funds in illiquid investments.
This is partly what has allowed SMSFs to tailor their own asset allocation. But it’s not easy for them to get access to alternative investments without being overcharged or by making complex risk/return judgements on often sparse knowledge.
So SMSFs are at a crucial turning point. It’s not just enough to ensure safety of capital; now they need to add an overlay of a higher target income from their portfolio.
Important: 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. Consider the appropriateness of the information in regards to your circumstances.
Also in the Switzer Super Report
- Peter Switzer: Could Roger be wrong on BHP?
- Paul Rickard: Macquarie Capital Notes – the risk premium is not there
- Rudi Filapek-Vandyck: Weekly broker wrap – NXS and SXY upgraded
- Margaret Lomas: The ins and outs of property management
- Penny Pryor: Auction clearance rates – steady as she goes