Will your allocated pension last the distance?

SMSF technical expert and columnist for The Australian newspaper
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Allocated pensions were a major feature of the Australian super industry for about 15 years – from the early 90s until mid-2007 – and as they were the first market-linked pension in Australia, they caused quite a stir.

In an attempt to simplify the super system, the Government stopped allocated pensions (APs) for all super funds on 1 July 2007, making lifetime pensions (for large funds) and account-based pensions (for SMSFs) the only options. However, if you commenced an AP before July 2007, as many of you reading this may have, you can continue running that pension until it’s either commuted or runs out of money.

In practice, APs operate just like account-based pensions. The account balance is increased by investment earnings, including capital gains, and is reduced by expenses and income payments. Just like ABPs, the minimum and maximum income amounts have to be determined each 1 July using the net market value of the pension’s assets.

Will you outlive your pension?

A specific design feature of APs was that they were designed to last for an investor’s average life expectancy. For example, in 1994 a 65-year-old male was expected to live less than 15 years. In other words with fluctuations in investment earnings, and even allowing for the minimum income payment, the product on average would run out on about your 80th birthday.

I strongly suspect that not many investors who used these products actually understood this feature. With decent returns and taking modest income drawdowns most, people have managed to make these products last longer than expected.

Why they were attractive

Many retirees were attracted to APs because of their ability to provide pension income using a wider range of assets that specifically allowed them to mark their assets to the prevailing market. They also allowed pensioners to leave the assets to their deceased estate; prior to 1992 such a concept was thought impossible in super funds.

Having said that, AP weren’t considered revolutionary when they were released because they worked in a way that was very similar to a life insurance product called a variable annuity, although the Australian Tax Office bludgeoned these to death in October 1988 not long after they first appeared.

So those in the super industry were amazed that the Government officially sanctioned APs just a few years after that ruling was given.

Some life companies started offering allocated annuities (AAs) in 1993. From an investor’s perspective, these were essentially the same product as APs except they were provided by a life company and not a super fund. These AAs had one major advantage over APs – at the time AAs had Centrelink income and asset test concessions not available to APs. It didn’t take long for the Government to close this loophole.

In many ways it took a good five to ten years before APs became a product with significant market penetration. The take-up of APs was really quite slow and it wasn’t until the early part of this century that many SMSFs began offering these products.

From the time they were first offered until July 2007, APs had to pay an income between a statutory minimum and maximum. A revised set of minimum and maximum factors designed to take into account longer life expectancies were introduced in 2004.

Under the 2007 Better Super changes, the maximum income concept was dropped (except for Transition to Retirement pensions). If permitted by their trust deed, super fund trustees were allowed to adopt this new flexibility, and some SMSF trustees even converted to these new rules without worrying about what their trust deed had to say. If you were one of those, you should get your trust deed updated.

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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